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| Edited By: Sandeep Shanbhag |Source: |Updated: Sep 15, 2017, 01:58 AM IST
What the markets are seeing is the opposite of irrational exuberance — delirious panic
The last two days have seen absolute carnage in the Indian stock market. Being in the business of managing other people’s money, I have been besieged by a slew of calls and emails from my clients, asking me what they should do now. My answer has been, “do nothing,” a rather difficult proposition under the current circumstances.
Here’s why. Let us say you have taken exposure to both the US and the Indian stock markets. Now, as it turns out, while your Indian investments are doing exceedingly well, the US portfolio is suffering acute losses. What is the most obvious action you would take? You will book profits in India in order to make up for the US loss. This, in a nutshell, is what is happening currently. The only difference is that the investors are foreign institutional investors (FIIs) who, by definition, have investments across the world. So, not just India, even Singapore, Hong Kong, Japan, Australia, South Korea and even China face a sell-off.
The cause is in America, but the effect is being felt across the globe. At the time of writing this, our market is already down 21% since the all-time high closing. Regular readers of DNA Money would know that the so-called subprime crisis is the chief culprit. I am not going to delve into its finer nuances of the subprime crisis sice reams of newsprint and scores of web pages have been devoted to analysing, discussing and dissecting the issue.
As Indian investors, all we need to know about this issue is that 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 hedge funds, cavalier FIIs and a minority of unsuspecting but deep-pocket private investor groups.
In the 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 how deep-rooted the problem is — the subprime market is estimated to be over a trillion dollars and as per current estimates, the default rates are around 1%. However, as we go along, these numbers may well change.
For US investors, as if the subprime predicament was not enough, a rapidly rising current account deficit, a falling currency, high energy and food prices and a weakening job market have combined to threaten a severe recession. In response, the US government has announced a $150 billion rescue package that could entail amongst other things a one-time cash payment to taxpayers and various economic concessions to industry. As was widely expected, the Fed has cut interest rates by 75 basis points, thereby injecting the US economy with a strong liquidity steroid. The effect of these measures remain to be seen.
US stock markets were closed on Monday on account of a public holiday. However, the level of stock index futures suggests that Wall Street may well join the bloodbath when trading resumes on Tuesday.
Therefore, what we have is the opposite of irrational exuberance — delirious panic. The panic is the creation of the international financial community, by the international financial community, and for the international financial community. In other words, this entire mess is totally extraneous to the Indian market.
And therein lies the opportunity. The US is in turmoil, but there is nothing wrong with us. Amongst all emerging economies, our export to GDP ratio is the lowest. Consequently, even a full-blown US recession will shave only around 40-60 basis points off our GDP growth rate, which means we still have the capacity to chug along at an 8%+ GDP growth rate. Add to it an earnings growth rate of around 18-20% p.a. and a return on equity at the same level, and what we have is a safe haven for investors spooked by risk. Look at it from another angle. At the current level, the Sensex is trading at around 15 times 2008-09 earnings adjusted for embedded value. Compare this with early 2000 when the Sensex was at 25 times earnings. At that time, not only was GDP growth much lower, but also interest rates were high and the overall profitability of the corporate sector was nowhere near current levels.
I repeat — the fundamentals of our economy make our market nothing short of a safe haven during such turmoil. Therefore, I don’t care if the market falls to 13,000 or even lower. But, mark my words, once this storm blows over, things will be back to normal trot. In the meanwhile, your fortune as an investor would depend upon how you react or, more appropriately, don’t react to the situation.
Here’s what I am going to do - nothing. After carefully studying, I have invested in some stocks and some MFs and I am convinced that these remain intrinsically good investments. The index falling is not going to suddenly reverse the quality of these investments. If anything, I am looking forward to picking up some cheap but quality stuff. When the affected come back to our rewarding markets, no prizes for guessing who will be selling.
