This is the time to ride your convictions – Not get out of them

Over the last few days as the newsflow on Greece has dominated the markets and concerns on China have grown with the fall in the Chinese markets a number of investors have become jittery and are getting concerned about the future direction of the markets. We have seen the broader market starting to underperform the indices with investors trying to reduce their risks and booking out profits wherever they can.
In my view this is the time to ride your convictions and build up a portfolio of high growth stocks that will deliver strong returns over the next 2-3 years. We stand today almost at the same place as where we were one year after the last bull market had started in 2003 and we had the first major correction in global markets in the first half of 2004. The concerns at that time were largely on valuations, given the fact that 2-3 years of a downmarket had resulted in valuation expectations moving down and the psychology was that of a bear market valuation. A similar thing exists today where most investors are concentrating on immediate valuations without looking at the fact that economic growth prospects are improving and earnings growth is likely to be strong over the next few years. That is not to say that the issues that the markets are concerned about are not for real, however finally these issues are due to the same event which caused the crash of 2008. It is the over leveraging and debt financed cycle of the last bull market whose impact still lingers on.
I believe that the Eurozone crisis which has essentially been driven by a lack of cohesiveness in terms of response, mainly due to the fact that since it is not a single country there is obviously the feeling that why should we take a hit to bail someone else out. However once problems came to a stage where panic was setting in the response has come and now should follow its logical conclusion where these issues are resolved over the next few years with the fear of a default going away. The apprehensions in the minds of people are similar to the ones which were there when the US bailout packages were announced and most experts decried that it is not going to work. However it seems to be working as of now and the rally in the US Dollar (which was supposed to be a doomed currency ) shows that the confidence is back in that economy. As the Europeans get their house in order the concerns on the Euro’s survival will also diminish over a period of time. The short positions on the Euro are also believed to be at all time highs and it just needs a small trigger to set off a short covering rally.
The other big concern has been on China and that is something which has concerned me too and I have touched upon various facets of it in my previous article. However the biggest positive of China is the fact that fiscal deficit in China continues to be extremely low and the Debt to GDP is also very low at just 20%. As such the government of China should be able to handle things due to a strong balance sheet.
Although I cannot comment as an expert on the recovery process in other economies, the revival in India is for real and only likely to accelerate going forward. Consumer demand which picked up very fast after the downturn is gaining strength with adequate availability of credit and finance for the purchase of durables. Hiring has picked up in a big way and salary increments and bonuses are back strongly, which will further support consumer demand. Auto sales growth in India was around 40% in April and was higher than Chinese growth of 32%.
The investment demand is also picking up strongly with the growth in a number of sectors being restricted due to capacity constraints. Shortage of tyres and some other auto components led to a slowdown in automobile sector growth which should otherwise have been faster. Similarly logistics constraints are leading to a slowdown in demand for a number of other sectors. Unlike the West where there is huge unutilized capacity and high unemployment. As against that there is again a fight for talent in India and lot of core industries are finding it very difficult to get trained manpower.
As we interact with a number of companies, they are extremely positive on growth prospects and are today in a stage where they are finding it difficult to cope up with the pick up in demand mostly due to the fact that because of the doomsday predictions that were going on a year back most companies scaled back on their plans and never anticipated such a strong revival. There are some concerns on rising input prices, however given the fact that the investment cycle in China and Europe in particular should get restricted over the next few months a big upmove in commodities is a highly unlikely scenario and as such the pressures should level off now. The inventories of lot of commodities like Crude Oil, Steel, Aluminum etc. continue to be at extremely high levels. As we have seen in most commodities, as the prices are moving up there is typically stocking up which creates a vicious cycle for prices and as prices start falling the inventories also start getting liquidated. The biggest example of this in the recent past has been sugar where prices halved in a period of just three months.
Every bull market will find reasons to correct and every bull market will have sell offs. However these sell offs get taken out very fast and are never long lasting. The last bull market of 2003-07 had several of them in May04/May06/Feb 07 etc. Around the same time in year 2004 the Sensex was at 5700 levels and the Sensex EPS was around 350, giving a P/E of around 16.5X. The current P/E is around 5-7% higher, however it is also important to note that 2004 was the time when most investors were unsure of growth (specially in India as historically India had not growth over 5-6%), today we are sure of a 8% growth, if not 9%. As such looking at P/E ratios to make a judgement on future market direction is likely to be a futile exercise. A large number of high growth mid cap (as well as some large cap) stocks went up by several times after the crash of the markets in May 2004 where the predictions were that the markets are doomed as the government with Left support was formed. However look at what happened, we had the biggest bull market that India has ever experienced.

My advise is not to listen to the market pundits who change their views every few days but concentrate on the long run. Pick out the right kind of stocks to make money over the long run. The future is bright and the outlook is strong. Signing off with one of the quotes that I really like –
Winners never Cheat”

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