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MEA (maxima) culpa?

After the decisive election mandate in favour of the Grand Old Party of Indian politics, India seems to have rediscovered its sheen all over again.

Dipen Sheth | Print Edition: June 25, 2009

By all counts, it seems that I have spectacularly stumbled over what now seems to be the bottoming out of the Indian stock market. After the decisive election mandate in favour of the Grand Old Party of Indian politics, India seems to have rediscovered its sheen all over again. Our cautious under exposure to stocks (as indeed, our cynical set of short positions in Wealth Zoom) has got in the way of delivering some absolute mouth watering returns on both portfolios.

By themselves, the stocks in our portfolios have done fabulously. But it’s my decision to re-start the portfolios with very low overall exposures and high cash (especially since political and global economic uncertainty was staring us in the face) that lies at the root of the severe underperformance vs the Sensex. And what an underperformance it has been. On 4 Jun 2009, the BSE Sensex closed above 15,000 for the first time since Sep 2008, and had gained 83.92% since Mar 2009. In (painful) contrast, Wealth Zoom crawled to a NAV of Rs 7.84 or 0.36% in the past fortnight, while  Safe Wealth lumbered to Rs 10.84 or 0.21% in net asset value. Truly uninspiring and unconnected with what was happening in the markets, one would think.

So what was happening? Here is my rear-view mirror prognosis: driven by some inspired government spending in the months leading up to the elections, GDP growth prospects for India broke away from the global shackles of recession. Aided by low oil prices (that helped keep the BoP under control), resultant low inflation (WPI was near zero for a number of months, although CPI has so far proved to be more difficult to manage) and the relatively insular nature of the economy, India was suddenly seen as a counter-cyclical play by global investors. So were the other BRIC countries : China, Russia and Brazil. In fact, Indian stock markets have actually underperformed vs many (if not most) other emerging countries.

That begets the question: what now? Is it too late to jump in? Are we at the threshold of another magnificent bull run and can still jump in? Or will Indian stock markets crack (yet again) just as we make some apparently overdue investments into stocks? It’s really a haranguing time to be a fund manager! Fundamantally speaking, the big reason to buy must always be that we can see strong gains to be made, and relatively low downsides to buy into. On this count alone, I do not see a compelling reason to add to our stock exposure. Yes, the markets may drift up even more from here, but do we really want to try and catch this (relatively small) upmove after having missed the big one? Or should we not patiently wait for the much awaited crack to help us get some decent bargains?

After all, consider the onerous task in front of the finance minister as he readies his team for what seems to be the most eagerly awaited budget in recent times. The toughest issue is perhaps that of reconciling the profligate (and incurable) ways of the government with the decidedly left of centre views of the Congress Party and the expectations of investors. If Prime Minister Manmohan Singh is pro-reforms, the Gandhi family surely has welfare spending (and rightly so) uppermost in their minds. Remember, the party has won not so much via votes from the stock market or industrialists as it has from votes by the aam aadmi. Strong doses of populism will surely creep into the most liberal of reforms, thereby capping the real benefits that might accrue to the economy (or investment sentiment).

So, notwithstanding the thumping mandate and huge hopes, let’s not assume that the fiscal deficit will vanish as a result of aggressive privatization and 3G spectrum sales. Consequently, if meaningfully large chunks of the public sector are not privatized (and the pressures on the fiscal deficit are identified), we might see some disillusionment coming back to the markets. On the other hand, there is little doubt that infrastructure and construction activities will get renewed thrust and that much of the slowdown over the last few years in the roads sector will get reversed. That brings us to the (apparently silly) situation where construction companies that deliver equity returns in the low teens in the best of times (and rarely, if ever, do they post positive free cash flows) will again command valuation multiples in the twenties.

All in all, this is a time not to get rattled about our short term underperformance. Instead we will cautiously wait for the budget and revisit our assumptions after going through the fine print. If markets  run up strongly before the budget, we might actually get a chance to exit or even short (in Wealth Zoom). Consequently, we are not making any change to the model portfolios this fortnight.

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