As an economic slowdown looms, investment experts agree that now is the time to prepare for the next boom. By Mohan Sivanand
Samyukta Iyer, a 34-year-old New Delhi educational consultant, has been investing in shares since 2003. She rejoiced as the value of her investments grew by more than 300 percent last December. Then came the fall.
By early-January, as the first reports of an impending recession in the US emerged, Indian stock markets began to weaken steadily, until they saw a free fall in October. “Today my shares are worth only 25 percent of their January value,” says Samyukta.* “It was heart-rending at first.” Even so, unlike millions of other investors the world over—whose panic-driven selling caused the crash—Samyukta has not sold a single share. Instead, she has, in the past weeks, been buying more shares at their beaten-down prices. “This is an opportunity,” she says. “I know the markets will bounce back to new highs one day.”
Economists and financial experts are agreed that the chill winds of a recession are blowing across the world. In India, the resultant slowdown may only get much worse in the coming months before it gets better.
So, first, the bad news. A global recession means lower earnings for most businesses and industrial sectors. Many of them, especially those dependent on exports, may even suffer losses just as it happened during the last recession, which began in 2000 (after the “tech bubble” burst) and ended around May 2003. Today, we’re seeing a replay. Everybody, from car salesmen to shopping malls, is offering discounts. We’re also seeing salary and job cuts, and even if you’re securely employed, your next increment may not be as good as last year’s.
“But bad news is an investor’s best friend,” wrote Warren Buffet, the world’s most famous investor, in a New York Times article in October. He said so because any recession has to end. Although nobody can tell for sure when that will happen, many experts say the current one will run through 2009. To decrease its impact, governments across the world are taking steps like never before with interest-rate fixes and “bailouts” for failed banks and other key businesses.
Meanwhile, the mainstream Indian banking system is secure (making your deposits safe). And, thanks mainly to domestic consumption, experts, including the prime minister, predict a good 6 to 7% growth in industrial output this year, even though developed countries like the US, Japan and Germany don’t expect to see any growth at all. In fact it’s been said often that a final recovery from this recession could be led by continued growths in China and India.
As individuals, there’s little you can do to control any economic slowdown or global recession. But you can indeed control your own affairs; especially in the way you spend, save and invest your savings.
“This is the time to act and be positive,” says Gaurav Mashruwala, Mumbai-based certified financial planner (CFP) and member, Global Advisory Council of the US-based Financial Planning Association. “I’ve seen several slowdowns, and there’s nothing abnormal about these ups and downs. The reports scare you. Pick up old newspapers from 2002 and you’ll read the same kind of doomsday stories. Yet we saw the best of times after that. Without downturns like these, you can’t make really great profits.”
Reader’s Digest consulted several other experts too, and used hindsight to bring you these invaluable lessons learnt from the last global recession.
INVESTMENTS
Periods of recession can be the best of times to sow the seeds, be it in fixed-income investments or in equity shares. Take a look at each one.
Fixed-income assets. Suddenly big banks have hiked interest rates on FDs from up to 7% last year to as much as 11%. If you take long-term (say, three- to five-year) deposits now at today’s rates and lock them in, you’ll get the same returns long after the recession ends and interest rates go down again, as Gilroy Gonsalves of Mumbai once enjoyed. The Post Office term deposit he made at 13% interest in 1997 continued well into 2003, although they’d slashed rates for new deposits down to 8% by then. “Like all Post Office deposits, my money was safe too,” says Gonsalves, 56, a regular investor, who moves his money to FDs when he makes reasonable profits from stocks.
Meanwhile, if you have an old bank FD that’s fetching only about 7%, talk to the branch manager about closing it and starting afresh at a higher rate. Many banks are doing so now with no penalty.
