February 2009

Equity markets continued to remain weak during the month on the back of continuing global pressures and some poor corporate performance. Earnings growth from companies in real estate, construction, automobile, energy and metals were very weak with average fall in earnings in the range of 20-70%. Companies in other sectors like consumers, finance, IT, utilities and engineering were fairly good. Outlook for corporate performance in the coming months is fairly muted, though some pockets of the economy are expected to continue to do well.

Global investor sentiment continued to be weak on the back of double digit drop in economic growth in Japan, a 6.2% fall in US GDP and continuing pressure across Europe, Middle East, Russia, etc. Consumer confidence in US is the lowest since measurement of such sentiment was started in 1967. Though the Barack Obama administration plan to spend its way out of this recession is expected to give some boost to sentiment, there is wide ranging skepticism on the plan due to increased government borrowings and the after effects it can have on the system. The Indian economy grew at 5.2% during the last quarter and the widely accepted GDP growth of 7% is under question. Our interaction with companies across various sectors indicates a continuing level of concern over economic recovery, though the situation seems to have vastly improved since December 2008. Several companies are also using the current environment to pass through some of the tough decisions, especially on cost control.

A large part of the current problem in India is due to the log jam seen in the banking sector towards the end of 2008 and this pressure has eased over the past few weeks. Despite a continuing fall in inflation to under 4% now, which is expected to fall further, and the RBI moves to reduce interest rates, banks are yet to start lending at lower rates. Interest rates will fall over the next 12 months as the high cost deposits raised by banks over the past year come up for renewal. Banks in general have tightened their lending practice and as a result are flush with funds. We do not believe that there is any concern with availability of funds in India, unlike the rest of the world. To give some perspective, the total deposits raised by State Bank of India over the past 6 months is much more than the sum total of all funds in equity Mutual Funds in India. The average Indian individual continues to save a significant part of their earnings and with savings at 34% of GDP, India is well poised in terms of availability of funds.

We also met with the HDFC management during the month to understand the business in the context of concern over the real estate market and predatory pricing by State Bank of India. Despite the slowdown there seems to be no real threat of bad loans in the home loan market in India. In addition, due to very low penetration of home loans, the company is continuing to see sensible growth.

Challenges for the Indian corporate sector is stiff and immediate term outlooks is cautious. Compared with other major economies including US, Europe, Japan, Russia, etc, India seems to be best poised in terms of growth, availability of credit and prospects over the next 3 years. Slowing exports, weakening Rupee and lack of international investor interest would weigh down on stocks in the coming months. On the hand, prices of stocks in certain pockets are looking extremely attractive for good returns over the next few years.