Global Financial Crisis - How to profit from it

The global financial situation continues to deteriorate and several institutions such as AIG and Citibank have been asking for more government aid.

AIG, the troubled insurance company is getting an additional US$ 30 bn as aid from the government. Infact Ben Bernanke (Federal Reserve Chairman) went to the extent of saying “AIG operated like a hedge fund and having to rescue this irresponsible company has made him angrier than any other episode during the financial crisis”.

Late last year, AIG had announced severe pay cuts for it CEO, restricting it to a nominal $1 for 2008 and 2009, while there would be no pay hikes for its senior executives in 2009. The stock of AIG is down 99 per cent from its peak to around 35 cents (US $ 0.35) as of Monday.

The legendary Peter Lynch had said in September 2008, “I can be just as dumb as anyone else”. Incidentally Peter Lynch had both AIG and Fannie Mae in his portfolio, the stocks which dropped by more than 80per cent in just one month.

Similarly Warren Buffet, the world’s revered and best investor also acknowledged the fact of making several mistakes in 2008. The point that I am trying to make is that even the best could not foresee the gravity of the current financial crisis.

The scenario today is far different than what has been in the past and looking at history to provide answers might not help at all. Nobody has any clue where we will land up 6-8 months down the line.

Our own markets have been plagued with several problems right from corporate governance issues to currency woes. To compound the problem further there is a lack of institutional buying that is happening and in fact we have seen a huge outflow by FIIs since February 16, 2009.

Opportunities in the Current Market

The Dow closed at 12 year low on March 5, 2009 and Indian markets might breach the 8000 levels and could witness 7800 levels in the next couple of days or weeks. There now seems to be strong indicators in place that we are headed downwards and there could be more pain down the line.

This will bring us to valuation levels (not index levels) witnessed in 2003 and for people who have missed the bus then, this could once again prove to be a great opportunity.

There is no rush to jump in today but one should certainly look to invest at 8100 or lower Sensex levels as these are mouth watering levels for the long term investor. March 2009 could look a little bit like October 2008.

Surely individual stocks can go down 50 per cent or more, but the broader indices namely the Nifty and Sensex will not go down 50 per cent. If this happens then one should take a significant higher exposure to equity, bypassing other asset classes.

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Just as an example, some of the Indian Banks are available at excellent valuations with some of them available at less than their book value. At the same time these are also banks that have been clocking growth of 30per cent p.a with negligible NPA levels.

They are attractive at current levels but a further 10-15 per cent correction in these stocks would mean a great opportunity for long term investors only (not trading buys). This is also the time to weed out stocks with poor fundamentals and move into solid companies that are available at extremely low valuations.

Gold: It has been the star performer as expected in the last several weeks and months. Everyone is talking about gold reaching Rs 20000 levels. Though I am very bullish on gold, I believe you must book profits if you have sizeable exposure to gold. Surely gold can go up from here, but the immediate upside looks capped.

In equity market jargon, we might be somewhere near 18500-19000 Sensex levels. Gold being a volatile asset class can correct by as high as 10 per cent in a day and don’t be surprised to see days of Rs 1000 fall in gold prices. Over the next 2-3 years gold could shine but book profit regularly and this is certainly a time to do so.

Real Estate: Not just home prices, but interest rates are on their way down as well. Banks and institutions today are offering a 9.25 per cent floating rate of interest. Some banks have come with innovative schemes as well and low ticket loans also attract a lower interest rate. With inflation going to 3 [er cent levels and lower GDP numbers, RBI could come up with yet another interest rate cut. We are moving towards a low interest regime where I will not be surprised to see a 7-7.5 per cent interest rate.

On the other hand prices have corrected sharply with some builders dropping prices by as high as 35-40 per cent . Prices will drop further as there is no genuine demand even at these prices. Looking at the current scenario, don’t jump into Real Estate till October 2009.

You could probably get some gems at that point of time. Even if you must buy a home now, think about your job or income stability and whether you will be able to pay EMIs comfortably in the next few years.

On the whole I believe that patience will deliver stupendous benefits on the real estate front too as you might just be able to afford a bigger house six months down the line.

Keep short term money in fixed deposits (people in the lower tax brackets), liquid and floating rate funds and also look at Income Plans (Long Term Bond Funds) from a 6-12 months perspective.

The impact of the current interest rate cut will take some time to take effect as government borrowing is also keeping bond yields higher. With a strong possibility of reduction in interest rates going forward, long term bond funds could deliver good returns.

Finally the world is not coming to an end. In fact it is changing in many profound and positive ways. The key is to understand the changes happening around you and be ready to profit from it.