But be careful! As rock solid state-owned banks like SBI offer you 11%, many private companies and non-banking financial institutions will lure you with much higher interest rates. During the last recession, innumerable companies and private borrowers defaulted on their FD schemes and investors lost all their money. “Don’t be lured by very high interest rates, because the risk of losing your capital also increases substantially,” warns Mashruwala. So protect your capital by sticking to the most reputed of banks that now offer around 10.5%
Beware! FD Scams
Those who offer abnormally high rates of interest are only doing so because savvy depositors, banks and financial institutions don’t trust them enough to lend them money like you would.
Your foremost concern should not be getting a high rate of interest. It must be about protecting your principal.
Avoid traders, jewellers and other businessmen in your town who may offer their own FD schemes. Many of them cheat or go bankrupt.
The safest places for FDs: state-owned banks, the Post Office, banks run by top financial institutions with a long and profitable track record.
Cooperative banks can be less safe and many have gone bust in recent times.
Income funds. These are mutual funds that invest in medium- to long-term fixed income securities like government bonds and debentures. “It’s a very good time to invest in income funds,” says Lovaii Navlakhi, CFP, managing director of International Money Matters, Bangalore. “That’s because interest rates are high. As interest rates come down, the value of the bonds and other papers that back these funds shoots up. That means capital appreciation and higher returns for investors.”
We saw that happen as the last recession drew to a close in 2003 and interest rates fell. It will happen again. Moreover, because your investment faces low risk, income funds can be a fine alternative to company FDs.
Shares. This is where you can benefit the most. During the height of the last global recession Reader’s Digest quoted Parag Parikh, leading Mumbai stockbroker and chairman of Parag Parikh Financial Advisory Services Ltd. “Now is the time to make selective stock purchases,” Parikh said in our September 2002 article “Staying Ahead in Tough Times.” He was right—if you’d paid heed, bought good stocks, and patiently waited, stocks did move up phenomenally from May 2003 for the next four-and-a-half years. We asked Parikh again for his opinion on stocks now. “Many of the best stocks are now available at mouth-watering prices, and it’s once again the time to buy,” he said. “Investment returns are a function of the price at which you bought a stock. So buying at today’s low prices means your returns are going to be high over time.”
Parikh, who is also the author of “Stocks to Riches” (Tata McGraw-Hill), explains that it’s value he looks at. “The stocks of some good companies now offer a high dividend yield of 10%,” he says. “I’ve now been making my clients buy. I don’t predict market conditions—that’s an astrologer’s job—but when there’s value like this, you buy for the long term.”
“There’s a sale going on,” adds Mashruwala, describing today’s stock prices. “Go pick them up selectively. Only by investing in times like this can you make abnormal gains.”
Lovaii Navlakhi of International Money Matters agrees, but he’s telling his clients “not to invest a lump sum” since stock prices may go down even further, especially over the next few quarters when many companies could show decreased earnings. If that happens, even today’s “lows” could seem relatively high. But markets tend to foresee the medium-term future and today’s low prices may have already factored those expected low earnings in. “Anyway, it’s best to invest in a staggered manner over the next six to nine months,” says Lovaii, “and hold on to those stocks patiently.”
Indeed, if the global recession worsens, many of our best companies will face challenges. But as Warren Buffet writes: “… fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records five, ten and twenty years from now.” (He was writing about American companies, and there’s no reason why that observation shouldn’t hold for Indian companies as well.) But there’s fear all around now, and relatively few people are buying stocks. But investors like Buffet, who are busy buying, think otherwise. “A simple rule dictates my buying,” he wrote. “Be fearful when others are greedy, and be greedy when others are fearful.”
Stock Facts
Choose companies whose products or services are in great demand.
Study a company's profits (it's easy at www.moneycontrol.com). Choose those with a long history of strong growth, profits and regular dividend payouts.
Buy when share prices are down. Sell only when prices go up.
Don't fall for initial public offerings. Companies launch IPOs only when "market conditions are favourable"—for the seller, not for you the buyer. (That's why IPOs have now stopped.) By November 24th, of the 146 IPOs listed since January 2007, only 16 sold above their offer prices, while 106 of them are 50 to 97% cheaper!
