The Bear Attack ……

The beauty of a bear market is that bad news comes out of the blue just when you start thinking the worst is over. Ranbaxy and Infosys are classic examples. Everyone seemed most bullish on these two. Ranbaxy was holding out nicely while the whole market was tumbling around it thanks to the acquisition by Daiichi Sankyo. Infosys was expected to do well after a substantial depreciation of the Rupee over the June quarter. But the numbers just didn’t meet the market expectations and guidance was muted. The worsening scenario for the financial sector in US and Europe only made things worse. Both the stocks lost over ten percent in just two days.

Bad news follows declines ….
The problem in a bear market (which is backed by economic doom and gloom) is that even the companies that we talk to have little clue about what’s going on. They are not quick to realize the changes that are taking place in the larger picture. None of the companies focus on the bigger picture of the economy since they are mostly reacting to developments that are taking place from time to time. The guidance that they provide to analysts rarely takes into account the macro economic risk factors. Hardly any companies were bullish when the markets ran ahead of the fundamentals in 2005 and I can say that right now hardly any companies are bearish about their business outlook when the markets are going down. Mostly they are surprised at the valuations that are there today. To me it just means that the market expects the fundamentals to deteriorate going forward, even if the companies don’t think so yet. The market is telling us that the bad news is somewhere on the way.

Collapse of the US financial sector likely to impact IT business…
In a situation where India is now so closely integrated with the world, it’s getting more and more difficult to know everything that can affect our economy and businesses. The increased uncertainty means more risk and therefore lower PE multiples. It will be foolish to assume that the Indian economy will move strongly ahead while the world’s biggest economies are in a recession. Failure of financial institutions in US and Europe is bound to create problems for the IT companies that have heavy dependence on the BFSI space for their revenues. Most of them will have a substantial exposure. Whether it happens or not, investor must be cautious and not become overconfident even if the analyst con-calls don’t suggest any problems yet. Past performance is no guarantee for the future when there are dark clouds over the horizon.

Lessons from the collapse of Fannie and Freddie…

Fannie Mae and Freddie Mac have been in the news during the whole of last week. These two companies account for around 50% share of the US mortgage finance market. The problems with these companies are not new. Fannie Mae had reported a loss of $2 billion last year (2007) while Freddie Mac had reported a loss of $3 billion. The sub-prime issue has been in the news for nearly a year now. Bad news kept piling on to push these stocks deeper as the crisis kept escalating to a point where they are being considered by some experts to be technically insolvent. The US government has had to stand behind these two companies to assure investors only because they are “too big to fail.” The smaller ones like IndyMac face closure. Over the last twelve months, these blue chip stocks from the US have lost more than 85% of their value!!

So what do we learn from this?
The more you wait for real bad news to come, the more you lose.

1.The more you wait for real bad news to come, the more you lose.

2.If the clouds are really dark, rain will come. More bad news is inevitable if there are dark clouds on the macro economic front.

3.The third and most important take from this example is, never underestimate the power of a bear market. A lot can be lost. The post-dotcom bust had wiped out the second rung players. Most of the companies had lost more than 80-90% of the value, while even the blue chips like Infosys had lost more than 70% from the top. Even the recent crash of the realty stocks provides a similar picture with many of the smaller players losing 80% from the top, when the financial numbers haven’t even turned bad!!

History repeats itself …

History provides us a good time perspective on bear markets. A bear market typically takes anywhere from 12-18 months from the top to provide a strong bottom. We have just been 6 months into a bear market while some of the other markets have been in a bear market for a little longer than that. So what’s the hurry? We have a long way to go. Let things unfold themselves. As I mentioned earlier (July 7, 2008), the world needs to go through a structural adjustment phase in terms of commodity prices, equity markets, housing prices, currency rates, interest rates, etc, all of which are related to each other. And this process will take time. May be all this will get over by middle of next year sometime to provide a strong bottom for a sustained revival. Till then it is anybody’s guess as to what will happen and how much more we might lose.

The best thing to do…
The best thing to do is to wait out a period of 12 months from the top and then look for companies and businesses that seem to be on a sound footing. Investing at the bottom can provide you great returns with minimal risk.

Vivek Bhargava

(For taking this discussion further please contact me at wealthbridgeindia@gmail.com)

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