Taking advantage of the current undervaluation of the market

28 July 2015 06:30 pm Views - 1769

The current political situation in the country is in flux and has created a sense of uncertainty within the public. This uncertainty seems to have pervaded their investment activity, where investors have sought to either be inactive and take a wait-and-see approach to investing or have chosen to withdraw their funds from the stock market. 

Due to the political hesitation in the country - there is somewhat of a directionless situation in the minds of investors. In any country, investor sentiments respond to this kind of situation and as a result of that, the entire market has been undervalued. 

However, investors should not be very concerned by this current situation; simply because we have seen over the past few years a certain convergence in economic strategies in Sri Lanka. Where the major political parties, compared to pre 1977 era have followed a similar market-friendly economic strategy since 1977. Therefore, we know that whichever political party comes into power – they understand the importance of the private sector. Similarly, that translates into the importance of the stock market, since it helps fund the private sector. Therefore, I don’t think that investors should worry too much about the current political developments because the values and directions of these companies and the fundamental valuations of these stocks will not alter dramatically - as a result of the new government. 

Nevertheless, there are certain sensitive areas, where government policy can affect the performance of companies and therefore the performance of their stocks. There are certain policy decisions that could affect specific industries counters listed in the market. For instance, some of the stocks related to the tourism and leisure industry could be affected based on bans against gambling and other tourist special-centric activities. There seems to be a temporary setback in the construction industry. Despite very niche areas like these, the broader political and socio-economic strategies would be similar – therefore, I can’t find any reason for the main sectors faltering. 

For instance the banking and finance sector is going from strength to strength and any government would want to bring in policies that benefit them and ensure that they are in a healthy position. Furthermore, all other sectors get the help of the banking sector. Despite the importance and resilience of this sector within the face of political instability, companies within it are being undervalued. When you analyse this situation from a detached perspective – there is no reason for this undervaluation because these are the essential core business areas of the country.  

There are certain areas such as tourism that will receive a natural increase – these are the areas we could see an exponential growth in the economy. When there was a situation of war and peace, tourists were very sensitive about it; there was adverse publicity externally. However, now, for tourists, the political situation is not a very large concern – who is going to run the country is not an important concern for them, therefore an increase in this sector is only natural.  

Brining stability 
We know that the President will remain for the next five years. Therefore, this will bring a certain level of stability. There is a certain policy agenda that he is directed towards, which is what he promised before he came into power. That would help us in terms of projecting a uniform image internationally, with this more west-ward leaning and non-aligned foreign policy agenda we can expect positive contributions to the development of enterprises. 

Certain concessions which we lost from the United States and European markets could be regained and these are high priorities on his list.  Moreover, as the head of state and the head of government he will stick to the good governance agenda, which is good for the country and its economy irrespective of who is going to get the power in the next Parliament. Market regulator, the Securities and Exchange Commission (SEC), is on the right track. This will definitely bring the necessary stability to the market and develop the long-term confidence of the investor. 

The President is well aware that, regardless of which government comes into power, he will have to fulfil his obligations to the people – he needs to work in-line with the next government and ensure they move towards a uniform direction. Therefore, it is very clear that the market has overreacted negatively due to the situation on the political front, by blaming this reaction on political instability when this is certainly not the case. The President definitely brought about some stability and in terms of economic policies the major political camps are convergent in their beliefs. 

Investors should take heart and begin investing in the market now, because the external economic landscape is also seemingly more positive than in the recent past. There were certain global issues due to changes in the worldwide commodity market, commodity prices came down. Similarly, we saw the benefits of the same passed down to the people – we did benefit from this decrease. On the other hand, in terms of enterprises - rubber and tea commodity prices fell; commodity prices have their own bubbles and collapses – but these fluctuations will correct over time.  

Furthermore, the United States is doing well economically. That is a good sign for Sri Lanka because consumption in that part of the world is increasing – and they are one of our major buyers.  America is the buying function of the world, because the world has dollarized and even the printed dollar has value and power. When America is doing well natural benefit will permeate over the global economy. We can see more export-led growth in the economy. Similarly, the yen is coming down and that too is a good sign for the Sri Lankan import market. 


Interest rates 
We notice very frequently that Investors in the stock market are adopting very speculative strategies, where they invest in the market today and hope to gain a return tomorrow; the stock market is certainly not the place for that form of investment activity. Investors who adopt strategies of this nature will find that over a period of time their return on investment would be very low when it is averaged out over a period of time specially compared to the long-term investors.
 
Another factor to consider is that Sri Lanka is heading towards a low interest rate regime, therefore once stability has been established the government has set its direction, there is likely to be more low-cost funding towards Sri Lanka from the rest of the world. Therefore, I also hope that in the future the low interest rate regime to interest rates further consolidates.  Keep coming down, because that is to be. 

This can be expected in any country where the gross domestic product (GDP) and per-capita income are increasing. Also when political stability comes, when politicians become focused on tapping better foreign sources, they will surely go after cheaper funds and this will bring about a decline in interest rates. In the past interest rates were very high, when the war was on, because borrowing was very expensive; now that we have political stability and that stability will only grow in the future we can hope to see a further continuation of current low interest rate regimes coming down. As a result of this, bank interest rates will come down and therefore the public will have to find an alternate investment avenue, which is certainly in equity. Then you think that it is time to shift your funds, however by that time it is too late. Therefore, it is most definitely the right time to invest in the stock market. 

I say this because, when the market turns again there is likely to be an overreaction – then investors feel they are too late to join the heard at that time and they have lost out. Therefore, what intelligent investors have to do is, when managing their portfolios they need to make careful assessments – not all corporates are doing equally well. Investors must analyse the fundamentals of companies and identify stocks that are fundamentally good. We see certain companies experiencing a dramatic depreciation in their stock prices – yet fundamentally their profits nor their core business activity have changed or declined. 

The people have lost sight of the bigger picture and have instead rallied around the trends in the market. Instead of taking this approach now is a good time to be selective and identify good stocks. It is for independent investors to do their own independent research, according to their particular risk profile. 

 (Prof. P.S.M. Gunaratne is a Professor in Finance, Department of Finance, Faculty of Management and Finance, University of Colombo and the Vice Chairman of the University Grants Commission)