Global Concerns – Should investors stay away from equity?

In one of my previous columns published in September 2007, I had noted “Indian Investors will be surprised to know that there are a lot of US Money Market Funds that have invested in subprime debt. Also there are several other financial institutions that have huge exposures to subprime debt. According to a recent Bloomberg column, AIG, the world’s largest insurer and reinsurer, had almost one third (33%) of its USD 104 billion networth invested in subprime related securities. And there are several such insurance companies with subprime exposure of 3 to 20 % of its networth. What would happen if one of these institutions or some large hedge fund with huge exposure collapses like the one we witnessed in August this year? Surely our markets will come down and the ‘decoupling’ that is a buzzword these days might seem like a joke.”

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Till now we have just had the bad news coming in from Citigroup, Merrill Lynch, and other institutions. Now it’s the turn of bond insurers with recent estimates of billions of dollars in losses by bond insurers MBIA and AMBAC; and S&P announcing that it will cut ratings on over $500 billions of subprime mortgage securities and CDOs.  This was in addition to UBS recent announcement of further write-downs of mortgage related assets (write-downs for the global financial sector now exceed $130 billion). I wonder what will happen if any of the insurance companies start reporting such losses. The Federal Reserve’s two successive cuts clearly indicate that there is more pain in the system than seen by the normal eye.

So what could be the implications for equity market investors and what should one do?

When markets go up, everyone is super confident and sees higher and higher levels. If I am not mistaken, the next level sought was around 25000 and if I am not mistaken, there was lot of chit chat going on about the market reaching 25000 before the budget itself. Now when stocks are collapsing, worst-case scenarios loom large in most investor’s minds and levels of 12000 are seen as the next surefire levels.

During the 1929 US Great depression and the greatest stock market crash in history, Dean Witter in one of his letters to his clients wrote, “There are only two future scenarios that are possible. Either we are going to have chaos or recovery. The former theory is foolish. If chaos ensues nothing will maintain value - neither bonds nor stocks, not even bank deposits or gold. Real Estate will be a worthless asset because titles will be insecure. No policy can be based upon this impossible contingency. Policy must therefore be based on the theory of recovery. The present is not the first depression; it may be the worst, but just as surely as conditions have corrected themselves in the past and have gradually readjusted to normal, so this will again occur. The only uncertainty is when it will occur. I wish to say emphatically that in a few years present prices will look ridiculously low. ”

In hindsight, these words echo wisdom and sound judgment about the temporary aberrations and behavior of stock prices and the stock market. However when these words were written, investors were so pessimistic about the future that this message went on deaf ears.

Are we in a scenario that spells doom or chaos? No absolutely not as far as the economy and corporate India’s fundamentals seem to suggest, but a quick look at some of the business headlines “Gone in 60 Seconds”, “Chuck De India”, and “Saare Zameen Par”, however entertaining would cause some heartburn.

So what should be the strategy in a market like this? There could be some pain in the market for some more time. We had seen some excesses in May 2006 where the markets corrected by almost 35% and leverage is one of the biggest reasons why markets such as ours crash. The art of making money in this market is not to panic but to do exactly the opposite of what the people are doing.

Invest with a long-term perspective for your goals and wealth creation. Keep a long-term outlook for your investments, as there is a possibility that the investments done could fall further for a short while. Third, never panic in this market. Don’t watch TV channels portraying bloodbath and calculate your losses or gains daily (instead watching Saas Bahu sagas for a change could be a good option). This will just make things worse and compel you to act.

Like we have mentioned earlier there will be corrections and there is none and will never be any equity market without corrections and volatility. If the level of equity in your portfolio makes you uncomfortable, speak to your financial advisor and rebalance your asset allocation. If you have been holding cash, buy on every fall. The market might still go down after you buy but this is precisely why you are getting a higher return on the investments and this is what is called as RISK. Another strategy could be to wait (I am certainly not advocating market timing) and be patient for some FII buying and liquidity to resume.

In the meantime, just remain calm and stay put. Hold on to your portfolio and do not take any rash decisions. We are confident that equity will do well in the long run provided you have the two key virtues needed in such times - patience and courage to buy when there is blood on the streets.

Since the future will always be uncertain, psychology and sentiment often dominate economic fundamentals in the short term, but in the long run, fundamentals will take center stage and markets should look up to reasonably higher levels from where we are.

- Amar Pandit

The author is a practising Certified Financial Planner. He can be reached at amar.pandit@moneycontrol.com

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