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Stock market: It's time to charge ahead

It's always a good time to invest in the stock market. It's only the allocation that you must tweak. If you are considering an entry in equity, invest with loads of caution and buy defensive stocks.

Dipen Sheth | Print Edition: April, 2010

It's an amazing time to be an Indian citizen. The whole world has gone through a gut-wrenching 2009 in the aftermath of the global financial crisis. In the midst of this messy scenario, India has emerged largely unscathed thanks mostly to its resilient consumers. Also responsible for this is the often clumsy, but mostly sensible, new government that took well-timed measures to stimulate India's economic engine during the year.

Halving of oil prices from their peak of $150/bbl and persistent global demand for the most competitive exports from India (IT and minerals) also helped. The economy has bounced back, with the latest growth estimates predicting an uptick for 2009-10 at 7.5 per cent. This has happened after India 'cracked' to under 6.7 per cent growth in 2008-9, following five years of close to 9 per cent compounded annual growth rate (CAGR). Pundits are now predicting a sustained 8 per cent plus score for the next three years, with reams of economic data and reasoning to buttress their arguments.

After more than a 100 per cent rise from the lows of March 2009, the obvious question for investors is: should we go aggressively long on Indian equities now?

My asset allocation instincts tell me that there is never a yes or no answer to such questions. Once you are able to make this philosophical and conceptual breakthrough in your mind, you will breathe a lot easier on the issue of whether to invest in equities. It's always a good time to invest in the stock market. It's only the allocation that you must tweak. Right now, a short answer is that your equity allocation (if you are already invested and sitting on big and, perhaps, unexpected profits) should be slowly wound down a bit, notwithstanding the terrific rise and the uniformly good vibes that all economic and investing gurus are sending your way.

If you haven't invested as yet but are considering an entry in equity (and are feeling left out of the great bull party since March 2009), do invest, but with loads of caution. Choose defensive stuff (read, multi-year growth, enduring brands/franchise, industry-leading businesses and top-class management) and be prepared for a few shocks.

The stock market and the economy may not move in tandem

Dipen Sheth
Dipen Sheth
This may sound strange but it's true. The Indian economy may be resilient and will probably stand out over the next few years in a world that is in an economic turmoil. But Indian stock markets may not necessarily replicate this show. This is because stock markets typically anticipate a future picture and discount it today. Much of the steady growth that is likely to pan out over 2010-11 and beyond is discounted in today's prices. The bull view says that we are still trading at about 16 times one-year forward (just around the long-term average and certainly nowhere near bubble levels), so upgrades to earnings estimates are likely. On the other hand, the bears would want us to err on the side of caution. Their arguments are:

  • Runaway inflation over the past year is likely to push the government into increasing interest rates, which will act as a gravitational pull for the stock prices.
  • A large amount of fresh/divestment equity is likely to absorb new inflows (from Indian households or FIIs) over the next few quarters, so, at best, the markets will stay flat.
  • The current (stimulated) growth is driven far more by consumption than by investment and capital formation. This is a structural change for the negative in the medium term, though the short-term results have been thrilling and might continue to be so for a few more quarters. Capacity constraints are bound to catch up, while inflation will spread and drive down affordability of goods and services, leading to a possible disappointment on the growth front in less than a year.
  • India's savings rate has fallen for the first time in seven years. While the fiscal deficit has been apparently controlled, the assumptions in this regard are that tax revenues will grow by 15 per cent and there will be some drastic control on expenditure (only 5.7 per cent on revenue expenditure, largely driven by a cut in subsidies). If oil prices surge again or expenditure gets out of control, it will affect the move back to fiscal discipline.
  • Finally, no matter how moderately we are positioned in terms of absolute valuations, it helps to keep in mind that we have risen by more than 100 per cent in a year and that a decent correction would be in order. The rise has been driven by strong FII inflows of over Rs 83,424 crore in 2009, coming after the net outflows of Rs 52,987 crore in 2008. A lot will, therefore, depend on global sentiment regarding India and the willingness of FIIs to invest here. Decoupling works for economics, will it now work for investing?

The big deal for anybody considering a move to equities right now is that their stance has to be defensive, rather than aggressive. There is a lot of promise on the growth front, but safety in the value area is a little more attractive right now. A retail investor will find it difficult to get the timing right. So invest by all means, but be prepared to stay invested for an extended period. Be careful to choose safety and quality instead of just a promise of growth from a less credible or less tested management. This will ensure that even if you were to lose a few points in the short term, you are more than likely to make up for these losses if you hang on to your investment for a reasonably long time.

Dipen Sheth is Vice-President, Institutional Equities, BRICS Securities

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