Irrationality fuels markets

An interesting week saw significant divergence in the markets. ITC, a stock which significantlysupported the index in its sustained rise suddenly gave way due to flimsy reasons. The stock perceived to have benefited from GST lost said benefit to a rule change. But, GST did not change or add to its earlier tax burden, it just restored the status quo. Yet, the markets thrashed the stock to pulp.

Another stock, Reliance, which  has been a weak participant in this bull run, ended the week at its all-time high. This was a surprise too, given that the stock has underperformed for the past several years. The trigger was new plans by JIO, which did not show possibility of revenue growth for three more years. This is something that should actually scare investors.

The side show, was the new all time highs for the bank nifty, the small cap indices, and the troubled stock pack. Strangely, the stocks which are roiled in the bad loan crisis of banks are outperforming the market in recent weeks by miles. Somewhere, the markets are turning more and more towards irrational stances. Clearly, these are exuberant times.

“Beware of little expenses. A small leak will sink a great ship.” – Benjamin Franklin

Liquidity Rules

Markets are hitting new highs every week. But, economic fundamentals don’t seem to support such a prolonged rise. Economic data is definitely mixed. Problems in our economy are on a slow mend. Yet, we see unprecedented buoyancy in our stock markets. IPOs now look like safe lotteries.

We have seen such scenarios before. It is not new to our markets. Liquidity can cause undue exuberance. The investment actions we take in such times are critical to our long-term investment performance. It is important to not get carried away. Investment choices must be strictly made based on valuations. Longer term choices can be made by deferred purchases of investments.

The markets can become even more exuberant in the near future. Investing can become even more challenging in the face of increasing flows and liquidity. Prudence should be abundantly in play during such phases. It is important not to let emotions get the better of us. Near term upside must be sacrificed for long term safety of portfolios.

A value driven approach to investing would greatly help tide through such irrational times. That is an enduring market lesson from the past.

 

“An ounce of prudence is worth a pound of cleverness.” – Baltasar Gracian

Consensus is absolute

The bottom up trade in our markets has never had it better. Individual stocks have shown the ability to buck overall market trend and deliver superior returns. Over the past two years, investors’ entire focus has been on finding the right stock that will show a big move. As one stock after another was discovered, slowly the stock ideas started reaching mature valuations.

Yet, the monies haven’t stopped chasing the same stocks that have been fully discovered. Institutional compulsions imposed by incessant liquidity are forcing the same stocks to be continually bought. This explains the market’s steady rise and very short lived corrections. The hurry to build significant quantities in good stocks is seen even at the IPO stage. The anxiety to buy enough quantity in a stock is significantly contributing to price moves.

There is little sense of fear.  Professional managers are more worried about deployment than about the downside. They don’t want to be caught missing out on near term performance. Measurements are being made on weekly basis to judge investment performance. The behaviour of most market participants reflects what is best suited for short term investing.

Nobody wants to be a contrarian in this market. That’s a very material observation.

 

“Know what you own, and know why you own it.” – Peter Lynch

Survival of the fittest

Every business adapts to change. Businesses without the adaptive strain in their DNA die. Adaptability is the key to survival. A classic all-time great example is WIPRO. When rampant tax evasion in the market by peers elbowed them out of the vegetable oil market, they didn’t blame the system. Nor did they shut down or go bust. They reinvented themselves into what they are now. Even now, they may well be reinventing themselves. Or actively exploring prospects of moving beyond IT services.

What happens when a firm is not viable as a business? Are taxes really the reason? Especially when they are uniform throughout India? Surely, externalising business weaknesses is not good for survival. Addressing them actively surely is. GST is all about adapting. The centre, states, big businesses, small businesses, tiny businesses, the self-employed, service businesses need to adapt. The list of agents in this churn can be much longer. But, this is a time of churn.

Investing should now recognise survivorship and bet on the right businesses. Everybody may not end up a winner in GST. Keeping away from the losers is just as important as sticking to the winners.

“In investing, what is comfortable is rarely profitable.” – Robert Arnott

Valuations over performance

Stock valuations have a mind of their own. Most of the time, stocks tend to trade away from what we evaluate as fair value. They either trade below or above what we enumerate as fair value. Mutual funds can never be insulated from the influence of stock valuations.

Whether stocks are trading relative to their fair value has a deep bearing on future fund performance. When mutual funds own stocks trading way above their fair value, they may be expensive. Yet, investors tend to pour money into them exactly when they are too expensive.

Investors’ excessive reliance on past performance in decision making can hurt when valuations are extremely high. Conversely, when funds own good stocks at valuations below their fair value, they tend to be ignored.  Investors show no interest when a fund’s near term performance looks soft. The lack of performance tends to be a dampener. But, buying such out of favour funds can be hugely profitable over the long term.

This is exactly how sensible investing should be done. Valuations rather than performance are a far superior driver, especially in times like the present. Mutual funds that own portfolios populated with expensive stocks are at risk. A better approach would be to buy funds with portfolios of sound stocks at reasonable valuations. Valuations, and not past performance, hold the key to future returns. Keeping minds open to change is crucial now, more than ever before.

 

“Price is what you pay; value is what you get.” – Ben Graham