Last year this time the stock markets were taxiing for take off. And take off they did. The BSE Sensex jumped from about 3,000 to 6,000 in a matter of months.
Pessimism was replaced by irrational exuberance. Fund managers were making presentations that the Sensex would breach 7,000 by July 2004. The brokers, not unexpectedly, were talking of Sensex 10,000! But just as one thought we were about to go into a higher orbit, something happened. There are two versions of that 'something'. Depending on who you are, this is what you probably believe in:
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According to the retail investors, removal of the National Democratic Alliance at the Centre led to disappointment. Coupled with this was the involvement of the apparently investor/business unfriendly Left Front in the new government (they are supporting the government from the outside, whatever that means!).
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According to 'experts', the fall in the markets had little to do with the domestic elections, though they may have contributed to the same. They attribute the fall to 'global factors' and highlight the fact that all emerging markets have witnessed significant correction since the start of the year.
(For those who are initiated into the world of global arbitrage here's an explanation -- till recently hedge funds in the US were borrowing funds at very low rates of interest (as low as 1%) and deploying the same in emerging markets. They were able to earn a 'spread' (both on the investment and the currency as the US Dollar was depreciating). However, with interest rates in the US already on a rise, this process is now working in the reverse and funds are diluting their investments in emerging markets and heading back to the US.)
Whatever you believed in, the result was the same. The stock markets went down. The question that now needs to be answered is where are the stock markets headed?
The current environment is one of cautious optimism among the business community as the domestic economy is gathering pace. A forecast of a normal monsoon has added to this optimism. With the US economy too on an uptrend, prospects for the domestic exports and services sectors have improved.
The numbers support this optimistic outlook. Let's take a look at four important indicators --
Bank credit
Total bank credit (food and non food) has grown by 3.5 per cent since March 2004 (end of FY04). This compares very well with growth of just 0.2 per cent that was recorded in the corresponding period last year.
Importantly, non food credit, has grown by 2.7 per cent during this period as compared to -0.1 per cent in the corresponding period last year! The sharp spurt in borrowings underscore the optimism that is prevailing in the corporate sector.
Diesel consumption
When an economy starts to do well, diesel consumption grows in sync (as more raw material, finished goods are transported). That the Indian economy is on a roll is underscored by the fact that diesel consumption grew in excess of 13 per cent YoY* in May 2004 (in May 2003 consumption actually declined by 9 per cent).
*These stats have been sourced from newspaper reports and have not been independently verified.
Export growth
Exports in financial year ended March 2004 grew by 17.1 per cent (YoY) on top of the 20.2 per cent growth recorded in FY03. The trend in growth seems to be sustaining this year with exports in April posting a YoY growth of 20.0 per cent.
The growth in non oil imports, which includes capital goods, continues to be robust. The YoY growth in April 2004 was 20.8 per cent. The YoY growth in FY04 was over 26 per cent.
Finally the bottomline
Industrial growth, which was put at 6.8 per cent in FY04 (5.8 per cent in FY03 and 2.6 per cent in FY02), jumped to 9.4 per cent in April 2004 (in March 2004 growth was estimated at 6.7 per cent). The Mining, Manufacturing and Electricity sectors posted growth rates of 9.5 per cent, 9.2 per cent and 10.7 per cent for the month of April 2004 as compared to April 2003.
So, businesses are doing well, and are expected to do well.
But as we have often seen valuations in the stock market tend to be far removed from reality. A large part of this 'divergence' is due to the sentiment that is prevailing at the time.
Presently, the sentiment is pessimistic (like it was in March 2003). And it is becoming increasingly so. The rosy forecasts for the Sensex are being revised downwards. But, importantly, there is no downward revision of forecasts pertaining to economic growth. Nor has there been any significant revision in forecasts pertaining to corporate profitability. This has resulted in a divergence between valuations and fundamentals.
For the smart investor, this is just another opportunity to invest. To quote Sir John Templeton -- "Help people. When people are desperately trying to sell, help them and buy. When people are enthusiastically trying to buy, help them and sell".
This is not to say the markets will not fall further. They could and probably will, given the amount of hedge fund money that apparently entered the country last year. But then, smart investors know that timing the markets is a difficult proposition. The best way to deal with this situation is to invest in small quantities and at regular intervals.
The point we are trying to make is that if you are pessimistic about the stock markets just because some hedge fund/FII money is yet to leave the country, you are probably on the wrong track, just as you were at the start of 2003, when no hedge fund/FII was interested in India. For you, the retail investor, the smart thing to do is --
Focus on fundamentals
Invest in small amounts and at regular intervals to minimise the risk of going wrong on the timing (most mutual funds offer a systematic plan option)
It's the nature of the markets to go up one day and down another (read sentiment). Therefore it is best you do not worry about the day to day or even month to month movements. Focus on the long term and you will come out good.
