For investors, it's time to be patient

Equity markets may face a period of consolidation as the economy settles down before accelerating again. Investors should use this period to build their long term portfolios. By Shivshankar Verma

Last week, when the Sensex slipped to its lowest level so far this year, the mood in the market was despondent. The doomsayers were out on the street, predicting further weakness for the market indices. Most market observers were pretty sure that the Sensex would drop below the lows touched mid last year, when SEBI disclosed its discomfort about participatory notes in no uncertain terms and unveiled steps to curb their popularity among overseas investors. Some analysts, overcome by a sudden rush of extreme pessimism, predicted that the Sensex may slip to even 9000 before the end of this year.

After just two trading days this week, the mood is not so bleak any more. Strong gains in frontline stocks have helped the indices gain nearly 4 per cent from last week's lows and the Sensex is back above 15500. Some technical analysts are predicting another 20 per cent rise over the next few months, before a two-year long bear market sets in. The mainstream view is that the markets will go nowhere and the indices will linger around these levels, until the clouds clear and everyone has a better view of what exactly is going on.

Not many are convinced about the possibility of a bear market next year either. So, where are the markets headed? Will last week's despondency return soon or can investors expect better days ahead?

The Inflation scare
Inflation is now probably the most debated global issue now, way ahead of the US presidential elections, Iraq war and even 20-20 cricket. There is not a single central banker, from Ben Bernanke to Y V Reddy, who can sleep peacefully these days because a monster called inflation is at the door. If they don't slay the beast, their carefully constructed legacies will be blown to apart. Star central bankers will be unceremoniously degraded from divine infallibles to mere mortals, as Alan Greenspan recently found out.

There is a price you have to pay to fight a war and the war against inflation is no different. When a central banker gets ready for the fight, with the entire monetary arsenal at his disposal, he is also getting ready to cool the growth momentum. Being used to days of heady growth numbers, the loss of momentum can be very painful for investors.

Then the question becomes, to what extent will growth be sacrificed to tame inflation? That is not easy to answer as it depends on other factors which are not fully known. If inflation pressures are well entrenched, it will take strong and sustained monetary steps. The trouble is, a central bank will know how entrenched inflationary pressures are only as it goes along. And once inflation is brought under control, it will take considerable time for the economy to shake off the effects of monetary tightening.