Category Archives: Market Wrap

Yin and Yang – Indian style

When DIIs sold, FIIs bought and when FIIs sold, DIIs bought. This was almost mistaken for some kind of Yin and Yang phenomenon. Investors and analysts reduced it to a complementary system, where the two counterbalanced each other. This would work well for the overall market. But, the two aren’t complementary enough to create a more dynamic market.

Often, one tends to overwhelm the other and the net effect is to weaken the system. In this case, the system happens to be the Indian market ecosystem. We could soon find out that the DIIs overestimated their ability to provide market stability. To make matters worse, we might face a situation where their indiscretions and indiscipline on the buy side will hurt their own performance.

FIIs have held a steady and stable approach in the past month. They are not seeing value in our markets and are relentlessly selling. Indian investors – institutional, HNI and retail, are living under a fallacy. They believe that they can sidestep the challenges created by overvaluation by simply coming together and buying whatever FIIs offer for sale.

Experience shows that fallacies in stock markets rarely last long and inflict swift and heavy costs on those who are not disciplined enough. This time, Yang could well take Yin down.

Disruption Returns

The last week saw a heated debate on electric vehicles. This brought back intense focus to the threat, disruption poses to the automobile industry. Advancements in technology can disrupt the world much more in the next ten years than it has in the last fifty.

This is not just restricted to the automobile industry. In fact, the threat to traditional BFSI (banking , financial services, and insurance) due to the triangulation of telecom, data analytics, and automation is much bigger. Consumers clearly stand to benefit. But, investors may have a lot more to lose than imagined. The reason is simple.

Disruption creates deep change at double-speed. It can hit an industry and make it irrelevant to the future. The threat of obsolescence can force businesses to cede pricing power, give more to consumers, and pay to retain their relevance. It can completely take away profitability. Bankruptcy will also need to be seen as a logical extension when all else fails. These are new to the Indian milieu. We are yet to see listed companies wind up, simply because they don’t have a reason to be. In such a scenario, discounting earnings for a longer time horizon may not be prudent.

This brings the investment focus firmly back to consumption and essentials. These are likely to remain more stable over longer periods of time. The risk markets run in every bull cycle is, that they tend to overstretch valuations of sectors just before they face massive disruption.

This time is no different.

“The number one problem in today’s generation and economy is the lack of financial literacy” – Alan Greenspan 

Priced to perfection

The investors are always more obsessed with knowing who is buying a stock than who is selling. The natural inclination is to follow buyer behaviour.

Bull markets bring this more sharply into focus as large deals start taking place between large investors. Sellers of bigger parcels seek to exit stocks and buyers find it easier to buy such parcels than to labour in the markets to buy enough.

Naturally, scarcity premiums come into the pricing of such parcels. We are now experiencing a sellers market. While it will take a long while to judge who was the smarter one in the transaction, some pointers are clear.

Domestic mutual funds are buying and foreign investors like PE funds are selling. Clearly, there is a flight of foreign money out of Indian equities and last week’s sale figure of Rs.3425 cr only reinforces the prevalent trend.

Domestic investors must also develop a sellers perspective before they go ahead and buy a stock. Knowing why somebody sells a stock is just as important as knowing why he buys a stock. At prevailing higher valuations, knowing both perspectives will bring the right balance into one’s investing. Choices will be measured and rightly priced. Getting the purchase price right ensures that the investment enjoys adequate margin of safety.

“It amazes me how people are often more willing to act based on little or no data than to use data that is a challenge to assemble” – Robert J. Shiller 

The Demon Remains

The one thing where market consensus is growing is that domestic inflows into equity aren’t going to slow down anytime soon. This growing consensus is emboldening the sell side and the mutual funds industry.

The persistent FII selling isn’t doing much to unnerve domestic players. They seem supremely confident. But, such confidence is always a function of altitude. The higher the market is placed, the more confidence in equity. Indian market participants have almost always demonstrated more faith in equity at higher levels. This time is no different.

What are the risks to the present overconfidence? When this question is raised, thought leaders say that there is presently no alternative to equity. The risks seem to be getting sidestepped.

Let us take the risk head on. The risk to equity will rise if the economy decelerates post GST instead of gaining momentum. The slowdown in the economy should end up being temporary rather than structural. Economic thinking in India is still deeply divided on the impact of demonetization. This leaves the jury divided.

“All persons ought to endeavor to follow what is right, and not what is established ” – Aristotle

Valuation drivers always prevail

What should be a good time horizon to judge your investment performance? Should this time horizon be the same irrespective of where we stand in the market cycle? These are questions that are rarely raised or addressed.

We almost always conclude without reason that one year is a good time to judge investment performance. We judge performance linearly just the same way we assess fixed deposits. But, equity as an asset class is incapable of generating linear returns.

Marketing literature that show high five-year returns always hide the fact that there could have been two or three years when performance was worrisome. Returns could have been lower than inflation or even negative. Recency bias is largely to blame for mistaking equity returns to be linear. If performance was good for one or two years, we forget the times before, when performance was bad. We treat this as inconsequential.

