April 2009
Equity markets in India, and to a large extent across the world, have been on an uptrend since the 2nd week of March 2009. This trend has been continuing through April 2009 and we saw a fairly strong performance for equities during the month. Foreign money has also started to flow into India after almost 15 months. The uptrend has been led by a belief that the worst of the global recession is over and some kind of bottom has been reached, though this does not necessarily translate to good times in the immediate future. At this stage, I think it is important to visit the sequence of events that has led us to this stage.
The main problem over the past year has been the collapse of the global banking system and several banks perched on the edge of bankruptcy. As per accounting regulations, banks were to carry their investments at market value and several of their mortgage investments are trading at very low prices. The US government changed the accounting rules that allowed banks to value some of these investments, not at market value, but at some other price that they deem fit. This ensured survivability of these banks with just change in accounting norms, rather than any fundamental change in business conditions. The actual bond prices have actually deteriorated further over the past 2-3 months, indicating a worsening underlying reality. Banks also saw some improvement in profitability due to their low cost borrowings. As a result of this change, the dark clouds hanging over the global banking system have started to clear bit, but this will also ensure that it will take a longer time to get out of the real problems. In India too, couple of important account rules were changed. Firstly, foreign currency borrowings were not required to be carried at current conversion prices. Secondly, banks were given some flexibility in value bad loans, as long as they were in the process of getting restructured. A sentimental bottom to the recession due to fundamental factors is always preferred over accounting change led factors, but should assume this to be a start. Interaction with people from the industry also indicates that the worst of the recession may be over, but the environment will continue to remain tough for the corporate sector for the next 2-3 years at least.
The March ending quarter was the first full quarter that was impacted fully by the global recession. Corporate results, especially from cyclical industries, were terrible. On the other hand, stock prices were strong despite weak results, as many of the results were ahead of expectation. Many of the portfolio companies like HDFC Bank, Glaxo Smithkline, CRISIL, Gruh announced respectable results. Companies in the IT sector are going through a rough patch, but outlook should look good if the global economic sentiment continues to improve the way it is.
Based on the quality of corporate results, valuations of several companies and the continuing tough environment, we believe that equity markets will start to face resistance soon. Election related uncertainty is also a deterrent. The most likely scenario over the next couple of year is an equity markets that remains flat and range bound. One should look at moving to higher component of cash as and when markets are strong and look at getting back into some quality stocks as and when we see more panic. It seems almost certain that the last of the panic is yet to come.