The best part about July was that some factors that had clouded investor thinking have been cleared, and decision-making could now be a tad easier, even when a lot many other confounding factors continue to boggle fund managers.
The UPA government winning the trust vote on July 22 was one of the factors. The Left Front is no longer with the government and the current government is likely to stay in power for some more time. And even though politics have not influenced the equity market to a great extent, the chance of the government pushing through at least some reforms, brought cheer to the market.
And then very quickly, on July 29, the Reserve Bank of India announced the first quarter review of the monetary policy and increased the benchmark rate and the reserve ration, signalling its tough stance to control inflation. And this has clarified another doubt – that of interest rates and growth. Rates are now bound to grow further and this will undoubtedly have an impact on the economy and corporate earnings.
Sandesh Kirkire CEO, Kotak Mahindra Asset Management Company says, “With a 50 bps hike in repo and 25 bps hike in CRR, some may call it a case of an overkill, but it is visible that there is an urgency in the policymakers to aggressively rein-in money-supply and inflation before the impending general elections arrive.”
While the expectations of a rate hike were factored in by the market, it was the extent of the hikes that surprised experts.
“The magnitude of the rate hike has surprised the market. This will push up rates both at the short and the long end of the yield curve,” reckons Sujoy Kumar Das, head of fixed income of Bharti AXA Investment Managers. He, however, believes that the policy measures are forward looking and that they would play a big role in taming inflationary expectations.
Not many share the same optimism. “The Sensex is likely to break below the 13,000 level in the near future. After a relief rally from lows, we are heading back to test earlier lows and possibly make new ones. This is typical of a bearish phase. Any excuse will result in a sell off in equities – a fall in global equities, un-abating inflation or crude resuming its up move” reckons Amar Ambani, VP Research with India Infoline.
The direction
However, there is consensus that rates will remain tight for some time and the growth rate will be lower than those recorded earlier. Given this, this could be a great time to revisit the portfolio strategy. Most financial planners and wealth managers are stressing on the need to get defensive and maintain liquidity for the growth trajectory to pick up again.
With home loan rates rising every other day, contracting a new loan at the moment is definitely not a great idea. In fact, prepaying some of your commitments, in case they are floating rates, could well be great idea, reckon financial planners. However, you should also be looking at pre-payment clauses carefully and working around them.
“This is also a good time to negotiate pre-payment and get some good rates with banks. They will be more than ready to do so at the moment,” says Sanjay Gupta an independent financial planner. “Banks don’t want to carry delinquencies on their books at the moment and will be ready to come to the table,” he adds. This would be some sound advice for those who are carrying huge credit card bills.
In the mutual funds area, Devendra Nevgi, CEO of Quantum Asset Management advises investors to keep a higher portion of liquid or near liquid assets and not to take chances with sector specific equity funds, especially real estate funds.
Staying away from fixed income funds with a longer duration holding is also what most fund managers prescribe. The uncertainty over the movement of bond yields, which rise when inflation expectations rise and cause bond prices to fall, makes them a risky proposition. Bond yields have moved from 8% levels, to beyond 9.5% levels in the past couple of months.
The equity call
With real interest rates, the difference between interest rates and inflation, turning negative, imply that you would actually be losing money on fixed deposits and saving accounts, equity remains the solace. Here, the age-old prescription of a systematic investment plan holds the best option. ?The equity market will always give you a return that is a bit more than the inflation rate plus the economy growth rate over four to five years,? says a fund manager not wanting to be named. And therefore, the only chance to help you from seeing your wealth being eaten away by inflation, he reckons. Keeping this in mind, an index ELSS with a three-year view will generate good returns, as the ELSS will help you save tax in the first year and an index fund will also have lower management costs and hence lower loads, he adds.
But if you intend to approach the market directly, then you surely need to factor in volatility and bigger falls. “Inflation in India is likely to hover around 12% till the third quarter of FY09. With possible earnings downgrades too, we see the indices falling further,” says Ambani.
And earnings downgrades are indeed round the corner, as the first quarter results have been rather disappointing. While the year-on-year sales growth of around 1,555 companies has been 38%, the net earnings have grown at a dismal 8.3%, the lowest in the past four years.
