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Some hopes, many fears
September, 09th 2008

Is the market getting back to its bullish ways? Or is this just another bear market pull-back rally? These are the nagging questions that are uppermost in the minds of most investors and investment managers that I have met recently.

Is the market getting back to its bullish ways? Or is this just another bear market pull-back rally? These are the nagging questions that are uppermost in the minds of most investors and investment managers that I have met recently. From its intra-day low of 12,500 in mid-July, the Sensex has risen by over 20% to cross 15,500 in less than a month. During this period, the NAV of Safe Wealth has risen 8.26%, while that of Wealth Zoom has gone up by 7.6%.

Our portfolio management strategy is directly derived from the market call we take today. So here's the trillion-dollar question: is this market uptick for real? It is, if you go by the official communication that fund managers are dishing out to their investors. Almost all of them are persisting with hope even though they admit to fiscal stress in government finances, global economic slowdown and realignment, credit contraction, oil price uncertainty and inflation-led demand destruction.

This hope is not wishful thinking; it's based on strong arguments. The strongest bull factor seems to be internal. While the Indian government may not be in a good financial shape, the rest of the country is more resilient. Indians are getting richer and consuming more, but remain thrifty. Household savings will rise to over $230 billion this year, close to a third of the total household income, and total domestic savings will be $340 billion, again about one-third of the national GDP. Show me another country that's growing at 8% a year with this savings rate.

Then again, corporate India is largely dominated by a high RoE, is competitive, under-leveraged and works at profit margins that are better than the global ones. There might be a slowdown in growth rates, but they still haven't fallen into a tailspin like the globally visible corporates in developed countries.

The problem, as always, is the people who are in charge. The big issues remain unresolved. Oil prices are certainly not being aligned with global realities. The additional (unanticipated) fiscal stress on government finances is now well over Rs 2 lakh crore (over 30% of the Union Budget for 2008-9), driven mostly by oil subsidies, fertiliser subsidies, the impact of the Sixth Pay Commission and waiver of farmer loans.

With election year approaching, the recent vote win in the Lok Sabha is not going to further the cause of reforms and lead to significant new sources of revenues for the government. Advance tax payments by corporates have slowed down this year. Taxes on (or indirect subsidy reductions from) KG basin gas and Cairn's oil fields are potential mitigants, but they may not be enough.

As the government resorts to borrowing more money, I suspect there will be at least one more spike in interest rates and pressure on the rupee. Meanwhile, poor fiscal management at home and a continuing dependence on imported commodities will keep inflation high and gradually undermine the householders' wealth as well as the consumption growth. In such a situation, the only saving grace can be lowering of prices of oil and other commodities. But we can only pray for this to happen.

I stand by what I said earlier: India has some great things going for it, but between now and the next six months or so, the stress points are likely to play out to the market's disadvantage. I have, in the past, picked some terrible stocks for the portfolios. I have also got my timing wrong by a mile in some other cases. As is to be expected, this has happened out of an irrational momentum chasing, rather than informed and rational analysis of the micro or macro reality. It is exactly such an analysis that pushes me to retain our roughly 50% exposure in equity for now. Markets confuse us all the time with their random, short-term thrills, but that does not mean we should get caught in their (often irrational) momentum. We'll hang in. And wait for the worst to play out.

The (upside) risk to this strategy could be that oil prices fall, commodities crash, the global economic slowdown abates, investors get bullish on emerging markets, the government pushes through innovative reforms with near-term impact and wads of petro-dollars in the Gulf and global investors reidentify India as the big investment opportunity.

It's a risk worth betting 50% of our portfolios on. That's why we are so heavily invested in cash and cash equivalents.

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