Through much of 2006 and 2007, Indian markets traded above fair-value. We saw a fine example of reflexivity as traders profited from riding a strong uptrend and reinforced it further by taking long positions. In the past fortnight, we've seen the opposite effect. Once the sell off started, the downtrend was reinforced by margin calls.
The casual retail trader and the less committed foreign institutional investors have been blasted out in the past 10-15 sessions. So have highly-leveraged operators. Only committed investors with deep pockets and traders who are prepared to go selectively short are now left in the game.
The entire cycle of fluctuation was prompted by changes in liquidity. We now have some clarity about policy trends in US and Indian interest rates. It can be summed up thus. The United States is likely to continue cutting rates. The RBI is not, though rupee rates could soften a little anyhow.
A look at India's credit-deposit ratios and the liquidity in the banking system suggests that there is room for banks to cut commercial rates even though the RBI has chosen not to touch policy rates.
The incremental credit-deposit ratio is down to 0.65 from 0.95 a year ago. Deposits are growing at over 25 per cent and the recent market sell off is likely to bring more money back to banks. Credit is now growing at about 22-23 per cent, which is much lower than the 29-30 per cent logged in the past two fiscals.
Eventually, FII funding will also come back into the Indian market as the spread between US and Indian rates widens and the rupee strengthens. But this will be a slow process because most FIIs have taken mind-boggling losses speculating in subprime mortgages.
It's a good time to take a broad look at fundamentals. At current levels, the Nifty is valued at a price earning of 21-plus. That is still on the rich side. It means that long-term investors will be selective, even if they are optimistic about growth.
On the EPS front, the Nifty basket is likely to produce about 20 per cent growth in the second half of 2007-08. Assume first-half 2008-09 earning per share will also grow at about 20 per cent. That means a PE ratio of up to 20 or so is acceptable for the optimistic growth investor, if we assume a fair-value price earning growth PEG of 1.
The 364-Day T-Bill is currently trading at around 7.4 per cent that translates into the equivalent of a PE ratio of about 14 in terms of earnings yield. A value investor would therefore, be seeking stocks trading at below 14 PE.
While GDP continues to grow at excellent rates, there has been a slow down in consumer demand - much of the growth is driven by investment rather than consumer demand. Auto/ two-wheeler sales are flat and home loans are slow. Manufacturing capacities are tight and capacity expansions will take a while.
We have already seen tacit recognition of changes in the consumption-investment mix as infrastructure industries have jumped while consumer-driven industries have dipped. That trend could be accentuated through 2008. In fact, we could say that the consumption driven segment of the economy is going through a cyclical downturn.
Now, quite apart from the subprime turmoil, 2008 and 2009 are likely to see violent market fluctuations because of geo-politics. A new US president must cope with a toxic legacy. It's also unlikely that the UPA will get a walkover in the next general election. Both events will cause volatility.
Whatever you buy, it makes sense to modify investment methods in this context.
You should try to use those price dips to keep adding to a core portfolio. Say, for example, pick market leaders across 10 key industries and add to these holdings whenever the price is ok.
You cannot time the market but you can put a war-chest together for specific political events that are guaranteed to cause fluctuations.
The US election, for example, will take place in November 2008. The Lok Sabha elections will be whenever. Sometime during both events, there should be a temporary crash.
If you can invest a larger portion of corpus at those times, your net costs will be lower. As to time-frames, this should be money that can be left invested till at least the second half of 2009-10.
