Markets at new highs, what next ?

Finally we see the markets breaking out of the tight range that it was trapped over the last three months. Although the underlying trend was clearly bullish the markets have taken their own sweet time to move up mainly due to global uncertainties, wide skepticism in the markets as well as significant selling pressure from domestic investors who have been bearish while foreign investors have pumped in significant amount of money in this time period. Mutual Fund equity schemes in general have been facing significant redemption pressures where figures for July indicate a gross redemption from equity funds of around Rs 8000 Cr and a net outflow of Rs 3500 Cr. In spite of the outflows the cash position of mutual has actually gone up thus indicating wariness from the side of Fund Managers. Also as per press reports insurance companies have been increasing cash levels which now stand at record high levels.

My view has been that this is just the start of the up cycle in India and given that global short term rates are likely to remain extremely subdued for at least the next 24 months the inflow of money into high yielding assets will be very strong. Also given the relative economic strengths the overall growth prospects of countries like India vis a vis the West are so high that rupee is also likely to appreciate over the next couple of years. As such foreign investors are not only likely to make asset returns but also money in currency.

The widely held concern in the developed world today is of deflation given the employment situation, restricted credit, low capacity utilizations, housing concerns etc. However the possibility of a global deflationary scare really does not exist as large emerging economies like India, China, Brazil, South Korea etc. will continue to grow strongly.

Under the circumstances I believe that the mispricing of assets is actually happening in the case of Bonds and Gold. Gold prices at all time highs when the fear is of deflation is difficult to understand. Also Gold has today become the preferred investment destination for retail investors, which by itself is a contrarian indicator for future price movements. Moreover specifically for investors in India, given the fact that the long term trend for the rupee is to appreciate against the USD the prices in rupee terms are unlikely to provide returns which will beat those of risky assets. In the meantime Gold ETFs continue to get strong flows.

The second big mispricing is in Government bonds of countries like the US, UK & Germany where the yields in Germany are already at all time lows at a time when German growth for the last quarter touched a 20 year high. In the US given the fiscal deficit scenario the huge borrowings by the US Government the current yields are difficult to justify. As per the latest reports the holding of US Treasuries by domestic US investors has been moving up along with the savings rate in that country. This again could be risky for that country in the long run as from the current levels Bonds are unlikely to provide and significant long term appreciation.

Infact the US stock markets might do much better than their economy due to the presence of a large number of MNC’s in that country with global brands where their proportion of Rest of the World business has been growing much faster than the domestic business. Most of the large US corporations be it Microsoft, IBM, Caterpillar, Boeing, McDonalds, Banks, Pharma companies etc. etc. are actually global corporations where their overseas operations will continue to drive growth.

Most commentators who try to correlate history into the current global economic scenario, especially in the Western world do not take into account the fact that it is no longer a Unipolar world in which the fortunes of everything depended on how the USA and Western Europe grow. Whereas 10 years back there would be just one Emerging economy in the top 15 global economies today there are 4. Over the next 10 years the number of current emerging economies in this could become a majority of the top 15 economies. As such taking the examples of the Great Depression or the 1970’s to forecast whets likely to happen over the next few years is likely to be a big mistake.

Given the fact that the current results season was a mixed bag the markets have also taken time to adjust to the same. However as I have always maintained, at this stage of the growth cycle where in the benefits of an improving investment cycle as well as benefits from a strong monsoon are still to be seen one should not be too focused on short term corporate results.

On the inflation front although the RBI has been criticized for being behind the curve I think that they are actually at the curve today as a significant tightening was achieved due to the liquidity outflows post the Telecom auctions which in effect squeezed out huge amount of money from the system. Inflation has clearly peaked out and we are actually likely to see a sharper than expected drop over the next few months as both global commodity and food prices remain subdued. A confidence on reducing inflation is also likely to boost market sentiments.

Overall I believe that we should continue to see the markets doing well over the next few weeks and the year end target of 20500-21000 Sensex looks to be very much in sight.

“In Fund Management it is important to do well with the right view as ultimately that is what will determine how you do in the long run”