I had the following recommendations for my group and blog readers. This has been backed by Killol Karia of HDFc Asset Management Company. He has attached a word document whose contents are as follows.
In the past 31 days, the Indian stock market, represented by the BSE Sensitive Index, has fallen very sharply, from 12671 to 9200, or a fall of 27.73%. This is a significant fall, and at this time we wish to share our thoughts with you on this matter.
Please do not panic: The worst thing that any investor can do now is to panic and try and sell his/her holdings.
It is the basic law of economics that when prices fall, demand rises, and vice versa. The caveat here is that all market participants have full information, and that all market participants are rational in their decision-making. In the stock markets, more often than not, when there is a fall, there is an initial reaction to sell and get out. Is this not irrational behaviour? When something that one considered as purchase-worthy has just become 20% cheaper, should one sell, or buy more of it?
Have the fundamentals weakened? Can the fundamentals of an economy weaken within 11 days? Just 11 days ago, almost everyone was so sanguine about the economy. Certainly, there was an element of hype and speculation at that point, but can anybody deny that the fundamentals are still good? Corporate profits have risen by 26% in FY 2006; interest rates are still within reasonable levels, operating profit margins for corporate India are at a healthy 17.6%. Many sectors continue to report good numbers.
This is not the first time the market has corrected sharply. Let us refresh our memories a bit, and look at the instances where the BSE Sensitive Index corrected sharply.
From 11/05/2006 12671 to 08/06/2006 9200 27.73% fall
From 05/10/2005 8821 to 28/10/2005 7656 13.21% fall
From 23/04/2004 5905 to 17/05/2004 4227 28.42%fall
From 10/09/2001 3224 to 21/09/2001 2594 19.54%fall
From 14/02/2000 6150 to 23/05/2000 3831 37.71%fall
Therefore, this is not the first time that the market has fallen. For each time, the reason was different, and all these reasons seemed very pertinent at that point of time. Ultimately, we have to remember that in the long run, the intrinsic business strength of the company concerned, and the profit growth of that company is what will determine its stock price growth. All other points pale in comparison.
Why didn’t the fund managers foresee this? After all, aren’t they the experts?
We are willing to go on record to say that nobody (absolutely nobody) can predict the movement of the stock market in the short run. This is because in the short run, the market is governed by thousands of variables (economic, political and emotional reasons, human emotions of fear and greed) over which we have no control. For all we know, the market can correct a bit more before it recovers, or it can recover straightaway. The job of a fund manager is to identify businesses that are expected to do well over a period of time, and at prices that are not extraordinarily expensive, and then stay invested. Time is the best friend of a long-term investor, as it helps in compounding the returns.
What should one do now?
If one is already invested in equities, and in companies where one is confident of the future prospects, the best thing to do now is not do anything at all.
If one is not invested in equities, or if the exposure to equities is low, then this may not be a bad time to invest in the stock market now.
At 10481, the Sensitive Index is quoting at a P/E multiple of 15 on estimated FY2007 earnings. This is significantly lower than the 19 P/E that we saw just 11 days ago. With the earnings growth for corporate India estimated to be around 16% for the next few years, this correction has provided a good opportunity for persons who are not adequately exposed to the stock market to do so.
For those whose exposure to the stock market is already adequate (the adequacy of the exposure should be judged by each person individually in consultation with a good financial advisor), this is a good time to realign the portfolio and concentrate holdings into businesses that one is more confident about. This is a good time to prune the marginal holdings and buy more of the stocks that one is more confident about.
In conclusion, the best way to participate in the growth of the economy is to stay invested in good quality businesses. When these businesses grow, the investor’s wealth grows along with it. Please ask yourselves these questions. If the answer to these questions is yes, then you should stay invested in equities.
(1) Do I have faith in the economic prospects of this country, and its private sector?
(2) Do I have the ability to withstand the fluctuations in the stock market, and am I in it for the long haul?
(3) Can I spare this money invested in the stock market without it making any impact on my Standard of Living?
Finally, in times like these, what better learning can one get than the teachings of the great masters? It is impossible to put it better than this quote from Benjamin Graham, the father of modern investing:
“ The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. This man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement. ”
Do we bother about the prices of the houses that we have bought on a daily basis? Do we bother about the prices of the other assets on a daily basis? Why then should we be bothered about the prices of stocks on a daily basis?
Please stay invested in good quality businesses. That is the best thing to do. Please do not panic. That is the worst thing to do.
Happy Investing !