Sunday, April 15, 2012
Keeping away from Equities- Abstinence, sometimes, is healthy..
This article appears in today's Deccan Chronicle (16/4/2012) Uncertainty seems to be the buzz word going around. I am referring to the financial markets where several tussles are going on simultaneously. The fiscal budget did not attract much attention, being viewed by all as an ‘accountant’s” budget and nothing more. A deeper look in to the broad numbers, bring to fore the fear that we could perhaps be faced with a fiscal deficit that is likely to be higher than budgeted. The one chance that we could perhaps restrict it if the government is unable to complete its spending as planned. Given the set of controversies surrounding virtually every government spending actions, it is not unlikely that we could see the fiscal deficit being within budget, albeit for all the wrong reasons. Growth is getting hurt. Global economic condition is one of the reasons. In my earlier piece, I had talked about my dislike for PSU stocks. That is being fortified by the governments actions on cases like Coal India, Indraprastha Gas and the various retrospective amendments that the government is trying to enact. I fear the PSU banks are next in line, with a high probability that the rules for recognition of poor assets will be changed in order to show that the banks are healthier than they are. It would be like changing the name of a disease from cancer to a flu and saying that all is well. Investors do not like uncertainty. Yes, we do not mind going wrong on our assumptions of growth or profitability or the price earnings multiple that the market may assign to a stock. However, one reasonable expectation has to be that the regulators will not step in and take a destructive approach to pricing or controls which result in changing the basic assumptions. Regulatory risks are the worst deterrents to any form of investment. The Vodafone case (without passing a judgement on its merits) started the uncertainty and the other actions on PSU companies are like adding fuel to the fire. It is a well known fact that our equity markets have been thriving primarily on the FII flows that keeps seeking better returns from emerging markets. Our economic growth rates, till the recent couple of years, have justified the faith of the investors. Yes, a temporary drop or slowdown in profits is acceptable. At a time when it looked like we could be the beneficiaries of FII flows due to our relative growth prospects, the regulatory moves have put a ‘pause’ button in to play. I only hope that we do not see further action that could result in a ‘rewind’ button coming in to play. Inflation and interest rates continue to be a worry in this environment of sluggish growth. If revenue expectations of the budget are not met (considering weaker profits, high fuel prices, supply constraints etc) we will be staring at government borrowings over shooting the target. It is also possible that we could see expenditure plans getting pruned given the clouds on virtually all government spending. That could balance out the revenue shortfall, but it would shrink growth. When we are expecting interest rates to come down, we are witnessing the phenomenon of banks raising deposit rates even beyond the year end. Add to this the strain on the loan books of the banks, we are not going to see significant fall in interest rates. Our trade deficits continue to be high and the balancing act falls upon portfolio and FDI flows. That is in turn impacted by capricious government policies. Oil prices continue to remain high. All of this could see inflation being stubborn and stall cut in interest rates. For investors, the options are becoming smaller, with equities looking weak. An entire universe of PSU stocks (oil, coal, gas, banks etc) have been recipients of swings in government policies driven by populism. Quality stocks (FMCG, Pharma etc) continue to remain expensive. The markets that ran up before the budget, seem to be losing steam and could drift lower. A double digit returns from here, in the next ten to twelve months, looks difficult, unless there is a resumption of FII flows. Fixed income continues to be my preferred option for the next one year or so. I will put my money in to bonds that give me a yield of over 11% p.a. In fact, even the tax free bonds look tempting, with yields of near about 9% on a post tax basis. In the event the clouds clear over the equity markets, one of the accompanying factors has to be falling interest rates. If interest rates start to fall, one can look for some capital appreciation in the bonds also. We then sell the bonds (earning the yield plus a small amount of capital appreciation- giving a good total return) and shift back to equities. The key is to buy reasonably liquid bonds of high quality. In buying listed bonds, one does not suffer deduction of tax at source (of course, the government can change it, but cannot do so retrospectively due to practical issues) giving one a longer use of cash.