Its 2003 all over again

Written by Prasunjit Mukherjee | Updated: Nov 17 2008, 18:12pm hrs
This is the fourth steep meltdown that I have seen in my lifetime in the capital markets, but by no means is it the steepest among the four. At least not so far. But anyone who has been in the markets after 9/11 and leading up to the current times will be amazed at the similarity between these two times, separated by half a decade.

Man-made crisis
The last time the bloodbath in the markets was caused by events in the United States when terrorists sought to bring the most powerful nation in the world to its knees. That time the destruction was caused by foreigners who wanted to harm the US but ended up doing far more. This time it was US citizens who recklessly sold out their nation and most of the world to make money for their companies and for themselves. But what is similar is that both the carnages were man-made.

After September 11, economies in much of the advanced world were in shambles as business confidence was severely shaken. Today much the same has happened, but on a much larger scale. Manufacturing and services were critically affected then: remember the drop in oil prices and vacancies in airlines and hotels. That scenario is repeating itself. Banks, of course, are facing the brunt. But as after September 11, there is a meltdown in commodities, and sectors such as auto, airlines and hospitality are also under pressure. Only this time round the magnitude of the problem is much bigger.

Liquidity infusion
In 2004, the Bank of Japan (BoJ) infused a massive amount of liquidity into the system that sent every asset class spiralling upward. Much of the investing population across the world subsequently reaped the benefit of this upward spiral. This included the hedge funds and the commodity traders of the world, but also the homeowners in the US and the rest of the world. Today, most of the worlds central banks, and not just the BoJ, are shovelling in billions of dollars worth of liquidity into the system in the hope that this will make the banking industry stronger and more amenable to providing credit to manufacturers and service providers. Again, the response so far has been much the same as in 2003. The only difference lies in the scale.

Lessons for investors
What lessons does this sequence of events hold for Indian investors Should you begin investing now or should you wait to catch the lows If 2003 has taught us anything, then the basic trend as the markets recover is likely to be the same. At 10X times earnings, the markets are incredibly underpriced. The debt segment, which has been a non-starter for most of the last five years, will benefit from the lowering of interest rates. Inflation, which has been the government and the central banks biggest concern, is likely to decline steeply as prices of commodities have fallen to half the level they had scaled just about six to nine months ago. With liquidity being injected into the system, there is likely to be an avalanche of money by the beginning of the new calendar year. Further, with the new US disposition in place by January 2009, the uncertainty currently plaguing markets is also likely to decline.

As Warren Buffet, the living god in our trade, says ad nauseum, money is to be made when there is blood on the streets, or something to that effect. In other words, invest when no one else is. If this is not that time, when will it be

I expect bond valuations to rise first because of steadily falling interest rates. And then it will be the turn of the equity segment to provide the returns.

The right investments
If you are a mutual fund investor with a cautious outlook and a sufficiently long time frame (two to three years), your best strategy would be to invest in balanced funds. Remember, bond valuation is directly related to interest-rate drops. So you are going to make money on the bond segment quite easily. By my estimates, long- term debt funds could possibly give upwards of 12 per cent annualised returns if you were to invest in them now.

If you are looking to raise your returns with minimum risk, then monthly income plans and debt hybrid funds are your ticket.

But if you wish to make some real money and have a longer investment horizon, then go with well-diversified equity funds that have a good track record in terms of providing return and containing risks. The reason why diversified are likely to do well is simple. No one can exactly say which sector will provide the first upside, so investing in funds with the largest, widest footprint makes sense intuitively.

Again, this was the trend that one witnessed in the aftermath of the 2003 bust. First, the boom happened on the debt side, which was then transferred into the MIP segment. And thereafter equities took off and provided very good returns for four years. But be sure to choose the schemes well. And make sure that the schemes are easy to understand and have a proven track record.

Finally, look at the table alongside which provides the compounded annual returns you could expect from different asset classes provided you are feeling to invest for the time horizon specified.