We start believing in new normals. But new normals in equity investing can never be linear. If returns are higher for a while, we would inevitably see time corrections follow. Valuations can alter time horizons and always play a big part in deciding the “how long” and “how much” questions in investment performance.

When the valuations are rich, we may need to wait for a while before we get richer.

 

“The individual investor should act consistently as an investor and not as a speculator.”

– Ben Graham

Atypical Times

Corporate governance is an evolutionary phenomenon in an emerging market like India. We recognize that a statement with strong portent was made. We are seeing several extraordinary situations that test our corporate governance. In the process, we believe that corporate governance will only get strengthened. The extraordinary situation is atypical.

For instance, in INFY the founder-promoters left the day to day operations of the company in 2014. The company then became board-run and independent of them. The board comprised of independent and professional directors. The board and founders took divergent directions on the way forward for the company. The founders questioned an acquisition decision. The board stood its ground. Shareholders, independent audit, and legal advisory firms endorsed the decision. The founder still didn’t agree with the board and expressed public distrust of the board. The ugliness reached a new low leading to the exit of the professional CEO.

Shareholders will now play a wider role in deciding whether it would be in their interest to support the board or the founders. It is more important to ponder over this extraordinary and overbearing role that shareholders are going to play. It is definitely unusual. It reflects a potential opportunity for shareholders to demand a greater say in affairs of the company. It also presents a unique opportunity for public shareholders to play judge. That in itself is a milestone in the history of Indian corporate governance.

We surely live in interesting times. We could well see a better tomorrow.

 

“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.” – Warren Buffett

Being Steadfast

A five percent crack in the index would not have been on anybody’s mind a week ago. But, investors are spending this weekend wondering if there could be more downside in the coming week. The real story is not in the movement of the indices. The real story lies hidden in the subprime trade in stocks of micro and small cap companies with limited track record and sudden valuation expansion.

The worry is that funds and advisors have bought too aggressively into these stocks. To make matters worse, the broking industry has supported a flourishing trade in margin funding against stocks of these companies with limited scrutiny. A crack in the market usually triggers a swift force unwinding in margin trade. The structure of margin funding gives very little response time for investors to save their margin positions. We could see such a situation arise in the coming days.

For investors who stayed away from leverage and speculation, there still will be pain. Such pain will be inflicted on them by the indiscipline of others whose holdings could get sold, depressing valuations of their own holdings. Market excesses always punish everybody equally.

But, opportunity in this crisis clearly lies ahead before the disciplined lot of investors. They must buy when there is selling all around. When the holdings of undisciplined investors get sold, the disciplined investor who buys them tends to profit significantly over the long term.

“A big part of financial freedom is having your heart and mind free from worry about the what-ifs of life.” – Suze Orman

Risk mitigation

Risk mitigation is an important aspect of investing. Every portfolio should have it innately built in. The composition of the portfolio should factor in the risks and provide for investment actions when risks arise.

Not owning too much of an individual stock or fund is one way of mitigating risk. Keeping cash to deploy in every correction and raising cash levels when valuations are not giving comfort is another. Investing in undervalued parts of the market is also a way of mitigating risk. Selling richly valued investments which already discount distant earnings is yet another effective way of mitigating risk.

Staggering investments or systematically deploying money instead of plugging lumpsums also effectively addresses the problem. Essentially, keeping close tabs on valuations and evaluating the investment worthiness of stocks will help us take effective actions that mitigate risk. Needless to say, valuations hold the key.

The coming weeks will see companies which aren’t doing too well release their quarterly performance. We need to align their performance to valuations, measure accurately and assess the exact need for risk mitigation.

“One way to mitigate our risk is to invest in companies with understandable business models.” – Andrew Tan

Hear the other view

Sounding a warning bell to the equity markets is a thankless job. If you are early, you are going to face ridicule as the markets go the other way from your warning. If you are late, you will still be seen as wrong. Bull markets are a contrarian opinionist’s nightmare.

Giving opinions is a tough task and demands enormous mental strength. Investing based on the contrarian philosophy is relatively simpler. The reason is simple; investing is a private affair whereas opinion making is a public affair. One can manage his investment thoughts in absolute privacy. This allows one the luxury to remain unaffected by criticism. Managing the self and one’s own conviction happens within a secure and protected comfort zone. But, giving a public opinion that goes against the market mood can be very challenging.

It is in this context that we must view Howard Marks’ latest memo. Global markets seem richly valued and Indian markets aren’t cheap. We need to understand the global risks to our markets. That makes Marks’ opinion very important. Our markets seem to be in no mood to listen to the other view. This makes it all the more important for discerning investors to fully understand the other view.

It is better to be early than be late and repentant. It’s time to listen to Howard Marks.

“I believe that through knowledge and discipline,

financial peace is possible for all of us” – Dave Ramsey

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