Monday, January 12, 2009
 Cover Story
Back to the trading ring?
Related Tables
Standing apart
A hurricane

The coordinated fiscal and monetary moves by central banks and governments across the globe, and the fall in inflation and commodity prices beckon investors

As the world waved goodbye to one of the worst years ever for the financial markets, 2009 has started out with a gripping sense of fear and greed. Domestic equity market participants have been in a dilemma over the last few weeks as the market moved in a narrow corridor, even as the late October multi-year lows were never within sights.

Despite valuations screaming ‘buy’ for almost all the blue chips, persistent worries on a global economic contraction are deterring investors from committing their funds to the equity markets. For savvy investors, however, the current times are providing a once-in-a-lifetime opportunity to grab the best of the bets at dirt-cheap value. After all, it must be remembered that the probability of a huge decline is a very low right now.

Valuations for Indian stocks have already priced in lower growth expectation, with recovery expected in the second half of 2009. This, of course, depends on the stabilisation of the global markets and provided the world economy reacts favorably to the recent fiscal and monetary actions taken by policymakers and central banks.

No matter how much investors would like to forget 2008 for the financial disasters, it is important to remember it for the hard lessons it taught us. The US housing bubble burst and asset prices are down to unrealistically low levels, just as they were trading at unrealistically high levels at the start of 2008. The global investment bank count was reduced from five end 2007 to ‘zero’ end 2008. While Lehman Brothers died, Bear Stearns and Merrill Lynch were absorbed by JP Morgan and Bank of America, respectively. Goldman Sachs and Morgan Stanley converted to bank holding companies.

For the Indian equity markets, the year could well be termed good, bad and ugly. During the first two weeks of 2008, the markets were on a roll, sending the 30-share Sensex to its all-time intra-day high of 21,206.77 points on 10 January. Then came Black Monday of 21 January, when the index lost around 2,000 points intra-day, but managed to close with a loss of 1,392.30 points, or 7.32% — one of the steepest falls ever. Then started a prolonged period of volatility, which eventually sent the Sensex to its 52-week intra-day low of 7,697.39 points on 27 October.

In calender year 2008 the loss of the mid-cap index was higher at 66.95%, while that of the small-cap index was even steeper at 72.41%. Among the 13 sector-specific indices, the BSE realty index fell the most, at 82.13% (see box: Standing apart).

2008 was filled with unprecedented volatility. Almost all asset prices witnessed their highs and lows in a span of a few months. Asset prices tend to sideline all the negatives in the last leg of a bull market, extending their upward spiral. The Indian markets were soaring in tune with the other global risky assets even as the negatives on the domestic front as well as global fronts were making their presence felt.

Does the same logic apply to the last leg of the bear rally as well? The terrorist attacks in Mumbai, the financial capital of India, termed as one of the biggest assaults in the world since 9/11, did not have a wee bit of influence on the local markets. In fact, the markets moved in line with their global counterparts in the aftermath of the attacks and ended the year on a rather optimistic note.

During market declines, emotions tend to overtake reason. The overpowering urge is to dump stocks or equity mutual funds and to retreat to the safety of money market funds and bank deposits. A few risk-averse investors seek to hold cash, while some others park their funds in gold. While these urges are very much understandable, investors who act on them often lock in losses and miss profit opportunities when the stocks eventually rebound.

History suggests that instead of selling during market slumps, investors should put their fears aside. It is a good time for investors to start bargain-hunting. Riding out a bear market is certainly painful but the rewards of moving to safer ground – even when it is done with impeccable timing – are far less dramatic than generally supposed. What’s more, standing still can be even more damaging to a portfolio than the cost of missing a major upward shift in stock prices.

The lesson is simple. There is more to lose by missing a bull market than there is to be gained by dodging a bear. The easiest way to capture the profit provided by the incoming bull market is to remain fully invested in stocks over the long term as time cures a lot of things, including volatility. Since plummeting to a three- and a-half-year intraday low of 7697.39 on 27 October 2008, the BSE Sensex has slowly gained steam and ended the year at 9,641.37, after kissing the 10K mark in between. This, in turn, translates into a rally of about 22%-23% in two months. Has the market bottomed? The global markets are also showing some sign of normalcy.

Angel Broking head of research Hitesh Agrawal seems to agree. "It is difficult to call the tops and bottoms in markets, especially so when they being driven largely by sentiments. It seems unlikely that we can head much lower from here on," says Agrawal. "This is because the very factors that led to the crash in the stock markets like high oil prices, inflation and high interest rates have all reversed their course convincingly."

