Staying the course during slowdown

Weighing the prospects of a US recession with continuing growth in developing countries, Dipen Sheth suggests investing in stocks with sustainable profits.

Dipen Sheth        Print Edition: April 3, 2008

Wishlist

Wealth Zoom:

Buy—jubilant Organosys

Safe wealth:

Buy—Bharti Airtel
Sell—Reliance Communications

Another fortnight, another rout. While Wealth Zoom continues its downward spiral (down over 11.5% for the fortnight), Safe Wealth has baffled me by slipping a full 8%, and is now truly into dangerous territory. In the past two months, Wealth Zoom has come down more than 32.5% from its 2 January peak. During the s a m e period, its benchmark index CNX Midcap slipped by 30.2%. Some of the stocks in Wealth Zoom have almost halved in value and are now in losses. Others have lost a good part of the gains made since June 2007. The going has not been so rough in the case of Safe Wealth, which came down by 19.5%, beating the 21.2% fall in its benchmark index CNX Nifty. But three heavyweights that account for over 21% of the portfolio— Infosys, Larsen & Toubro and ICICI Bank—are in losses. If you are new to equities, tracking these model portfolios is a real baptism by fire, which should serve you well in times to come.

Assuming that I still retain my job as your fund manager in these troubled times, here are some notes that provide some food for thought. These notes will help us stay the course and perhaps even take us back to more profitable territory over the next few sessions. For now, these are not translated into specific actions on the portfolios, betraying the paralysis that yours truly (like many other fund managers) is suffering from.

First, the discouraging part. The macro environment is pretty scary for the stock markets right now. It seems like the “decoupling” theory may just be a theory. The US, undeniably the largest and most powerful economy in the world, is staring down the twin barrels of recession and stagflation. And this is certainly not leaving Asia (or for that matter, India) unscathed. Across Asia, markets are bearing the brunt of an anticipated slowdown in economic growth.

Click here to see wealth zoom portfolio
Click here to see safe wealth portfolio

Add commodity inflation to this, and you have the classic setting for stagflation. The chief risk to our two model portfolios is that this stagflation is going to hit the Indian corporate profit margins and result in lower than expected earnings. This makes today’s Sensex price-earnings of around 15-16 times 2008-9 earnings look expensive. With frontline stocks taking a hit, there could easily be a run on the mid caps. Some mid-cap stocks (especially those with skewed ownership) could get beaten down to ridiculous levels. In particular, Wealth Zoom had better watch out for some rough weather in the coming weeks. Then again, there are plenty of counter arguments to this scary scenario. Yes, there’s bad news from leading first world economies like the US, Japan, Germany, etc.

However, there are significantly big changes panning out in China, India, Russia, Brazil and now, across Africa. The slack induced by a US slowdown will be somewhat negated as these economies traverse the virtuous cycle of development, investment and growth. And oil and gas production is on the verge of picking up in India, which should drive down balance of payment fears.

Also, think of the money sloshing into Opec and Gulf countries as a result of crude oil prices hitting $100 a barrel. According to a recent Morgan Stanley report, some $2 trillion (twice the size of India’s economy) flows into Opec and non-Opec oil-rich countries every year on account of oil exports alone. This is far higher than their infrastructure and welfare needs. We will soon encounter a “petrodollar tsunami”, as this wave of liquidity attempts to find profitable investment avenues.

What does this mean for our portfolios? What can we do to safeguard them against stagflation and derating threats, while remaining open to the upside that the developing world growth and petrodollar liquidity might unleash? I think we need to sacrifice hype and unrealistic growth claims in favour of steady companies with sustainable profits, in a good business. Is this too much to look for in these troubled times?

Last fortnight’s shortlist of prospective candidates for Wealth Zoom included Exide Industries, Punj Lloyd, Petronet, Rural Electrification Corporation, Zee News, Jindal Saw and Federal Bank. To these, I feel like adding Jubilant Organosys. Perhaps India’s largest contract research and manufacturing (CRAMs) story in the fast evolving pharmaceutical space. A low-profile company, Jubilant Organosys has, over the years, quietly transformed itself from a speciality chemicals maker to a specialised, contract active pharmaceutical ingredients player with strong research support capability.

For the Wealth Safe portfolio, the only major change that I would consider is an exit from Reliance Communications, purely because of how the market is jittery about Reliance-Anil Dhirubhai Ambani Group stocks right now. Replacing it with Bharti Airtel might not be a bad idea, given Bharti’s sustained leadership in customer additions and operating parameters. And, in case commodity exposures make you feel unsafe right now, you can email me to get rid of Tata Steel, Grasim (cement) and Sterlite (zinc, copper and aluminium).

Finally, a parting thought. How do I explain a 30% plus loss in “Safe” Wealth posted by none other than the redoubtable Infosys? And does the one-third erosion in market cap of Infosys, as well as some other leaders in the IT space, indicate it’s time to pick them up as value buys? I’m not sure. Take a look at Infosys’ customers, banks and large industrials in the US. And tell me whether they are going to up IT spend or be in any mood to let Infosys (or any other supplier) extract better margins in the face of a weak dollar. I think not. Maybe we’ll sell Infosys next fortnight and make history as the first model portfolio to actually book losses on this blue chip...

Share your comments and reviews of the two portfolios. Email it to mtportfolio@intoday.com

Disclaimer: Model portfolios are based on the independent opinion of Dipen Sheth, head of the research team at Wealth Management Advisory Services. They do not reflect the opinion of the firm.They are for reference and information of readers. The firm is not soliciting any action based on the portfolios.

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