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Thanks to the turmoil in the equity markets, stock valuations have become very attractive

Normally, in any market, prices and demand share an inverse relationship — when prices are down, demand increases and vice versa. But, the equity market seems to be an exception. Here, customers behave in the opposite manner — they crowd the market place when it is expensive and desert it totally when the prices are down and bargains are available.

More specifically, there is today a sale on Dalal Street, but very few people seem interested — in spite of the fact that such sales do not come very often. The last big one, called the Dotcom Bust Sale, was way back in 2001.
This time it is the Subprime Sale.

What brought about this sale? Well, mortgage companies abroad fell over each other to extend housing loans to questionable borrowers. Not content with this one indiscretion, they went a step ahead and sliced these iffy outstanding loans into small parts to be sold to reckless investment banks, hedge funds, FIIs and a minority of unsuspecting but deep-pocket private investors. In course of time, the inevitable happened. The questionable borrowers lived up to their reputation by defaulting, thereby setting off a domino effect. The housing finance companies couldn’t recover their loans and in turn could not keep up their obligations to the hedge fund guys. Everyone lost and we were deep into what has come to be known as the subprime crisis. Even now, no one knows just how deep the problem is — as per current estimates, the default rates could be upwards of $300 billion. However, as we go along, these numbers may well change.

Yes, there will be collateral damage in terms of tighter fund flows, more expensive credit and a significantly lower participation by FIIs in our stock market.

However, ask yourself one question — why are the FIIs selling in India when the problem lies elsewhere? One reason could be of course that emerging markets are considered risky and during times of uncertainty, money is moved to what are perceived to be safer markets. However, the other (and the key) reason is these investors are booking profits in India to cover up for their losses elsewhere. A credit crisis in America is affecting the equity market in India. This situation cannot last long.

All said, for now, it looks like this is more a crisis of confidence than of credit. And the US Fed knows this only too well. It has stepped in all guns blazing. Apart from cutting discount rates (the rate at which it lends to banks), it has for the first time set up a programme through which even investment banks may borrow funds on much the same terms. As a follow-up measure, the overnight Fed funds rate (that banks charge each other) is also expected to be cut by 50-100 basis points. At the same time, by lending $30 billion to J P Morgan to acquire Bear Stearns on a collateral of these very mortgage backed securities, it is also making sure that eventually American taxpayers too bear some of the cost. These are unprecedented but strong measures that will ultimately help in making the situation more liquid and stable.

My view is that in the time to come, the US will eventually overcome this crisis. When this will happen one does not know - actually, one cannot know — in spite of what stock market analysts and other story tellers will have you believe. In January, when we were at 21,000, these people were busy predicting a 10% GDP growth, 25% corporate earnings and index levels of 25,000. Now that we are at 15,000 levels, these very same people are drawing doomsday scenarios of 12,000 and 10,000. Predicting thTCS opens Ohio centre, eyes local talente future by extending and exaggerating the present seems to be a human instinct and in some cases, a means of keeping one’s job.

So, let me tell you a simple way to tackle this market. Throw those analyst and brokerage forecasts out of the window and instead rely on your common sense. Buy on cannons, sell on trumpets. And right now, the cannons can be heard loud and clear. Of course, this is easier said than done for it requires a bit of guts, a little conviction, and a whole lot of patience and common sense.

Do not let go of the basics. Asset allocation is the key. Have around 10-15% of your portfolio invested in gold, for gold is an effective hedge during uncertain times. Don’t buy physical gold, instead use exchange traded funds (ETFs). Allocate another 15% to relatively safe gilt funds. Cash can command around 10%. The balance is to be invested in equity, not in a lump sum but in a staggered manner, through systematic investment plans (SIPs).

Through the mechanism of an SIP, which essentially immunises you against market turbulence, discretion goes out of the door and discipline walks in.

Sum and substance — leave Ben Bernanke to get his house in order, you take care of yours.

sandeep.shanbhag@gmail.com