Publication: The Times Of India Mumbai; Date: Mar 18, 2008; Section: Your Money; Page: 42
In stormy markets, it’s better to stay alert and rational than to bank on prophesies
IN the last couple of months, several US investment banks, insurance companies and other institutions have reported big black holes in their balance sheets. A couple of weeks ago, American International Group reported a net loss of $5.29 billion for the October-December quarter on $11.5 billion that soured amid the subprime crisis. This is the biggest loss posted in any quarter by AIG, the largest US insurer, and also the biggest red-ink figure reported in the US insurance business. It’s a ironic that insurance companies, which are in the business of managing risk and which should have had control mechanisms in place, should make irresponsible investments and run up astronomical losses. Even more shockingly, some short-term cash management funds in the US also have subprime assets.
IN the last couple of months, several US investment banks, insurance companies and other institutions have reported big black holes in their balance sheets. A couple of weeks ago, American International Group reported a net loss of $5.29 billion for the October-December quarter on $11.5 billion that soured amid the subprime crisis. This is the biggest loss posted in any quarter by AIG, the largest US insurer, and also the biggest red-ink figure reported in the US insurance business. It’s a ironic that insurance companies, which are in the business of managing risk and which should have had control mechanisms in place, should make irresponsible investments and run up astronomical losses. Even more shockingly, some short-term cash management funds in the US also have subprime assets.
It’s pretty clear now that the decoupling theory, so trendy a few months ago, is laughable. Indeed, the correlation between the Dow and Sensex, which was believed to be on the lower side at around 0.25, is now around 0.8 to 0.9, meaning our market behaves almost in line with the Dow. No amount of diversification of assets will help in the short run. So what does this all mean for investors?
I would argue that there are two kinds of decoupling: fundamental and technical. Fundamentally, our economy is decoupled from the US economy, and the impact of a US recession on our GDP growth is likely to be minimal, and attributable to our exposure in certain exportoriented sectors. Common sense says the two key drivers of our growth are domestic consumption and infrastructure, which are insulated from the ripple effects of a US meltdown.
So does that mean investments made in domestic consumption and infrastructure-related sectors would be decoupled from the US meltdown? The answer is a big “No”—we have seen all kinds of stocks take a beating in the past two months. The reason for these beatings might not entirely be fundamental. It’s not difficult to see that, besides excessive leverage, the cause for the convulsions in our markets is the technical coupling of the Indian and US markets.
When hedge funds and other institutions incur losses in some place, liquidity becomes a constraint, and they pull out from markets worldwide. Such withdrawals shaved 30% off market values, and created fear in the minds of even seasoned fund managers. Everyone is waiting for someone else to bell the cat, and, very likely, they’ll all rush forward when the market stabilises. Don’t be surprised if the market surges once foreign institutional investors resume buying, and domestic institutions, who are sitting on huge piles of cash, try to get in on the action.
So, what should an investor do? The first rule is not make panicked decisions. Our markets will never be technically decoupled from international news. However, once market participants realise that Indian markets offer a favourable risk-reward picture, sanity will prevail and buying will begin. So, unless your money is in questionable investments, there’s no reason to chicken out now. Equity will always alternate between exuberance and pessimism. If you are feeling alarmed, consult your advisor and define what level of equity you’re comfortable with in your portfolio. The drastic market drop has likely lowered your equity component, and it may well be time to add to equity, not reduce it.
Second rule: ignore analysts who give out higher technical targets when the market is going up, and lower technical targets when the market is falling. If you follow them, you will end up buying higher, and never buying lower. At the same time, you would never end up selling higher, but could certainly sell lower. This is not to say you should try to time the market, but ignoring such analysts is the first step.
Globally, the situation is still not favourable. Nothing has changed fundamentally in the US, except that the US central bank is gearing itself to tackle the situation through interest rate cuts and other stimulus measures. The markets could continue to be under pressure, and there may be selling coming in on subsequent rises. The next trigger for the markets would be better news globally, but this is hard difficult to predict. Strong earnings growth could boost indices, but any negative surprises will exert additional pressure on markets. Even so, at some point, at least a few investors will inevitably realise that there’s no reason to punish the Indian markets severely.
The fact is: markets react, whether the news is good or bad. Even though sanity may prevail in the end, in the short-term, markets would be technically coupled. So expecting a complete reversal would certainly be wishful thinking.
Amar Pandit is a Certified Financial Planner and Director, My Financial Advisor
Amar Pandit is a Certified Financial Planner and Director, My Financial Advisor
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