What is the reason for the volatility in the market over the past few months?
Out of the two, (1) has been more responsible for the correction in January 2008, although it was triggered by (2). The latest bout of volatility (March 2008) has been largely led by (2). Ironically, the biggest fall in the last two months correction has been seen in stock/sectors in the power utilities, oil & gas and infrastructure sectors, which have less to do with a global slowdown but more to do with froth in their valuations.
1. Local reasons: Excesses building up in certain sections of the markets led by leveraged positions. Excesses include stretched valuations in certain sectors, excessive speculation, unrealistic expectations of subsidiary valuations and growth.
2. Global factors: Fears of a U.S. recession which can lead to global slowdown, global credit crisis continuing unabated and a global sell-off in the markets which had its collateral damage.
Does this mean that the India growth story has been weakened?
Equity markets never go up in a linear manner. Corrections and volatility are necessary for a continuing health check of the markets. Equity markets always, ultimately, reflect the fundamentals and growth of the economy and corporate profits. Has anything happened which endangers the strong fundamentals and growth prospects of Indian companies? Not at all. Global slowdown or not, India's 'growth gap' over the rest of the world will continue. In fact, India's higher relative growth will only look starker in a global slowdown scenario. Our growth is internal and relatively more resilient to a global slowdown than most emerging markets. Market valuations at around 16X one year forward earnings, are very attractive considering a 20-25% earnings growth prospect over the next 1-3 years and the last 15 average P/E of 15X for the Indian market.
Will the volatility continue?
Global factors, led by the U.S, will continue to cause more volatility in the global markets as well as Indian markets. There is bound to be collateral damage. India, though, has the potential to 'decouple' from the rest of the world eventually. Remember, decoupling based on relatively strong fundamentals, takes time. It is not something which happens, necessarily, in the short term. We continue to argue, as we have in the past, that two factors will drive Indian markets (a) continued economic and corporate profit growth and (b) a P/E re-rating due to qualitative changes in the Indian economy, companies and markets.
How have you reoriented your portfolio to deal with this slump?
At Lotus India, we focus on consistent and dependable performance. Our investment process and team work is geared towards disciplined stock selection and maintaining a balance between risk and return.
In the last one year, our investment strategy was based on three themes:
1. Domestic consumption: banks, media, retail, auto
2. Domestic investment: engineering & capital goods, construction & infrastructure, banks
3. Beneficiaries of a global slowdown: companies/sectors which will see lower input prices but which have pricing power/price stability on the output side
We have favoured (2), followed by (1) and (3). We continue with the above three themes, but not in the same order of preference.
Sector strategy: We are overweight on banking, media, consumer, auto, cement & engineering. We are underweight on metals, pharma, construction, ITR services & real estate.
Stock selection strategy: We continue to focus on stocks where the risk-reward equation is favourable as shown by our investment process.
What should investors do?
Volatility always gives an advantage to investors who invest in equities for the long term. These times will once again prove to be an ideal opportunity. This too will pass, but will test everyone in the market. Invest in phased manner over the next few months, but with a long term horizon of at least 2-3 years.
This interview appeared in February 2008 Issue of Mutual Fund Insight.
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