Slowly, but surely, the risk appetite seem to be returning to the global markets at the fag end of 2008. One of the major outcomes of the global crisis was the frozen credit markets and spiraling inter bank-borrowing costs. However, in the last few days of the year, global interbank lending rates fell, and money markets eased on cash injections from central banks and interest-rate cuts.

The benchmark global borrowing rates fell from a historical high to an all-time low: the three-month London inter-banking offered rate (Libor) dropped from a 2008 high of 4.82% to 1.42% end December 2008. And the overnight Libor rate plunged from an all-time high of 6.88% end September to 0.14% end of the year — near its all-time low.

The flood of liquidity courtesy banking guarantees by various governments throughout the fourth quarter have ensured there is sufficient cash sloshing around the system to bring down lending rates, even though banks are finding alternative methods of funding to traditional interbank markets.

This may mark a period in the near term, entirely different than what the global banking industry faced about six-eight months ago. Banks had difficulty acquiring loans and, at the same time, resisted issuing loans. However, with the credit markets stabilising, investors will start buying other types of debt, unlocking the flow of credit — the basic lubricant for the modem financial system.

Meanwhile, the yield on the three-month US treasuries — widely considered a gauge of investor confidence — edged higher to 0.12% at the turn of the year, after falling below zero twice in 2008 indicating a return of risk-appetite as investors started swapping risk­-free sovereign bonds to other risky assets like equities, commodities and corporate bonds.

Just like every dark cloud has a silver lining, the current global crisis is likely to lead us into a relatively safe period with less degree of volatility. It is quite clear that the global financial markets would enter a new order, ruled primarily by simplicity. It would take some time for the new age investment vehicles like asset-backed securities, collateral debt obligations and credit default swaps to come into vogue again. Fewer high-risk opaque assets being traded should provide a more orderly marketplace with the investors focusing on the underlying fundamental value of an asset before determining its market price.

Recently, US President-elect Barack Obama vowed to impose more stringent regulation of financial, stock and commodity markets. This is likely to trickle down in the other major economies as well. The global crisis has led to an unfortunate clubbing of financial capitalism with economic liberalisation. Authorities the world over are now most likely to bring about a reorganisation of the global financial system.

The current recession is unlikely to turn into a depression as what has happened over the past year has been the obverse of the 18 months after the Wall Street crash of 1929. Back then, the activity nosedived because policymakers did nothing. They sat back and watched banks collapse, delayed cutting interest rates, and sucked demand out of already weakening economies by balancing budgets. This time, policymakers have acted in a unified manner seen never before. The extraordinary impetus shown by the world’s major central bankers in cutting their benchmark rates in unison mid October has send a strong message across. The world is likely to fight the economic crisis in a unified way and the differences seem to be vanishing despite of the fact that the crisis primarily originated in US.

However, it may take time for economic policies to work, especially when the global system has suffered the sort of shock it received when the financial markets froze in August 2007. Combine that with the surge in oil and other commodity prices this year and the ingredients were there for a severe downturn. In the end, the policies pursued by finance ministries and central banks will work.

The headlong climb in oil prices has eased sharply with the collapse in the global financial markets. Rest of the commodities have also plummeted. This has removed the threat of a stagflation from the global economy in quick time and the quantum of the fall suggests that commodities are likely to be under stress in the near term. This is likely to make its easier for the fiscal and monetary stimulus to take effect.

The US Federal Reserve recently announced it plans to implement its mortgage-backed securities program early January and set a goal of buying US$ 500 billion in assets by mid 2009. The action by policymakers is likely to put a floor in relentless slide in the US house prices — one of the prerequisites for a turnaround in economy.

What is the chance of recovering from the global recession any time soon? The best-case scenario is the bottoming out of the US housing market within the next few quarters. It is reported that currently unsold housing stocks in the US could be digested in the market in six months to one year as housing starts on the supply side are now so depressed that the optimal inventory level may be restored and the housing market may become gradually normalised within the next couple of years. Another scenario is that coordinated financial stabilisation policies around the globe may work effectively, resulting in sharp drops in equity risk premiums and leading to the normalisation of the capital, credit and other asset markets in the world economy.

For this to happen, the health of financial institutions must be fully restored and widely acknowledged in the global markets. Needless to say, the recovery of the US housing market is a prerequisite for this scenario. Yet another scenario may be a reversal of the vicious circle in the global stock markets by involving more active individuals and institutions including investment funds and pension funds. There should be a large number of potential investors who would think of the current low stock valuations as ‘best buying opportunities.’ Once the momentum changes, the stock markets in various countries might well bottom out.

