Rajaram Ajgaonkar
CA.

Sub-prime meltdown

Last month saw a lot of turmoil in the world financial markets due to sub-prime mortgage loan defaults in USA. Number of banks and funds, even outside United States, had taken exposure on the borrowings and this caused tension in all the leading financial markets of the world. The sudden twist pushed the aggressive players on the back foot and the liquidity in the financial market dried down thereby causing panic. Central Banks of Europe, U.K. and U.S.A. had to come to the rescue of banks by pumping in liquidity. The stock market all over the world melted for a while. Fortunately towards the end of August, the problems were left behind and there was a smart recovery in the stock markets. The markets bounced back – in absence of further bad news.

Though the major concerns regarding the sub-prime mortgage defaults has dried down, the fact remains that the defaults exist and they have badly affected the property market and construction industry in U.S.A. A slowdown in the economic growth in U.S. is expected and if the slowdown is not managed properly, it can cause concern recession. Even in the days of high growth and high consumption in Asia, the world is fairly dependent on U.S. demand and a slower demand can affect economic growth of many countries of Europe and Asia.

The economies across the globe may slow down during 2008. The growth rate will be positive; but the dazzling performance 2005 and 2006 may not get repeated. The current indications are for moderate growth.

Indian economy has been doing well and a couple of months back the expectation of GDP growth for 2007-08 scaled to 9.5% or even higher. However the changing global scenario in the last couple of months is likely to affect the Indian growth rate and it may slip below 9%. This slight slowdown is not a cause of concern; but it indicates slower growth than the earlier year.

Stock markets

The FIIs disinvested equities worth about 2 billion US dollars from Indian stock market during August 2007. Though initially the stock market took a bad beating, fortunately the local operators and mutual funds came to the rescue and the market was supported at lower levels. The market has recovered most of the lost ground and it is marching ahead towards a new peak. Though I am optimistic about Indian stock market, I feel that, it is necessary to exercise caution. The stock market may start going down on slight adverse news. The news can be domestic or international. The operators may start booking profits on slightest doubts about the prospects. Investors may book partial profits if the BSE Sensex crosses 16,000 marks during September.

The long-term prospects of Indian stock market remains good. The profit booking may be made only to reenter at a lower levels or at a later date. I do not advice any reduction of weight of equity in any portfolio. The balance of allocation in equity still needs to be maintained in a portfolio of an investor. Now, investors need to be selective. All the sectors of Indian economy are not equally promising. The biotech, telecom, steel, cement, Infrastructure, engineering and power sectors look promising, auto, auto ancillary, metals, petrochemicals, reality look week. Investors may concentrate on the selective sectors with bright prospects. Investment in weaker sectors may be avoided at present, though there may be opportunities in the future to buy good stocks of these sectors, at a lower price.

Real estate

The real estate sector had a phenomenal up trend in India over the last few years. The property prices doubled in many areas. The boom in the property prices was a world wide phenomenon. However since last few months the property market in South East part of U.S. has crashed. The prices have also come down in other parts of U.S., though to a lesser extent. The prices in Spain have come down which had a tremendous appreciation over the last five years. Places like U.K. and specially London are holding on and there has been moderate uptrend. Still, except for selected markets the big boom may be over.

The property prices in class III cities in India have started coming down on the lack of demand and over supply. The prices in class II cities have stopped appreciating and showing wariness at high levels. Class I cities and specially the prime areas are holding on and even growing; but the upward prospects from the current high levels do not seem to be great, at least for the next few years.

India property prices have a fair co-relation with the stock markets. If the stock markets stop appreciating, they will drag down property market. It is wise to invest in prime property. Commercial properties may show better potential than the residential properties.

Precious metals

The gold has crossed Rs. 9,000/- mark. The gold prices had depreciated earlier mainly due to appreciation of Indian rupee against U.S. dollar. Gold has not weakened in the international market. After a long time silver has broken the bad of 2:1 co-relation with gold. For quite some time 1 Kg. of silver was sold for around twice the price of 10 gram of gold. Silver has slipped below Rs. 17,000/- a Kg. I feel that this is a temporary phase and silver should gain in months to come. The investors may keep on holding these precious metals for a reasonable appreciation and as a hedge over inflation.

I am not very bullish as diamonds as of now though they may give reasonable appreciation based on U.S dollar strength and Indian inflation. The diamond cartel of the world is slowly and gradually losing its grip on the supply and there is a possibility that excessive mining may cause over supply in the years to come. Caution is advised for investors in diamonds.

Debt market

The debt market, which was showing slight weakness during the last couple of months, has strengthened again. The call rates have improved and yields have increased across the spectrum. The FMPs of mutual funds with a maturity period of one year plus have started giving yield of more than 9%. Such yield had dropped down to around 8.1/2% in June and July. The current inflation rate is around 4%. So investment in debt, even post of income tax and inflation, is giving positive returns.

I do not see easing of liquidity in the near future, unless Reserve Bank of India takes deliberate steps to reduce the benchmark rate, the interest rate may not go down. As of now and even for months to come, debt can be a good investment. Investors may invest a fair part of their current savings in fixed deposits and FMPs of mutual funds. A moderate exposure can also be taken on the debt funds. Even the liquid funds are offering a return of around 6% and they are good investment for parking temporary liquidity.

Conclusion

The stock markets have managed to cope with the first major attach; but they are vulnerable at high levels. On every major rise, profit may be booked to invest in debt. On every fall part of the debt may be converted into equity related investments. Average investors may use mutual fund route to invest in stocks, as selection of stock is not going to be an easy affair.