July 2010: Grim global outlook

Equity markets continued to trade in a narrow range, closing this month with a 1% up move. The Indian market continues to trade at near its 2 year high while most other major global equity markets have had reasonable corrections from their peak levels. The sense of optimism surrounding the Indian economy continues to be strong, so much so that Indian markets are now stiffly priced compared with several other comparable markets.

Corporate results in India continue to show good growth, but there is a trend of margins coming under pressure. This is due to a combination of reasons – lower demand in some pockets, effect of higher excise duties and higher raw material prices. At the same time, the RBI is continuing to increase interest rates at a measured pace in order to bring inflation under control. These rate increases, which have become inevitable in light of the high rate on inflation in India, could potentially slow down the economy over the medium term especially since the transmission of monetary policy into rate action by banks is much higher now. Some banks have already started to increase deposits rates and one could see borrowing rates for consumers go up soon. Today, consumers are able to borrow at rates which are comparable to those at which the government is borrowing (usually considered risk free) and the real interest rates are currently negative by more than 2 percentage points. It is possible that this scenario may undergo a change in the coming months.

The global economic environment continues to look a bit grim, as unemployment levels in countries like US remain at very high levels. No economic recovery can be construed to be strong when 10% of the workforce are unemployed. Leading indicators out of the US are suggesting that growth rates going forward may be a lot slower than those witnessed over the last 6 months, owing largely due to the effects of government stimulus waning. On the other hand, the risk of collapse in Euro zone seems to have been tempered over the past month.

Several of our portfolio companies continue to do reasonably well in this environment and we are fairly satisfied with the performance of these companies. We have been seeing strong price performance in some of mid-cap stocks that we have been holding for more than a year. A few of these stocks have reached expensive levels and we have been using this as an opportunity to sell down the position – we can always buy them back when prices moderate somewhat.

In the context of a weak global economic environment, continued increase in interest rate to combat inflation and stiff valuations, we continue to remain cautious. Moreover, we are not seeing compelling investment opportunities – at prices where the immediate terms risks compensate for more than attractive returns over the medium term.