While the US and most of the developed economies are facing a severe recession, India is likely to face a cyclical slowdown with the monetary tightening in the first half of the year also playing a part in it. A moderation in growth is not necessarily a bad thing after an extended period of boom. Unfortunately for India, the cyclical downturn has come at a time when the rest of the world is in a mess, aggravating the gloom for the real domestic economy. About 20% of India’s GDP growth comes from exports and a recession in major developed economies would directly hurt export revenue.

To contain surging inflation and inflationary expectations, the Reserve Bank of India (RBI) raised the repo rate (a key short-term indicative rate at which it lends to bank) from 8% to 8.50% – a seven-year high – six months ago. It is quite clear that the RBI expected the domestic economy to be rather insulated even as the global turbulence continued to hold sway and was rather keen to arrest the inflationary spiral due to rising global commodity prices. The last round of measures taken by the central bank were effectively in response to the soaring prices of commodities like crude oil, copper and select agri commodities like crude palm oil.

A cyclical slowdown means a period of protracted growth followed by a recovery. The valuations for Indian stocks seem to have already priced in lower growth expectation for the next two quarters or so. The markets may still reel downwards from here before a sustainable recovery sets in. But the bounceback would be much more pronounced than the global counterparts. This is simply because of the fact that India has been battered more on the downside, dropping 50% in the calendar year 2008 as compared with 34% in case of the Dow Jones Industrial Average.

While the FIIs moved out of the Indian equities at a runaway clip, foreign direct investment (FDI) equity inflows registered a phenomenal upswing. FDI equity inflows were US$ 17.21 billion in April-September 2008. This represented a growth of 137% over the year-ago period.

In its analysis of the global trends and sustained growth of FDI inflows, the Unctad World Investment Report 2008 noted the significant increase in FDI inflows in India is mainly due to an improved investment environment and further opening up of the telecommunications and other industries.

On 7 December 2008, the UPA government unveiled a fiscal stimulus package that is expected to help boost output across sectors and fuel the growth. The government is also seeking authorisation for additional expenditure of Rs 20000 crore for the current year. The major step taken by government was the reduction of Cenvat by 4% for the remaining year.

On 2 January 2009, the government announced a second fiscal stimulus package. To help maintain the momentum of expenditure at the state government level, states have been allowed to raise in the current financial year additional market borrowings of 0.5% of their gross state domestic product, amounting to about Rs 30000 crore, for capital expenditures. Public sector banks have been given additional capital of Rs 20000 crore over the next two years. Foreign investment limit in rupee-denominated corporate bonds in India has also been increased from US$ 6 billion to US$ 15 billion.

The RBI cut its benchmark repo and reverse repo rates by a further 100 basis points (bps) to 5.50% and 4% — the lowest levels for the key lending and borrowing rates of the central bank in nearly three years. The cash reserve ratio was also cut by 100 bps to 5% — the lowest in two years.

The swath of interest rate cuts and other measures aimed at liquidity infusions by the central bank are having a positive impact on the domestic interbank credit markets. The call money rates have dipped to the lowest levels in six months and should stay lower as the benchmark 10-year government of India bond yields are hovering around a four- and a-half-year low.

Industry lobbying group Ficci has stated that despite the global economic slowdown, India’s services sector has shown some resilience with 12 of the 31 segments surveyed recorded a ‘high’ to ‘excellent’ growth rate ranging between 10% to over 20% in April-November 2008. Twenty-six segments of the services sector recorded this order of growth in 2007-08. Although the slowdown is expected to make a further dent in the growth of some segments of the services sector, given its overall contribution of 63% to GDP, the services sector growth is expected to help maintain a healthy GDP growth this fiscal. India’s domestic savings rate has also remained strong and risen sharply with higher growth during the last five years – a factor that is unique to the India growth story.

For the domestic markets, the levels around 10k look ideal for all investors with a broad time frame of three-five year horizon. Since the crisis has originated outside India and the fundamental growth drivers of the local economy should largely be insulated in the long term, the declines are providing an excellent opportunity to enter in select blue chips and mid-caps at attractive valuations. But Agrawal of Angel Broking cautions: "Investors need to be careful about the sectors they select as a majority of the sectors and stocks are trading at very attractive valuations, of which many are not without reason."

The one caveat that must be borne in mind, he adds, is that there should be no further negative news, particularly about another big global financial institution facing bankruptcy problems. His warning does sound ominous, particularly in the context of the free fall of nearly 80% of the fourth largest IT company by Sales Satyam Computer Services (SCS) in the intra-day on 7 January 2008. SCS chairman Ramalinga Raju resigned from his post after confessing of fraudulent activities like inflating the books for several years. This particular fraud could raise concerns over corporate governance practices in India and may impact sentiments in the near term.

