Ignore the ‘Taper Tantrum’

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2014 has begun with another round of emerging market hysteria and both retail and institutional investors are hitting the panic button. The Indian Rupee after bottoming at 68 against the dollar in September recovered and is now trading back at 62.50. My inbox is getting flooded with e-mails from subscribers who are asking the same basic question: “What do we do now?”

My response is to stop panicking! The US Federal Reserve is cutting back on quantitative easing, which has been the biggest driver of US equities since 2009. Anytime a central bank reduces liquidity in the global financial system there will be increased volatility in markets. Yes, there will also be a short-term impact on Indian equities. But Raghuram Rajan, the head of the RBI, is doing the right thing by hiking interest rates to bring inflation under control. This also has the impact of shoring up the Rupee.

I’m in no way a macro forecaster. However, I do think that there is limited scope for further Rupee weakness. Unfortunately, investors are currently lumping all emerging markets together and assuming the worst. However, you need to distinguish between the various countries that make up the emerging markets. Two currencies that have been hit hard are the Argentinian Peso and Turkish Lira. The Argentinian economy is a basket case and is facing inflation in the 30% range. Poor monetary policy and a socialist government are purely to blame. In Turkey, the issue is a massive current account deficit and a major political crisis.

The Indian economy has undoubtedly been slowing with FY14 GDP growth expected to be in the 4.5% range. On the positive side, corporate balance sheets have been repaired as companies have used excess cash flows to pay down debt over the past two years. As the economic cycle turns, corporate spending on capital expenditure will pick-up and drive improvement in GDP growth in FY15.

In my view, further reductions in quantitative easing are going to create more volatility across all emerging markets. Which means, astute value investors in the Indian market will have plenty of buying opportunities to pick-up great franchises at discounted valuations.

In the book, The Warren Buffett Way, the author Robert Hagstrom states the following:

“One of the principles demonstrated clearly several times in this book is to buy great businesses when they are having a temporary problem or when the stock market declines and creates bargain prices for outstanding franchises.”

The recent market volatility is producing some excellent bargains in the Indian equity market. In the recently published February issue of VIIR (Value Investing India Report) I highlighted a business that is currently a dominant player in its field, produces high ROE (Return on Equity), has virtually zero debt and run by a management team that is laser focused on shareholder returns. You could literally buy this one company’s shares and hold them for a decade and you would probably beat the market over that period.

My point is that the current problems related to “tapering” are short-term. Focus on the long-term and try to find businesses that are great franchises and buy them at a discount. Don’t get too hung up on what is causing the discount. If you have a 3-5 year timeframe it’s not going to matter whether the Fed “tapered” in 2014 or not.

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