(My annual piece for the year end issue of the Dalal Street Journal) 2012- A long year for stock markets 2011 will go down as one of the most frustrating years for the Indian markets. It also is a year when the India story started to sound less than convincing, to global investors. It is also the year where the supply side constraints have kind of imposed a lingering consumer price inflation which is stubborn and the RBI has tried to hold it down with over a dozen interest rate hikes. Alas, the interest rate hikes seem to only have added fuel to the fire. A panic stricken RBI has freed interest rates on savings bank accounts leading to a free for all within banks to grab deposits. Liquidity has dried up so much that even SBI is offering near eight percent returns on deposits for just one week! The PIIGS problem in the Euro has awoken the world to the evils of living beyond one’s means. However a conclave of the wise men of the Central Banks of Europe and a few countries are putting up a brave front and offering to pump in more of the printed currency. Is this going to turn the markets around or is it a golden opportunity to exit? Reason supports the latter and hope supports the former. Now, Central Banks are resorting to window dressing! There is a fair chance that the world is heading to a kind of stagflation (with Central Banks printing more money and producers not producing more). It may take a long time to unwind, but looks like we are headed out there. Every country’s finances (barring maybe a China here and a Russia there) are in bad shape. Political survival worldwide seems to be the excuse for fiscal profligacy. Indian economy continues to grow on the back of strong consumer demand. Consumer still has his pockets full thanks to services growing at a decent clip and rural India enjoying the benefits of high farm produce prices. In addition, government freebies (whether it is NREGA from the Centre or other state sponsored freebies) give more thrust to consumer muscle. The banks have also joined the party, with auto loans being given at ridiculously low interest rates of six to eight percent when SME’s are paying over fifteen percent . Add to that the liquidity crunch and the weakness in capital markets, supply bottlenecks grow whilst demand continues to keep rising. A natural outcome is inflation. Over a dozen successive doses of misguided interest rate hikes by RBI has only fuelled inflation rather than taming it. Indian politics has done nothing to encourage investment, being hit by one successive accident after another. Commodity prices will remain soft so long as global economic growth is weak. Gold and silver continue to shine as excess money chases safer havens. The US dollar is the ‘last man standing’ when it comes to currency, thanks to the Euro tottering. In all this chaos, our stock markets have held up remarkably well, with valuations still in excess of fifteen times earnings (that will perhaps fall in the next year). Whilst a one year picture does not look very good, the Indian market show, if we measure it from the bottom of the Lehman crisis, is fantastic. Yes, traders have not had a good time and luck with market timing perhaps had more than its fair share in the way we measure our gains from investing. Fixed income instruments are offering interesting returns of eleven to twelve percent on AA rated paper. SBI is offering eight and a half percent returns on one week money! Short term money is as expensive if not more as long term money as companies postpone projects due to fund raising constraints. Perhaps, one to two year returns on these will beat stock market returns. For stock market returns to be good, we need falling interest rates. This gives us a great option to buy tradeable fixed income paper now and sell it when interest rates fall (will they fall significantly is a debatable issue).I will stay invested or add to Gold. Equities are yet to turn interesting. Perhaps a decline to BSE Sensex levels of around 14000 or so would make it more value investment than now. In the absence of long term leveraged options, trading in volatile markets is going to be tough. I will still remain invested in stocks of companies focused on domestic demand and having high (preferably over thirty percent per annum) Return on Equity (ROE). The upside seems capped for a couple of years at least. Fixed income returns at eleven or twelve percent per annum look all set to beat equity returns over the next couple of years. Unless of course we have a great fall and can then buy in. R. Balakrishnan (balakrishnanr@gmail.com) December 6th, 2011

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