April 2010: Continuing negative news from Europe

Equity markets in India continued to trade in a cautious zone, finishing the month on a slightly positive note. Despite continuing negative news from Europe, equity markets have been holding up due to be a combination of positive corporate results and the continuing loose monetary policy by governments. Our portfolios broadly continued to do better than the market, despite the high cash holding, as the value in some of the larger holdings are being recognized.

Over the last 2 years, governments across the world have been borrowing aggressively and maintaining high deficits. In a democratic system of governance, governments will continue to pursue this path unless forced to change. In the case of Greece, the government was forced to change this path with the cost of borrowing going up significantly. The Greece government’s cost of borrowing, for a 10 year bond, has gone up from about 4.5% to over 9% over the past 4 months. Imagine a friend of yours who has borrowed for his house at 8%, and suddenly needing to pay double the EMI. The situation is very similar. The Greece government, if it does cuts is spending, will take the economy further into recession. The only other option left is to default on the loans, unless someone bails them out of the problem. The real concern for the world today is not the problem isolated to Greece alone, but several governments are walking this thin line between survival and holding up the base of their respective economies. Portugal and Spain have also moved a bit closer to testing this thin line. Some other countries may not be too far away from asking this question. If this problem spreads, the global economy may have to face the prospect of another recessionary phase.

The other big event has been the Goldman Sachs related events and the finance industry practice of misleading clients. This is a part of a series of events that leads to a higher levels of regulation. The regulatory whip lash can have certain severe impact of financials markets in the short term, but would work towards building a more durable system over the longer term.

The Indian economy is definitely better poised than many of the developed economies. As a result, there is continuing investor interest in Indian markets in particular, and other emerging economies like India in general. Corporate results in India has been fairly good and the sense of optimism continues. The real risk Indian markets face is that, given the high valuations and dependence of foreign flows, markets will get affected if the global economic problems continues.

From individual stocks perspective, the stock prices of mid and smaller companies have been going up faster than larger stocks. Our assessment is that, though there is some value left in these kind of companies, they are steadily moving towards their full value. Normally, markets correct only after even these stocks are fully priced. Overall risks in the market out weigh the superlative reward opportunities. Given global uncertainties, it seems better to be cautious.