DSIJ Mindshare

Market Swings: Surviving tools for rough times

S tanding below the iconic Jeejeebhoy Towers which houses the Bombay Stock Exchange, P D Dewani, a self-employed chartered accountant, looks slightly worried. On further imploration he admits being invested in the current market and sounds amazed at the way the mar-kets are behaving. Dewani is not just a one-off case. Look at P P Shah, an employee of a mid-sized company in his late 50s. Shah expects the Nifty to come down to at least the level of 5,500 before the market goes up again. Bullish on infrastructure and IT, he too is invested in the current market.

There is one common thread that is currently running through the thought process of investors like Dewani and Shah and that is the wildly swinging market. Rising interest rates, higher inflation, squeeze on liquidity, Q3 corporate performance, political uncer-tainty, and the global economic scenario have been sending the market on a roller-coaster ride for quite some time now. These are the kind of wild swing's in the market that impact investors. However, investors believe that the various factors that are responsible for these rather uncontrolled moves will be taken care of in time to come. “I am not really worried about the volatility. As far as this scenario is concerned, I am already seeing an impact on my portfolio but this is more of a concern for the trader community. I am a long-term investor and I am therefore not feeling as insecure,” Shah says.

His justification is that growth for the Indian industry will be very good going forward and that will take care of the situation. As far as factors like interest rates are concerned, the RBI will have to stage a balancing act on that front. “Though we can always say that inflation has to be controlled very soon, I don’t think that the government will be able to do so,” he says. The question is: How volatile is the Indian market? Take a look at the movement of the broader indices since Diwali. Between November 5, 2010 and January 24, 2011 the Nifty and the Sensex have declined by 8.5 per cent.

The problem is that the journey has been very painful with no clear indication of where exactly the markets are headed toward. During this period the Sensex has declined by as many as 492 points on a single day and on the other hand has also gone up by as many as 372 points on a single day. The volatile nature of the market between this period is clearly visible in the chart above. Having seen what the markets are behaving like, let us look at the various factors that are impacting the market and making it so volatile and also analyse what can be expected going forward.

Inflation And Interest Rates

As far as the markets are concerned, the two factors that are very heavy on the minds of the investing fraternity are the hardening interest rates and rampant inflation. This is just not lim-ited to the Indian market but similar seems to be case with the Chinese and the Indonesian markets too. Even these markets have been reacting sharply to inflation numbers and any news on the tightening of the monetary policy. Though these two factors are indeed considered the major culprits for increasing the uncertainty and vola-tility in the market, there are certain questions that come to our mind. First and foremost, is inflation really at such an alarming level? At 9.4 per cent for 2010, inflation is certainly steep and well above the RBI’s initial target of around 5.5 per cent.[PAGE BREAK]
However, what deepens the concern is the inability of the government and the RBI to contain this rampant infla-tion. According to the data available, the number has been more driven by food inflation, which has increased by a massive 17.49 per cent in 2010 and this would be the second year in a row where food inflation has been in double digits. Food inflation increased by almost 13 per cent in 2009. Meanwhile, the rising crude price is making matters worse. Opines Dr Arun Singh, Sr Economist, D&B India: “The current inflationary pressures in the primary food articles and fuel group are primarily due to supply-side constraints. A coordinated course of action is warranted as the rising inflation could have serious socio-economic implications like fall in purchasing power, reduction in consumption, and investment demand.”

