Oil, Liquidity and the Sensex @ 12K

The BSE Sensex – the default benchmark for the Indian equity market – touched 12,000 on Friday last week. There is a sense of euphoria, disbelief and caution in people depending on which group they belong to. There are people who have been waiting for a correction from 6000 and are amazed to see the sensex at double that. There are others who are perennial optimists and expect the market to continue giving them the returns in the way it has in the last 3 years.

Milestones like 12000 are a nice point to just stand back and access the overall situation. So, what is the reality of the day? Today, the price of oil is hovering around $70 with the political situation in Iran not getting a whole lot better. Don’t think its going to come down in a while. Interest rates are showing signs of hardening. Prices of gold, silver, steel, aluminium, copper, zinc and sugar are in multi year highs. Real estate prices are going through the roof. So, in a way all asset classes are seeing handsome appreciation. Foreigners are investing in India as if there is not tomorrow.

My feeling is two factors need to be watched most cautiously today. First is the oil price. And second is the liquidity coming into the markets. Oil price hike is inevitable after the state elections are done with. My estimate is that there will be quick and big hikes in the price of retail fuel in India and petrol may move up by around Rs.5 to Rs 8. This will create a spiral of sorts of inflation and further hardening of interest rates. Once bank interest rates start moving up, the retail credit boom is going to be dealt a serious blow. The whole Indian consumption-led story can fall apart if the interest rates are rise quickly. Demand for steel, cement and consequently capital goods companies can start to fall. Once, the market falls, industry growth rates will start reducing in a big way and the market will start looking a lot expensive than today. Already, the market is trading at a PE of 21 which is far more than what I am comfortable with. But the market will be the market and will never care for individuals’ feelings and comfort zones.

There are two things that can save this market from a macro view. First is if the global oil price stabilizes at on or below $60 per barrel. And the second is if the foreigners or even Indians perception of relative risk-reward moves a shade towards riskier assets. In simple terms, it means that if people continue to pump in more money into the system, the system will not break down. It is possible that following the herd mentality, the Indian markets continue see a deluge of foreign investment. There are cycles in these things also, and it is looking to be a great time for India and China as they are in the minds of investors everywhere. As long as the money keeps flowing in we should be good. There is another trigger in the form of full convertibility of the rupee waiting to happen. Once that is available to global investors, they will be much more comfortable to invest in India knowing that they can pull out at any time.

In this backdrop of events, the ever pertinent question of what should be done now with our holdings crops up. Should we buy, hold or sell? If buy, then buy what? If sell, then sell when?

The Indian market – probably unlike some other developed markets – has always been a market driven by momentum. My prescription is to keep holding as long as the going is good. But don’t get married to your stocks. Have some part of your portfolio in trading positions (short term – typically for around a month). Keep rotating these positions to suit the flavour of the time (e.g. now its cement, sugar and metals) and book profits regularly. For your core long term holdings, keep a liberal mental stop loss – say 10% or 15% below the current price (I am assuming that you are making more than 15% profits on your core long term holdings). Stick to the stop loss and sell if and when the price gets there.

Just as an example, my personal portfolio comprises now of 40% trading stocks, 40% core holdings and 5% fixed deposits and 15% cash. You will have to select your own holding proportions.

Happy Investing!!

“One who fights and runs away lives to fight another day”