Tips on Investment on Recession

The global situation in the last two weeks has turned for the worse and investors around the world are a scared lot.

Even the price of gold, considered as safe haven investment, has declined by nearly 7 per cent in dollar terms in the last 30 days. The mayhem in equity markets is there for everyone to see. Everybody now wants to hold cash and that too in US dollars. As a result, the exchange value of dollar vis-�-vis all other currencies rose steeply in the last few weeks, resulting in more problems for emerging markets like us that are net importers of goods and services.

The only positive for the emerging markets is that global commodity prices have also fallen because of lack of growth in the developed economies and slowdown in developing countries. Depreciating currencies will, however, offset the benefits of declining commodity prices to a great extent for the emerging economies. Nonetheless, it will help to cool down prices.

Rate cycle

While declining commodity prices along with a good harvest will have a dampening effect on inflation, particularly in India, the high inflation base during this time last year will make the extent of the price rise look smaller in the coming months. This will, in turn, prompt the Reserve Bank of India to take a break from its rate-hike spree.

If the RBI abstains from further rate hikes, this will send a good signal to the bond markets and prices of bond will start soaring in anticipation of the central bank's next move to cut interest rates.

In other words, it is a good time to lock in at least part of your surplus fund in short-term bond funds or bank fixed deposits. I shall prefer short-term bond funds simply because it involves an element of capital gains in addition to interest income. Besides, bond funds are more tax-efficient than bank fixed deposits.

On a bank fixed deposit of less than 2 years, you can now get anywhere between 9.5 per cent and 10 per cent. Private sector banks are giving a higher interest rate than their public sector peers. At a 10 per cent interest rate on a 2-year deposit, the price-earning ratio (what is the price you are paying for an asset to earn Re 1) of a bank deposit works out at 9.64, which is close to the lowest in the last 10 years.

During the last six months, short-term debt mutual funds and income funds (MIPs) have given between 5 per cent and 8 per cent return.

On an annual basis, these returns work out to 10 per cent and 16 per cent, respectively. This is a fabulous return for any risk-averse investor. And, even if you are a risk-taker, a more than 10 per cent return in these market conditions is alluring enough.

Glam gold

Gold investors, however, have to be careful from now. The price of gold in the international markets has slipped to $1,656 a troy ounce from a peak of $1,900 on August 23 this year. The fall in gold prices has not been reflected in the domestic market because the Indian rupee has depreciated against the dollar. Once the rupee starts appreciating against the dollar, the price of gold will fall in the domestic market as well. The triggers that can prompt the rupee to appreciate are lower inflation and a pause in rate hike by the RBI.

So, the next month is going to be crucial for investments. In fact, October has many a times turned out to be the worst month for the equity markets. This year, a number of crucial developments are expected to take place in October.

Besides, the RBI's second-quarter monetary policy review on October 25, there is the meeting of the European Central Bank's governing council on October 6, and the Open Market Committee of the US Federal Reserve is also scheduled to meet on November 1 and 2.

The equity markets have started witnessing a panic among global investors. Share prices have fallen like they did in 2008 after the collapse of Lehman Brothers.

The difference between 2008 and 2011 is that the crisis in 2008 was unexpected while the crisis of 2011 had been anticipated for a long time.

The 2008 crisis showed that concerted efforts by various governments helped recover the situation quickly. The Eurozone crisis of 2011 may take longer to recover.

But that may actually benefit emerging economies such as India. The recession-like situation in the developed economies with low-interest rates will drive the flow of funds into emerging economies which now account for half of the world's economic growth.

Slow and steady

An intelligent equity investor should be greedy when others become extremely cautious. The 30-share Sensex is now trading at 12 times its 2012-13 earnings estimate (called, one-year forward price earnings ratio). This is barely 10 per cent above the lowest one-year forward P-E multiple (11) of the Sensex recorded since 2000 after the collapse of the Lehman Brothers in 2008.

This means in the worst case scenario the Sensex can go down by another 10-12 per cent from its current level. Now, consider the long-term PE average of the bellwether index. It is 15. This means, while the Sensex can go down to 14,000-14,500 levels from here if the global situations further deteriorates, it can move up to 20,000 - 20,500 in the next 2-3 years. So, the downside risk to equity investment has now become much less compared with the gains.

So, if you are willing to take risks and hold on to your investments for three years or more, start nibbling in high-quality stocks that are now being traded at throwaway prices. However, you should put in small amounts as the stocks markets are likely to go through this volatile phase for some more months, giving investors an opportunity to pick up good quality stocks at lower prices. So, look at price averaging rather than putting in all the money at one go.