But there is also a contrarian view of the above matter. Sandip Sabharwal, CEO PMS, Prabhudas Liladhar, says, “Although high inflation that sustains for long periods of time does impact growth, savings, and the consumption pattern of people in general, the kind of fear and panic that has been cre-ated around the inflation phenomenon today is a bit far-fetched in my view.” Besides, RBI has hiked the Repo and Reverse Repo rates by 25 basis points each respectively at this juncture. But considering that this is more of supply-stoked inflation than a demand-stoked inflation, would it really serve the pur-pose of arresting inflation? And if it is a known fact that these steep numbers are on account of supply-side con-straints and though the government has taken some measures like restrict-ing exports and importing commodi-ties to bring in price rationalisation, these steps are far from being effective at the moment. 
Says Dr Singh: “Some concrete action by the government is the need of the hour to remove the bottlenecks in the production and distribution of food items to address the core issue of managing the food prices.” Amidst all these elements, we believe that inflation may taper off in the com-ing months, a point of view to which Ajay Jaiswal, President, Investment Strategies, Microsec Capital, concurs. “The inflation rate should come down from March onwards with the base effect being very high than anything else. Our inflation target is around 5.5 – 6.0 per cent by March 2011,” he states. But the major concern that remains is the movement of the crude and if it keeps marching ahead then it could keep the rate on the higher side. However, we believe that the current levels might also be factoring the worst case scenario as well.

Political Uncertainty

One of the biggest factors influenc-ing the market currently is the uncer-tainty looming large on the politi-cal front. The previous session of the parliament was a complete watershed with the opposition not allowing the government to function properly. The ruckus surrounding the 2G scam and the demand for a Joint Parliamentary Committee (JPC) probe has been a bone of contention between the ruling UPA and the opposition. As a result, a huge question mark has been raised on the progress of reforms in the Indian context - a worry which is likely to further impact many foreign investors. The government seems to be dithering about the decision on the JPC as it fears that the opposition could use it to tarnish the prime minister’s image, besides asking for a greater voice or wider terms in the JPC. [PAGE BREAK]
But while this stand-off is hurting the normalcy of the parliament, it has more importantly hurt the reforms process. If the centre doesn’t come up with a feasible solution to this, it could probably also derail the entire budget session - a major yearly event for the market. According to Jaiswal, “There are some in the markets who believe that if the JPC does not happen then the budget may not be put into pro-cess this year, which will be a major set-back. With this Sword of Damocles hanging on the head, the investor fraternity would rather wait till the budget day than take any decisions right now.” The recent cabinet reshuf-fle points to a rather weak government that will have to put its house in order. When the nation was expecting the government to show the door to the under-performing and non-perform-ing ministers, the cabinet re-jig was a mere reshuffle of these ministers to low profile ministries or portfolios.

All this sends out a signal about the lack of the government’s will to come clean even if it could mean serious damage to its political image. What makes this entire episode worse is that the prime minister has been hinting at a major reshuffle post the budget. Now this creates more sus-pense with the markets pondering over what this major reshuffle would entail and whether it will help clear the fog. However, we believe that the sharp market fall has priced in the above-mentioned scenarios and hence one can expect a reaction but the overall impact could be minimal.

Corporate Results - A key factor in providing future direction

The corporate results have been and will always be an important factor for the markets to take a cue for the way forward. They certainly have the potential to swing it both ways. But the usually resilient India Inc has certainly shaken up some investors’ nerves after its growth rate slowed on the bot-tomline front in the first half of the current fiscal. While everything looked hunky-dory till the last quarter of FY10 with investors only looking forward to a much better fiscal, a sliding profit ability growth indeed brought in an ele-ment of surprise that investors weren’t prepared for. A bottomline growth of 15 per cent in Q1FY11, followed by a 7 per cent growth in the second quarter, did raise some eyebrows and suddenly turned the market’s attention to factors like rising input costs, rising commod-ity prices, and borrowing costs, which the market seemed to have forgotten until then.

Despite clear signals from the quar-terly results of the September quarter, the market kept on going up, defying all gravity with record FII inflows tak-ing it to new peaks up to Diwali. It was only about that time that reality sunk in and the market woke up to the deteriorating quality of earnings. The quality of earnings not only raised concerns about the sustainability of growth for India Inc in the coming quarters but also about the sustain-ability of the stock market. This only added more fuel to the uncertainty already created by the other factors such as higher inflation levels and ris-ing interest rates. The result was that the market that many expected to sustain above the 21,000 level on the Sensex is down almost by 8.5 per cent from its Diwali peak.

