Category Archives: Market Wrap

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

Keep Global Watch

The index has held steady and only gone higher in 2017.  Corrections haven’t even lasted beyond a day or two. But, at the same time, several traditional index movers have tended to be weak. IT and pharma majors have remained weak and every rally in bellwether stocks in these sectors has been sold down.

The index is being held together mainly by a small basket of favoured stocks. These stocks are already richly valued and are factoring in most of the potential good news. This makes one wonder what new drivers will be coming into play for the indices.

Mergers and acquisitions are a strong factor and could become market drivers. We have little visibility except the clear expression of intent by managements in the IT sector. We should see several M&A deals across IT, pharma, telecom, and banking. These could become the new market drivers.

The market needs fresh levers to move forward. Flogging the existing overvalued index movers in private banks, consumption, and automobiles will only put the indices at greater risk. A more measured onward movement of the indices with wider participation from the ignored parts of the market, is the best bet for a sustained rise in our indices.

For now, we should closely watch the global market which seem to be entering a phase of turbulence. We shouldn’t make the mistake of thinking that India is decoupled. We never really were.

 

“Great investing requires a lot of delayed gratification.”- Charlie Munger.

BE DRIVEN BY VALUE

What is going on in the market now?

Most people are wondrously looking on. The anxiety to invest remains high. The index seems infallible despite company-level bad news periodically hitting the street. The interest has shifted​ towards larger companies. Midcaps seem to be taking a momentary pause. Global ETFs seem to like the Indian markets a lot. Investors, both domestic and foreign, are clearly eager to participate in larger economy plays that they believe will deliver over the long term.

The bigger QIPs are going through smoothly. Institutional Investor appetite for placements is at an all-time high. The SBI QIP is clearly evidencing that trend.This is making the Index movers even more expensive. As the markets become expensive, the government is trying to push the RBI for a rate cut. That is not working either as the RBI’s monetary policy committee, a brainchild of the current government, simply refuses to oblige.

So, the wait for growth to return seems to be getting excruciating as GST gets ready to roll out. Will GST deliver the economy its much needed magic potion?  The economy should most certainly see a shift in a number of businesses from the informal, un-organised space to the formal organised space. We don’t know how soon the headline numbers will perk up. But, clearly, the cause for gloom advocated by the GDP critics seem to be a bit stretched and imaginative.

A more pragmatic approach would be to invest in parts of the market where valuations are modest, risks are controllable, and drop in uncertainty can significantly alter public sentiment. Typically, these will only be in the domain of value investing. Finding such opportunities should be every investor’s priority.

 

“Markets can remain irrational longer than you can remain solvent.”- John Maynard Keynes

When it rains, it pours.

“When it rains, it pours good news on markets”. The prompt arrival of the monsoon has eliminated one chapter in the investor’s worry book. The market’s monsoon worry got eliminated even before it began. With the monsoon arriving on time, the stage is set for the best year of sowing in Indian history. This is possibly one of the most bullish economic signs since demonetization brought gloom and worry to the investor community. When sowing is better than ever, a regular progress of the monsoon can lead to a historic high Kharif output. With the government’s support prices, this could lead to one of the best years for the rural economy. The markets seem to have already sensed this and the moves in consumption stocks clearly indicates this influence. The markets will always be hungry for more good news. This brings us to a situation where both good news and bad news are flowing thick and fast. The problems of groups embroiled in defaults are also heading towards a climax. But, the markets have little time for bad news and are simply dumping these groups and moving on. This shows an overwhelming tendency to focus market energies only on good news. The markets then look only for more good news. This is typical bull market behaviour. So, what next? The poor GDP data and the better than expected inflation data could possibly create a positive surprise from the monetary policy committee at the RBI next week. A cut in interest rate is currently not on the market’s agenda. If the RBI obliges the longstanding demand of the Fin Min, we could see the markets break out into a song. GST is set to be implemented from July1. This sets the stage for more good news and firms will crank up production from July1. The narrative on GST will change once it has a formal start. Markets will start viewing the benefits more clearly and companies will offer greater clarity. When good news rains, it can only pour money into markets. Domestic flows seem to be the best indicator of how the markets are seeing the emerging narrative.

Stay Contrarian

The stock market is the only place where heightened optimism and extreme pessimism actively coexist. The same investor who is overly optimistic about one set of investments is strongly pessimistic about another. The majority view is also prone to holding both judgments at the same time. It is only a small subset of people within the market who hold a view contrarian to that of the majority. This minority differs clearly from the majority. The majority thinks very much like a herd. To go against the majority is seldom easy. Everybody will vehemently disagree with you. Even to put forth a contrarian view in a public domain requires enormous courage. Contrarian conviction will be virulently challenged. Such challenges will be born out of the insecurity of the majority rather than superior conviction. Often, weak conviction makes a more virulent challenge. Such virulence is surely not born out of logic or basis. It is merely born out of the necessity to manage the insecurity of a large section. The majority fights contrarian opinion with its might. Typical tendency is to put forth short term investment performance to bolster one’s own position. The majority always fails to realise that short term investment performance is often the outcome of their own irrational behaviour. Such times are usually testing for the contrarian minority. Staying together and keeping faith is never easy. But, that is what it takes to tide over periods of extreme investment behaviour.

Every once in a while, the market does something so stupid it takes your breath away.”- Jim Cramer

Maintain Vigil

The Indian markets have rallied continuously from January 1, 2017. The Indian markets moved towards making new highs post-election results in Uttar Pradesh, India’s largest and politically significant state. Sentiment among Indians towards equity remains high. There is a sense of urgency to move money from other asset classes towards equity.
 
A similar sentiment prevailed in 2014, after the results of India’s general elections. The indices made new highs in 2014, only to lose momentum as corporate performance could not keep pace with the market’s moves. The current rally is also going to be tested by domestic corporate performance. Most Indian investors seems to be underestimating the impact of the Trump rally on global markets. Investor confidence has been driving global flows. And, that confidence has a Trump connect. From what is evident, the Trump rally will meet the same fate as our own Modi trade did in 2014. This would change global investor sentiment. Global flows can become volatile. This volatility will further be fuelled by economic instability in commodity dependent nations. The collapse of the Brazilian markets and its currency, the Real, is an ominous sign of things to come. Investors must re-calibrate their strategy to a potential shift in global sentiment.

The good news is that Indian corporate earnings revival seems far more imminent that ever before.

 

Opportunity is not always at an opportune time.- Diane Hendricks