The same truth holds for new fund offers (NFOs) of mutual funds schemes. They aren't cheap, just because you get them at Rs10. Choose an existing scheme with a good track record instead.
Read business papers; keep track of companies and investment opportunities.
Never take blind advice from relatives or friends, or buy or sell based only on rumours. If you can't do your own study and research, stick to equity mutual funds.
Never borrow money to invest in equities. Invest your surplus cash only.
Index funds. This might sound incredible now, but stock markets tend to move only in one direction—up—over long years. The Bombay Stock Exchange (BSE) index, the most popular barometer of our equity market and better known as the Sensex, was at 123 points in March 1980; 778 points at the start of 1990. It touched 6150 in 2000; it came down to 2594 in 2001; crossed 10,000 in February 2006; and peaked at 21,206 this January. This October, it was down 63%.
Nobody can predict what the BSE Sensex will be at a few months or a couple of years from now, but over the next ten, 15 or 20 years, there’s every possibility that it could break all previous peaks, making this year’s crash, too, look like a blip on the graph, just as all the older dips (of 1987, 1992 or 2001) now seem. Indeed, research has shown that the Sensex keeps growing at a compounded average annual rate of 20% over almost any given 20-year span (but any short-term gain or loss will remain unpredictable).
Index funds are mutual funds that always go up or down with the Sensex (or any of the other stock market indices, like the Nifty, the National Stock Exchange’s index). The world over, index funds have given good returns over the long term. And to buy them, unlike stocks or other mutual fund schemes, you need do no homework, although it’s best to invest when the Sensex and Nifty have made a big fall—as it’s happened now.
Take this example. In September 2002 (during the last slowdown), the Sensex ended the month at 2991 points. Had you invested Rs10,000 in an index fund, it would have
been worth over Rs70,000 (growing 600%) on 1st January, 2008. Even today, although the Sensex has steadily fallen to under 9000 points, your investment would still be worth over Rs30,000—a 200% profit in six years. Proof that investing during “bad” times pays.
Boom (shown green) and bust (red) cycles have followed one another. Previous recessions and slowdowns look like minor blips today, because over the long term, stock markets are efficient and the Sensex has moved to
new highs after every fall.
Click to enlarge
YOU MUST DIVERSIFY
“Don’t rely entirely on stocks or index funds,” says Mashruwala. “Plan for a balanced mix of equity and fixed-income investments.”
When the recession ends and the markets move up considerably again—and when, as Buffet says, “others are greedy”—that’s when you should be fearful and sell part of your swollen stocks. Invest your tax-free profits (there is no tax if you sell shares or equity mutual funds after a year of purchase) in bonds, Post Office deposits, or bank FDs. This way your assets will be rebalanced and your capital much better protected against another recession and yet another future stock market crash (inevitable given time. “Only there could be a different excuse,” says Mashruwala).
GOOD TIMES AGAIN
How will the recession end? Even if you read all the financial papers, you won’t find an announcement saying so one morning, but you’d get real indicators if you watched. We saw it coming the last time when Business Standard reported in mid-May 2003 that the “overall net profits of Indian companies may now touch a five-year high,” and “as many as 59 listed loss-making companies saw a turnaround and showed profits during the 2002-03 fiscal year.” A big reason, the Standard explained: a drop in interest costs for businesses. Also, that month, Hewitt Associates in their annual salary survey projected an average raise of 8.5 to 11.4% across all employee groups in India. The good times were back!
Similar reports will appear again. Other indicators: A rising Sensex with foreign investors returning to India with their billions; in 2003 bank shares were the first to move up; a stronger rupee; inflation levels below 4%; discounts fast disappearing from shops—and from equity shares.
Until then, it’s the time to save and invest wisely, and enjoy the discounts while they last, so that you may reap rewards when the good times return.