The first six months of 2011 has been very challenging for the world economy. So it would be appropriate to look back on how the investment landscape has changed over the last six months and also delve on current and emerging opportunities. The article is specific for Indian investors though most of the ideas expressed are universal.
2011 - The Story So Far
A little over six months back Jasmine was just a flower and an Arab spring was better known as an oasis. Now these two terms have the potential to ruffle the very fabric of global financial interdependence. Whether the spring will spread and turn into a long unclear winter causing oil to spike and exacerbate inflation depends on how the big powers play their geopolitical game.
While the political springs are turning into fountains in the Middle East, further north the EU (European Union) is still bickering on what to do with their PIGS. The springs that feed the financial systems of Portugal, Ireland, Greece and Spain (PIGS for short) have all but dried up. Germany, the financial powerhouse of the EU is not feeling so charitable to just bail out the squealing foursome. On the other side of the world the US is continuing to make money out of thin air, having completed QE1 and QE2, there is talk of releasing another blockbuster sequel QE3. For the uninitiated, QE is not another science fiction block buster from Hollywood. QE is Quantitative Easing where the US government buys back government bonds and mortgage securities from commercial banks to increase money supply and stimulate the banks to lend. The idea is to rekindle lending by flooding liquidity into banks which had taken a hit in the 2008 subprime crisis. But part of the money thus created flows out of the US seeking higher returns and causes price volatility in equities, Oil & commodities across the globe. If QE3 is implemented it will further stoke the prices of commodities and oil and add fuel to inflation in the emerging markets.
Back home we have a different kind of issue which is perplexing the mandarins at the finance ministry and the Reserve Bank of India (RBI) - a raging inflation that refuses to be tamed. Interest rate and growth are intricately linked. Higher interest rates stifle capital creation. Companies put off expansion plans as consumers rein in big ticket spending like cars and houses. The RBI wants to increase interest rates to bring down credit growth and money supply and thus tame inflation but this will hit overall growth and hence GDP numbers. Neither the Government nor the industry bigwigs want to play ball. The tussle continues. The RBI mid quarterly policy review on June 16th has raised interest rates by 0.25 %. The next review will be in the last week of July and we will know who has prevailed.
Investment Opportunities
It is good to know the current situation in the financial world, but ultimately what matters is the likely impact on each of the investment avenues in the remaining 6 months and beyond.
Stock Market
A rising interest rate regime is not good for the stock market. A stubborn inflation along with rising oil prices is putting pressure on input costs of corporates. This leads to subpar profit growth. In the first financial quarter [Apr-Jun 11] sales and profit growth were quite reasonable. The next 3 quarters are not going to be as rosy. This is going to put downward pressure on equities. Returns on equities in the developed markets have been better. There is a feeling that these economies are turning around as the prospect of double dip recession which was bandied about last year has all but disappeared. So FIIs and other big players are likely to favour developed markets to emerging markets for the remaining part of the year. This is not bad at all. Good investors will rub their hands in glee at the prospect of a temporary slowdown. It is the right time to pick some winners at bargain prices. It should be noted your picks are likely to yield good returns only in the medium term [1-2 years]. As the market weakens look for winners in beaten down sectors, like Cement which has a demand glut and pricing pressure now. Banking stocks also do badly when interest rates rise. They incur losses on bond holding and bad loans go up. Pick the leaders in each industry. Do not immediately jump in to buy. Wait and watch and start building your portfolio during strong corrections.
Fixed Income
The next six months is going to see a peak in interest rates of fixed income instruments. It is important to note that interest rate movement is cyclical and the peaks keep getting lower as the country becomes more developed and our financial system aligns to the developed economies which have a low interest regime. So it is better to lock in your FDs for longer periods of 5 years or more in a cumulative option so that by the time of maturity we can again catch the higher interest rate. Do the same for recurring deposits as well. If you are going for shorter term then choose a bank which does not charge for premature closure. This will allow you to move your deposits in case you get a better rate later on. It would also be good to diversify a little bit into company FDs. Limit the deposit to 3 years and choose a company with at least FAA/LAA credit rating. If you hunt around you could get returns of over 10 % from a few reputed NBFC (Non Banking Finance Company). This is also the best time to go for FMPs (Fixed Maturity Plans) and Debt mutual funds. They are likely to give superior returns in the next one year.
Another option would be Tier II bond issue by banks and financial institution. Note that these are going to be listed in the National Stock exchange. So people looking for quick gains can sell it once it is listed. One such issue is open at present.
Precious Metals
Uncertainty is the biggest contributor that fuels the return on Gold and to larger extent silver. And uncertainty is what we will have in plenty for the remaining part of the year. Political or financial -nobody really knows what is happening or what will happen. Gold is sure to retain value and appreciate if the US financial situation or the Middle East situation worsens. Silver would be more volatile. If you are wealthy then it would good to increase exposure to gold when it corrects.
Real Estate
High interest rates discourage investment in the lower and middle end houses and apartments and prices are likely to come down for these. Upper end residences are likely to retain value or go down a little. The best investment will be in land. You are likely to get good deals by the end of the year if interest rates rise further.
The next six months is to going to open up a lot of opportunities for good returns in the long term. If you pick and choose you can take advantage of the opportunities that come your way.
The writer works as the Country Head for AGEM India Branch, the foreign branch office of the Euro 32 Million Spanish company AGEM S.A. He is in charge of the Indian operations and primarily engaged in sourcing of products from India. He is also Consultant, International Business Development for QualiMed Systems, a fast upcoming medical equipment start-up. His interest in investment started when his father introduced him to the stock markets in the early nineties in the pre-Harshad Mehta era. He also writes for the investment column "Money Matters" in the website Yentha.com.