However, global cues are known to dominate the broad sentiments. The Indian markets, already having weathered the catastrophic 26/11 Mumbai terror attacks, could brush aside the shocking episode of accounting fraud at SCS and spring back on positive global and domestic economic indicators going forward.

Laying out the red carpet Government and Sebi have taken steps to attract foreign funds

During the last few months of 2008, foreign funds, which were like adrenalin for bulls till 2007, started selling Indian equities rather heavily to cover the huge losses they had incurred in other markets, notably the US. According to the Securities and Exchange Board of India (Sebi), during a year when Indian stock market lost its valuation by more than half, foreign institutional investors (FIIs) pulled out an estimated US$ 13 billion from the domestic bourses — an amount equivalent to nearly three-fourth of the over US$ 17 billion invested in 2008. FIIs turned out net sellers for the first time in a decade. Their net investment in the country’s equities market stood at US$ 53.194 billion end December 2008 as against US$ 66.329 billion on 1 January 2008.

With such a massive-sell off in 2008, what is the outlook for FII inflow from a medium-term perspective? Aditya Birla group Deputy General Manager Corporate Economics Cell Mangesh Soman says India will be attractive estimation for investment this year thanks to attractive valuation and better growth prospects even under crises. "We have seen problems in fund raising, but the Reserve Bank of India has already replied to it. FIIs have withdrawn cash not because they have some other attractive place to invest but on negative sentiments round the globe," he says.

The attractiveness of India as an investment destination is still intact. With the stockmarket coming under a massive selloff in 2008, FIIs shifted their loyalty to the debt market, where they made net purchase of over US$ 3 billion in 2008 — a sharp surge from about US$ 2 billion a year ago. Had there been something fundamentally wrong with the Indian Growth Story, overseas investors would have taken their money out of all the domestic assets.

FII outflow gathered momentum after financial giants in the US and the UK collapsed amid the credit crunch experienced by the global economy. The impact of the credit crunch in the US and the UK led to major institutional investors shoring up finances to bail them out from the crisis at home. Thus, they started pulling out their funds from emerging markets including India.

The recent steps taken by the Union government are likely to help keep the tempo of foreign inflow strong. In October 2008, Sebi lifted the 40% limit on investment through offshore derivative instruments or participatory notes. Also, the rupee seems to have come out of a bear grip and looks headed for a steady rise. This augurs well from the point of view of overseas investors.

Standing apart Two sectors with potential to withstand the slowdown

Fast moving consumer goods: FMCG has emerged as one of the best sectors in 2008. Be in a recession, stagflation or deflation, goods in categories such as personalcare products, toiletries, soaps and soft drinks in the rural markets are a good nick. FMCG manufacturers are also riding high on falling input costs due to a massive moderation in commodity prices. Most companies in this sector are focusing largely on rural markets, where the effects of the global crisis is likely to be very slim in the near term. Moreover, categories such as health supplements and cooling oil have a huge untapped potential in the urban and rural markets

As per a study by industry chamber Ficci, the FMCG industry is projected to grow by 16% to Rs 95150 crore in 2008-09 — up from Rs 85470 crore last fiscal — amid rising raw material prices, increase in costs of various inputs like petro-based raw and packaging materials, and above all, that of key ingredient: palm oil. The year also saw the FMCG growth in rural market overtaking that of the urban market.

Telecommunications: Telecommunications has been one of the most happening sectors in India even as the country’s overall economic growth is expected to slide to around 7% this year. India has been the fastest growing telecom market, was adding over nine million new subscribers each month. India has the second largest telecom subscriber base, ahead of the US and behind China.

Among the key policy initiatives outlined by the government, the decision to bring in mobile number portability will allow mobile users to change their operator without giving their phone number. The other big initiative is the policy on introducing third generation mobile services and high-speed broadband wireless access technologies.

However, the revenue growth in the next few quarters is likely to be under stress. In the last five years, domestic telecom companies have added subscribers mainly through tariff cuts. With no major cut announced in the last one-year or so, there is a high probability that markets may see the subscribers base reaching a plateau in the next few months.

Also, after the constant reduction in the tariffs over the last few years, operators now face declining realisations per minute and would also need to invest in enhancing their network to provide for more talk-time. Given the strict subscriber-linked spectrum allocation regime, falling realisation and constant capex upgradation required, only players who have achieved substantial scale by being regional or national heavyweights are likely to remain profitable.

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