High input costs have started taking a toll on the operating margins and this has resulted in a 4% erosion in operating margins – from 27% in the previous year to 24%. Thanks to the fall in the equity markets and the dilly-dallying currency, trading gains have waned. Other income in these companies has grown by a meagre 8% in the first quarter.
Defensive and bargain picking
And while picking stocks, the overwhelming consensus exists on staying away from interest rate sensitive sectors. ?We remain negative on interest rate sensitives – banks, autos and real estate,? says Ambani.
Here, cash rich companies in the pharmaceutical and FMCG sector are seen as the best bets. “The FMCG sector continues to vigorously stroke ahead, while economic and political waves flagellate virtually all other sectors. There has yet been no evidence of consumption slowdown, even as other sectors flail their arms about, which is exactly why the sector continues to demand a defensive premium today,” says an ENAM equity research report.
?We expect a tightening bias will remain in policy in the near term and now expect a hike of 25 basis points in the repo-rate and the CRR respectively by end-October. We think, however, that rates will start easing from Q1 2009, as inflation begins to come off,? says Tushar Poddar, economist with Goldman Sachs.
While the rate growth expectations persist, and the markets keep beating down the rate sensitive sectors, this could well be a great time for picking up fundamentally strong companies in sectors that have bright prospects.
And, in case you have a penchant for ?contrarian? investing, the much-beaten banking sector could well offer great opportunities. An ENAM research report reckons, valuations (banking sector) are beginning to look very attractive from a long-term perspective. At current levels, a basket of banks would afford relatively less risk to deteriorating sector fundamentals.” Banks with a high level of current and savings account levels and lower level of government security exposure that are held for trading, are the preferred choices.
Brighter side
Amidst rate pressures and earnings downgrades, the government’s reform agenda brings in a whiff of enthusiasm. Facing the pressure of a rising fiscal deficit, the government will be bringing some of the companies to the markets. Plans are afoot for a huge BSNL initial public offer and a subsequent merger with MTNL to create a mega telecom corporation. There are other attractive public section enterprises, which will be made available to public subscription. “Considering the market conditions and the government’s need for raising funds, the pricing is expected to be very attractive this time around. And I would recommend investors and portfolio managers to keep cash aside for such opportunities,” says an investment banker with a foreign bank. Companies like HPCL, NTPC, Oil India, Coal India, NHPC, IRCTC and GSPC, have fund raising plans on the anvil. With the government also set to accelerate pension reforms, the likelihood of fresh funds moving into the equity market, are strong. Experts put the figure at around Rs 10,000 crore. This, will not only support the market from sliding further, but could also attract fresh buying from other institutions.
However, all eyes remain trained on crude oil prices and the real gains in the market will start coming in when rates fall below the $100 a barrel mark. And, erosion in the markets if they start climbing further. At the moment, both possibilities are not ruled out, even though there is a downward bias. So overall, the safe bet would be to maintain cash and near cash assets and play defensive in the markets. Debt is something you want to stay away from at the moment.
5 Portfolio Mantras
1. Shed debt
Rates are expected to stay high and could even get higher. Avoid taking new debt commitments at the moment. Pay-off credit card bill and negotiate rates while settling loans. In case of pre-payment of home loans, be aware of pre-payment caluses and be ready to negotiate.
2. Go on a liquid diet
Increase level of cash and near cash assets. Here, liquid funds, and selective fixed maturity plans, could be great option. Maintain cash levels to pick bargains and other opportunities when reform plans start kicking in.
3. SIP rules
Systematic investment plans are still the best choice; they offer averaging benefits in volatile markets. Do look at an SIP with equity linked saving schemes. You can still get tax gains in the first year. Here, experts advise avoiding sector specific funds at the moment.
4. Stay defensively alert
For direct equity exposure, stay defensive. FMCG, Pharma, selective infrastructure sector stocks are being recommended. Also stay alert for some strong value stocks to be available at bargain rates.
5. Catch the reform rush
The government will be initiating reforms, though not widespread, and this will throw up a lot of opportunities. Some of these could well be once-in-a-lifetime and it would be savvy to be ready for them.