Resist the temptation to sell investments and stay away from gold.
Ever since Standard & Poor's downgraded US sovereign debt, all hell seems to have broken loose in the world markets. As investors, we have two options – either succumb to this panic or take a step back and get things in the right perspective. Now, if history is anything to go by, the first lesson we have learnt is not to take what a rating agency says, as gospel truth. Isn't it hardly three years since the sub-prime debacle? Weren't all those mortgage backed securities that almost threatened to take down the global financial system also rated? And in any case, why do markets need a downgrade to be spelt out to start panicking? Isn't $14 trillion of debt, in the first place, enough to get people worried? A 2011 fiscal deficit of $1.65 trillion with $2.46 trillion of the aforementioned mortgage and treasury securities sitting on the balance sheet of a country should have been enough to terrorise even the most optimistic of investors – it didn't necessarily require an S&P endorsement.
Coming to India, it so happens that our stock market comprises two distinct sets of investors - the first set is the Foreign Institutional Investors (FIIs) who over the years have pumped in billions of dollars into our stock market. The second set consists of us, domestic investors. Ironically, it is we domestic investors who have traditionally shown far little conviction and confidence in our own markets than our foreign counterparts. When the foreigners invest their billions thereby driving prices up, we tend to jump on the bandwagon and enjoy the joyride. And when the foreigners liquidate their holdings (as they are doing now) thereby driving down stock prices, we stampede out trying to beat them to the exit.
This, in spite of the fact that India continues to grow between 7.5-8.5 per cent, depending upon whom you are listening to. Yes, there will be collateral damage in terms of tighter capital and trade flows and of course a significantly lower participation by FIIs in our stock market. However, why are FIIs selling in India when the problem lies elsewhere? One reason could be, that investors are booking profits here to cover up for their losses elsewhere.
Then there are those institutions that are healthy and remain relatively unaffected. However, looking at the carnage all around, these global money managers prefer holding on to their purse as tightly as they can. Compared to their developed counterparts, as an asset class, emerging markets are considered to be riskier. In the current situation, this is nothing but an irony. Despite ample evidence to the contrary, India exposure at this point is considered unsafe - another example of how common sense goes out the door when the fear psychosis hits
However, it's not as if this is the end of the world. Right now, the wounds are being licked and in the course of time, these very investors will consolidate and regroup. And once that happens where do you think they will turn to? Of course, to the very markets that offered them a profit in the first place! It's logical, almost intuitive. So it should not matter if the market falls to 15000 or sinks to 12000. But to be sure, once this storm blows over, things will be back to normal trot.
There is yet another reason for such faith – and that is the cold fact that the US has a symbiotic relationship with the rest of the world. Both thrive off each other. In other words, the Chinese manufacturer, the Indian service provider as indeed the Brazilian miner, all, require the American consumer to survive. The US, is simply too big to fail. Metaphorically and literally!
Also, the problem though complex is identifiable. The components of government spending or the main causes of the debt are of course, interest payments (on account of increasing debt), Medicare (free healthcare for those over 65), Social Security (contributions during the working life do not even come close to the annuity paid by the government upon retirement) and defense spending. The Tea (Taxed Enough Already) Party, if it has its way, will prevent any attempts to increase taxes to bridge the shortfall. So the focus has to be government spending, specially on Medicare and defense. In time, things will have to be worked out, partly curbing the welfare measures and partly by perhaps bringing in a sort of public-private partnership in other areas of expenditure. In the meanwhile, the world has no other option but to be patient and wait.
In the meanwhile, investors would do well to embrace a Buffetism - "Be greedy when others are fearful and be fearful when others are greedy". This is something that Buffet has always maintained. And now, all one sees is fear. A fear that is bordering on terror. And to my mind, this represents a great opportunity for those investors who succeed in correctly analysing the anatomy of this terror.
Try to resist the instinct of selling investments. Let others make this mistake. At every fall, stock up on blue chips and qualify equity mutual funds (MFs). And then sit tight and let the market do its thing. Don't buy gold at this point. Reason being, gold prices have gone through the roof on account of the safe haven syndrome. Yes, there is a tectonic shift taking place in the world order and over the long term the dollar will indeed lose value. It is for this very reason that, over the past four years, money, hitherto parked in dollar denominated securities is gradually moving into gold thereby driving up prices. But the current spike is more of a knee jerk reaction and already prices have started paring down. Its best to wait till the dust settles. Consequently, any portfolio allocations to gold are best done in a staggered gradual manner when things become a bit clearer.
Now, in the midst of all this turmoil, going ahead, one cannot expect our market to post new highs. However, this kind of a fall borders on sheer lunacy. When someone else has been inflicted with a disease, albeit serious, there is no reason why we should be rushing to admit ourselves to the intensive care unit.
The thing to do is to keep your mind when the world around you is losing theirs. Keep your eyes firmly on the fundamentals of the market that you operate in. It is possible that all the negativity around may drag the index down further. However, sentiment can only hold so long - sooner or later, the reality of the health of our economy will kick in. And when that happens, only those who were greedy when others were fearful will be smiling.
The writer is Director, Wonderland Consultants