However, the only heartening thing here is the strong double digit revenue growth that India Inc continued to wit-ness over the last two quarters, which not only brings in a sigh of relief but also reiterates the improving demand scenario and growth that is not only driven by the volumes but also by the improving realisations. Hence, to cool the jitters, it is once again the results of India Inc that are coming to the rescue of the market and investors will follow the third quarter results’ season closely. Historically, the Q3 numbers have always been better due to festivi-ties. And in fact it seems that the 384 early bird Q3FY11 numbers that have come in so far are certainly living up to the expectations with topline and bot-tomline growing by 21.35 and 22.03 per cent on a YoY basis respectively.[PAGE BREAK]
As Sabharwal puts it, “The results’ season has actually been very positive with most of the companies meeting or beating the expectations despite severe input cost pressure.” However, Amar Ambani, Head of Research, IIFL – India Private Clients, has a contrasting view. “Profitability will be affected on multiple fronts. The operating margin will be impacted due to the rising commodity prices and the substantial rise in wage costs. The other income will be subdued due to lack of tradable liquidity and the interest outgo is expected to rise. In our opinion, the consensus estimates will be downgraded in the coming months,” he reasons. It is too early to conclude the quarter as a bet-ter one but the initial numbers should calm some nerves and if the pace of growth remains the same we think it would certainly take care of this factor going forward.

The Global Perspective

The global economic scenario has always weighed heavy on the Indian market. One probable reason for this is the huge participation of foreign money (portfolio inflows) which has been a major driving force for it. While the market has always been euphoric about FII money flooding in, it has been equally worried about a sudden with-drawal of these funds which could take it all the way down. The problem is that this anxiety about the FII funds moving out of the emerging markets in general and the Indian market in particular has been gaining ground in recent times, thereby adding to the volatility of the Indian market. One important factor that influences this thought is the US economic recovery. The US economy is expected to grow at over 3.2 per cent in each quarter of 2011.

Moreover, growth is expected to be more on account of the rising domes-tic demand and higher exports rather than being supported by the stimulus. How does this impact India? A return of risk appetite and the expectations of a higher return from the US market following the economic recovery will probably lead to FIIs pulling out of the emerging markets and investing back home. But this is a probable scenario. If one were to take a practi-cal view of this matter, it doesn’t look as bad as it is made out to be. Abby Joseph Cohen, Managing Director and Senior Investment Strategist at Goldman Sachs, in a very recent inter-view, has succinctly summed up what US growth and recovery mean for the developing markets. 

According to her, “If the developed markets do well, it does not mean that the developing markets would do poorly because this is not a zero-sum game.” As for the fears of whether the money that has come in would go back, Cohen says, “Most of the global capital flows from the US into the non-US markets have actually come from pen-sions, endowments, and others with a long-term view. There is every pos-sibility that the flows may slow down compared to what we have been seeing but it would be a rare case scenario for the money already invested to go out in a hurry.”

Now look at Europe which has been a major cause of concern for inves-tors globally. The fears of a sovereign default by many European nations - big and small - have gripped the market in the recent past. Except for an impact on trade that happens between India and the Euro region there is nothing that has hit us badly till now. This means that there is no funda-mental fear to the market from any news flow that may emanate from the European region. Another important factor to look at while trying to get an international perspective of what could probably happen going forward is to look at China.[PAGE BREAK] 

The Chinese economy is reported to have grown by 10.3 per cent in 2010, thanks to a strong investment-boosted demand. The growth in Q4 picked up to 9.8 per cent from 9.6 per cent during the third quarter. The fears of a declining Chinese growth curve have thus come to rest. On the mon-etary policy front too, China tightened its belt last year. This is likely to see a moderated yet stable growth envi-ronment in China. A strong Chinese growth is what has driven the global economy for quite some time now. Going forward this is one fact that will act as a major stabilising factor for the market. The point is that the interna-tional factors that are being bandied about as being reasons for the market to swirl around will not really be as influential as is made out to be.

