What shape will get the recovery take?

Believers of this theory are of the view that the worst is over for the economy,and soon it will be chugging along nicely. According to its proponents,October 2008 was the bottom of the V and today we are well past that crisis scenario. Recent data from various government agencies also suggests that the worst might indeed be over for the Indian economy. Recently C. Rangarajan,chairman of the Economic Advisory Council to the Prime Minister,also said that he expects strong GDP growth next year.

The RBI,in its monetary policy review next week,is widely expected to hold key rates steady. If the RBI does not tinker with the repo and reverse repo rates and cash reserve ratio (CRR),then there will be adequate liquidity in the system,as is the case now. If it goes ahead and imposes a ceiling on the amount of money that banks can park with RBI (through the reverse repo window),then we may actually see banks getting more aggressive in pushing loans. This will also lead to a situation where the economy gets a boost. Stock markets may then have a reason to move higher over the next one to three years.

Recently Australia hiked its interest rates and that led to the Aussie (the Australian currency) soaring. Similarly,our Reserve Bank Governor has also made statements which convey the point that interest rates cannot remain so low forever,and tightening of rates has to begin somewhere. If in the policy the RBI even suggests that they may consider tightening rates in the next quarter to control inflation,that will make our currency soar as well. That’s because as rates increase,more money will flow into India,and that will lead to a higher demand for the local currency,causing it to appreciate. Further,when global funds come to India,our forex kitty will swell and the macro picture will improve. This will attract more money. All this money will find its way into our stock markets. Thus it appears that our stock markets are poised to move higher over the next few years.

W-shaped recovery

This theory suggests that it is not yet time to pop the bubbly. At best the current rally in stocks can be said to be a nice bear market rally and nothing more. The fundamentals are not as rosy as might appear at first glance.

Today the US is confronted with unemployment levels that it has never seen before ever since it started maintaining records of unemployment data. How will a country whose economy depends on consumerism come out of the woods if its citizens are unemployed? How will they spend if they are not earning in the first place? Thus all export-led growth sectors can safely be assumed to be underperformers in future (since the situation is not too different in the other developed-world economies as well).

Secondly,if you look at the results of the banking sector,most of the profits have come from treasury income,and not due to a pick up in credit demand. Banks made money in the bond markets as long as interest rates were going down. There is no way they will be able to make similar big profits,either from treasury gains or through higher credit offtake,in future. In the near to medium term,results of the banking sector may not be something worth writing home about.

This brings to the fore the fact that other industries are not borrowing. Whatever results have been delivered,in most cases they were the result of improvements in operational efficiencies,and not due to an increase in the topline. The implication: even these results may not be sustainable in future.

Then there is the threat of RBI increasing rates in the next policy review meet,which is hardly three months away (some time in January 2010). If RBI hikes rates then corporates will find it even more difficult to borrow,and hence credit offtake may be even lower.

Then there is the liquidity theory. According to this theory,a situation may arise some time next year when the US starts reducing the massive supply of dollars from the system. The moment this happens,expect foreign money inflows to decline. This could lead to another big fall in the market. This would be the second bottom of the W curve. After that the actual solid long-term recovery would begin.

What should you do?

Retail investors should continue with their systematic investment plans (SIP) in mutual funds. A better way to invest than SIP is what is known as Value Averaging Plan (VAP),which allows you to book profits at higher levels and enter again at lower levels. In SIP you never book profits! But for investors who don’t understand VAP,SIP remains the best choice.

Investors who wish to invest in bulk should take a call: are you a V or a W theory believer? Accordingly take a stand. Whether V or W,over the next five years there is no reason to believe that the Sensex will not hit 36,000. Assuming that we are at around 18,000 today,this translates into a 14.4 per cent compounded annual growth rate. Not bad at all!

For retail investors index funds and exchange traded funds (ETFs) are the most inexpensive investment vehicles. Sector funds should be considered by those investors who understand the risks and the returns of that particular sector. Power and banking are two sectors that many experts believe will be long-term winners. However,at current levels valuations appear stretched in both. So have a sufficiently long investment horizon if you wish to profit from these stocks. u

The author is a professional financial trainer and proprietor of Nagpur-based Money Bee Institute.

E-mail: ashutosh@moneybee.info