December 2009: Time to lift Stimulus

Equity markets witnessed a spectacular run in 2009, with the Sensex moving up from 9,647 as on Dec 31, 2008 to 17,464 as on Dec 31, 2009 – climbing up 81% over the past 12 months. Note that in 2008, the Sensex fell from 20,287 to 9,647 – a fall of 52%. Despite the 81% positive return in 2009, equity markets have broadly delivered negative returns over the past 2 years. It is based on this mathematical fact that our investment philosophy is geared towards capital protection.

Last year at about the same time, the global economy was widely considered to be at the brink of a depression. Its state was similar to patient admitted in a hospital with a massive cardiac arrest, requiring urgent and immediate attention by the doctors. With the assistance of the massive and coordinated support by most major governments across the world, the economy survived the risk of a great depression. But the patient continues to be in the ICU, under constant monitoring by the doctors, and the life support systems are still on. The coordinated stimulus programs by the government is largely feeding the global economy. Till the Life support systems are removed and the patient walks out of the hospital, it is difficult to assume all is well. The stock markets, on the other hand, seems to be pricing in assuming the economy has fully recovered. The celebrations following the patient surviving has been massive, whereas one should be heaving a sigh of relief only.

The Indian economy, though still supported, is in a far better shape compared with most large global economies. Apart from the risk of inflation – which continues to be a serious problem – all other economic indicators point to a positive economic momentum. The Finance minister has given strong indications that some of the stimulus measures will be lifted in the next budget, scheduled for Feb 2010. Bond markets are also starting to factor in an increase in interest rates. Given these circumstances, and with stiff equity market valuations, it makes sense to be cautious.

Investments in India by FIIs continues to be strong, partly supporting equity markets. On the other hand, the last few days has seen some strength in the USD globally. This can influence FII fund flows in the coming days and needs to be watched closely.

Over the past few weeks, we have been seeing the mid-cap stocks starting to perform much better than the large-caps. More of the mid-caps are starting to reach the target intrinsic values and we continue to exit stocks that have reached their intrinsic values, those that offer little reward and large risks of price correction. Apart from some pockets of small cap stocks, there is very little value available in the markets. We believe it would be wise to commit capital to equity market only after seeing some sensible prices.