Increase investments when prices drop substantially.
This year has been quite disastrous and the prognosis for 2012 doesn’t look great. Although 2008 saw a steeper fall in stockmarket prices, governments had resources for counter-cyclical action. Now, government finances are under strain everywhere.
There is no global engine of growth. Europe is busted, the US is busted, Japan is busted. India is financially stressed though not quite busted. China is in slowdown. To add to worries, there is continuing turmoil in the energy-exporter region of Arabia. That might keep crude and gas prices ruling higher on fears of supply disruption.
Things always get better eventually. But all the signs suggest that it will be a long haul. So 2012 could well be a second successive year of negative returns. India's macro-economic indicators have deteriorated to the point where it will take two to three quarters before a significant turnaround.
Another problem for an analyst is the unreliability of macro-economic data. It has always been poor in India (and China). But global data, including First World data, is also dubious at the moment. So investors will just have to assume generous error margins and punt in hope.
Under the circumstances, I wish that the market had fallen quite a bit more! The current index valuations of PE 16-17 are near long-term average valuations and clearly, the situation is quite a bit worse than average.
If the stockmarket had corrected deeper, one could invest in equity with a two-three year time frame and some comfort. Since Indian bear markets usually bottom out at PE 12-13 or less, the current valuations are not comfortable.
As things stand, one would have to wait for one of two things to occur in terms of equity valuations. There may be a sharper downtrend in the next three to six months, driving index PEs down to 12-13. Or, the market will mark time for a much longer period, while earnings gradually rise.
In terms of broader signals, there will have to be several rate cuts before the equity market starts to respond positively. Other numbers like investment flows, and consumption indicators such as vehicle sales and housing finance offtake would also be worth checking, of course. But those are likely to improve only in the wake of rupee rate cuts, or positive external events.
The RBI started hiking rates in February 2010 and paused only in December 2011. I think, it would take at least three consecutive cuts amounting to a cumulative 100 basis points before the equity market develops any confidence in an RBI policy reversal. The recent combination of lower food inflation and growth slowdown makes cuts look a little more likely.
On the external front, stability in the Euro zone would definitely be a positive signal. So would stability in Arabia. That would ensure that currency fears don't drive the rupee down to even lower levels and that high fuel prices don't cause stagflation.
In the meantime, a lot needs to be done on the policy front and it is increasingly apparent that it won't get done. Investors display a natural reluctance to invest in risky assets during bearish situations. That reluctance is reinforced by consistent policy inaction allied to populist measures. In particular, investment into infrastructure has slowed alarmingly.
The reasons are manifold. They are also apparent to everyone. But the underlying issues are not likely to be addressed by a government that is struggling to survive and importantly, still believes it can. At the very least, it intends to wait out key assembly elections. The opportunity costs of inaction are already mounting.
India has seen two major periods of reform. One was 1991-93, when a minority government that didn't expect to last, formulated the New Economic Policy. Once that government managed to buy a majority, it stopped being active. The second period was in 1999 when a caretaker government passed a series of ordinances after losing a Vote of Confidence.
During both periods, policy action occurred only while the government was insecure. Perhaps the best hope of reform in 2012 would arise as and when UPA-II reckons it would not be able to last the full-term. In that case, it might be galvanised into doing something. Until something like that happens, remain cautious. Hold onto your current portfolio. If prices range-trade near current levels, invest systematically. If prices drop substantially, be prepared to increase commitments.
In a two-three year time frame, these are reasonable equity prices Valuations would get very attractive if prices drops another 15-20 per cent. But be prepared to wait at least two or three quarters for positive returns.