Dos And Don’ts For Investors

Having dwelt at length about the reasons for the volatility and its impact, the question that arises here is about how does one handle or negotiate this volatility. During such phases, jittery investors do take some rash calls, thus hurting their portfolio returns badly. To avoid such occurrences, we at Dalal Street Investment Journal are present-ing here certain guidelines for the investors to enable them to tide over this phase. 

• First and foremost, it’s very impor-tant for the investors to re-align their focus from just pure returns to returns as well as capital protection. Thus it makes sense to focus on safe bets rather high-risk high-returns or high-beta scrips, which will help in stabilising the portfolio and limit a possible downside in case the market corrects further.
• One should focus on sectors that are less prone or neutral to volatile swings. This may include defensive sectors such as pharma, IT, and even FMCG. 
• On the scrip selection front, it would be better to hunt for high dividend yield companies as these scrips have the potential to give the best of both worlds i.e consistent dividend income and capital appreciation once the market stabilises. Besides, the down-side potential is comparatively limited for high dividend yield stocks. 
• That apart, it would be wiser to stay away from interest-sensitive sectors where there is uncertainty over the interest rates. 
• Opt for low-debt companies as they would have better profitability and margins and sooner than later would catch the investors’ fancy.
• In fact one can opt for companies with high level of cash and cash equivalent in their books. This is because when the cost of borrowing is moving up, a company with high cash in its books may still be able to expand its operations without over-leveraging itself.
• Last but not the least, use your own money for investment rather than over-leveraging yourself to invest in the stock market in anticipation of better returns.

While these are broader guidelines, what we would like our investors to know is that volatility does tend to get the worst out of them as they tend to panic. But we believe that the market has already touched the pits. Just to put the thought into perspective, it should be noted that the Sensex is down by almost 6 per cent from the beginning of 2011 till date, while since its Diwali peak it has declined by 8.5 per cent. As for the market breadth, since Diwali, 2,445 shares have declined for 326 advances. Thus for every one share that has advanced, more than seven shares have fallen. In fact, to see how worse this uncertainty has been and its impact on the scrips, we also looked at the number of companies group-wise that are trading close to their 52-week lows. We found that almost 53 scrips out of 200 or 27 per cent of the scrips in Group A are trading close to their 52-week lows, while in Group B 29 per cent are close their yearly lows (refer table for group-wise details).[PAGE BREAK] 
Usually in a gloomy scenario, inves-tors tend to get more bearish and expect more pain in the coming period, but we feel otherwise and ask ourselves what more could go wrong? Our sense of this volatility is that it’s only about time that it will dissipate. Jaiswal agrees, saying, “This is the right time to enter into the market, and on a conservative basis with a year-end target of 6,600 on the Nifty you can get a return of around 17-18 per cent. On stock specific, irrespec-tive of the market condition one can always enter the stock market bearing in mind the growth factors in that par-ticular stock.” Taking it a point further, Sabharwal says, “The markets seem to have factored in most of the negatives without appreciating the positives. We are in a bull market correction and nothing beyond that as there are no indications to show that the markets are over-extended in terms of the fundamentals or investor psyche.”

Though one cannot ignore the fact that there are a number of concerns lurking around, there could be a knee-jerk reaction and the market would absorb the same and move ahead. Besides, with the positive surprises that the initial results have brought in, the market would now be all eyes and ears for the forthcoming numbers and this could certainly be of comfort. As for another major trigger, there is the forthcoming budget which the market would continue to look out for. It will provide the required blueprint for the next fiscal. Hence, volatility will continue but the worst seems to be already priced in and hence the intensity of the same would be quite low than what we have seen over the last 2–3 months. Our suggestion is that investors should stay put if invested and look at the market from a long-term perspective without unduly disturbing their port-folios. Follow the basic suggestions put forth by us and ride the rough times in a much better manner.

DSIJ MINDSHARE

Mkt Commentary28-Mar, 2024

Multibaggers28-Mar, 2024

Interviews28-Mar, 2024

Multibaggers28-Mar, 2024

Multibaggers28-Mar, 2024

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR