Over the last year, Indian debt markets witnessed a lot of volatility. In early 2017 the consensus was that interest rates would continue to fall. On the contrary, 2018 begins with mixed expectations. While some believe that interest rates may fall, there is enough reason to believe that the RBI’s neutral stance and macroeconomic factors suggest otherwise.
Previously, crude oil prices were driven by demand conditions. However, of late OPEC and non-OPEC countries have created an artificial rise in oil prices by agreeing to cut down on production. These decisions may have been made in light of Saudi Aramco’s impending IPO. While this strategy may be effective in the short-term, it is unsustainable in the long run.
A hike in fuel prices has a direct impact on headline inflation. Yet, the RBI will maintain its cautious approach with interest rates and may not immediately react to oil price movements.
The Federal Reserve’s Actions
The Fed has been working consistently to improve various aspects of its economy. Economic recovery in terms of employment, growth, etc. has supported the Fed’s decision to reverse its QE program. Consequently, there has been a mild uptick in inflation. This has weakened the dollar. In turn, this is favourable towards higher exports and the Fed is consciously devaluing its currency.
The Federal Reserve will continue to raise interest rates this year. When interest rates are more attractive in advanced economies, money flows out from emerging markets. The RBI may raise rates to counterbalance this movement of capital.
India’s Fiscal Deficit
The ruling government overshot their fiscal deficit target in November. For a government that has otherwise been fiscally prudent, this is out of character. Lower tax revenues, lower dividend income, and higher spending contributed to this breach.
Adhering to fiscal deficit targets serve multiple purposes. Firstly, fiscal prudence improves creditworthiness. Second, a breach could affect macroeconomic health. A high fiscal deficit could result in higher inflation, increased taxation, and lower credit growth. Third, it results in a vicious cycle where future targets may be broken.
Taking the volatility in crude oil prices, the Fed’s actions, and our fiscal deficit into account, there seems to be little room for a rate cut. The RBI’s neutral stance could simply be an inflexion point.
As we bid adieu to a wonderful investing year and welcome a new one, it’s time to pause and ruminate a bit. It is that time when we set our expectations. We actually need to assess how expectations played out in 2017.
Investment performance significantly outplayed our expectations in 2017. We did far better in the stock markets than in the real economy. That’s not unusual. Often, stock markets run ahead of the real economy. Now, economic performance needs to catch up with the stock markets. Can the markets keep running ahead of economic performance for two years in a row? While we can’t rule it out, it would mean that the economy will come under very severe pressure from the stock market. And, at some point in time, the stock market will lose patience and confidence.
The key factor to watch out for now is economic performance. This would be a shift from the company-focused approach that worked exceptionally well in 2017. The best thing to happen for investing will be the return of economic growth.
While the markets seemed unaffected by bad news in 2017, taking everything in its stride only to head higher, 2018 will certainly test its resilience and patience.
“The road to long-term investment success runs through risk control more than through aggressiveness.”– Howard Marks
The last week of a calendar year is usually the time when global institutional investors take a break. When they return in January, their investment actions are often radically different from those made in December. Just like a test batsman takes a fresh guard after a lunch recess, fund managers take a fresh view of things in the New Year.
When nothing changes drastically in the economy over a fortnight, what causes this sharp divergence in investment behaviour? Global fund managers realign their investment allocations across different markets. This often causes drastic shifts in their India strategy and outlay. Indian funds are usually left only with the option of responding to what global funds do.
Recent years saw domestic funds simply play counter strategies to what FIIs did. If they bought, we sold. And vice versa. The behavioural lead was always in the hand of FIIs, while DIIs were more reactive. 2017 changed this dramatically because of domestic investment flows. While FIIs did sell, DIIs took the lead buying and began driving our markets.
2018 will be an interesting year. It remains to be seen if DIIs continue to be the lead drivers or if we will have twin drivers or if FIIs will lead again.
“First-level thinkers look for simple formulas and easy answers. Second-level thinkers know that success in investing is the antithesis of simple.” – Howard Marks
If you are an Indian investor, asking the right questions now is the most important thing. The logic is simple – when the going is too good, it is important to question the sustainability of good times. The stock markets have done extremely well in 2017. This is evidenced in performance across equity categories. But, investor interest has been fixated mainly in select areas – the balanced, mid-cap and small cap funds. 2017 has predominantly witnessed domestic capital flow into these areas.
Risk taking which worked well in 2017, may not find it as easy in 2018. The reasons are simple. First, business performance is likely to change as economic growth patterns evolve. Next, investment performance will always chase emerging business performance. More importantly, when some sectors have been punished badly in one year, they could show improved stock market performance in subsequent years.
Investors must note that the equity categories which worked very well for two or three years at a stretch tend to stagnate thereafter for a while. In the dynamic investment environment that we live in, it is essential to capture the emerging dynamics, invest in areas where time corrections are likely, and to bet on the ensuing structural improvement of the economy.
Given the investment track record of 2017, this isn’t going to be easy. To walk away from immediate successes of the past towards what will succeed in the distant future is going to be challenging. Investing is about working towards the future. Only investors with a yearn for risk will find the right path to future investment success. Every December, savvy investors relearn the same lessons.
Risk means more things can happen than will happen. – Howard Marks
The coming weeks promise to be interesting. During recent months, domestic investors have put behind almost every market setback and resumed buying equities. Domestic liquidity has absorbed any selling by FIIs. Traders have also remained supremely confident on equities and we are entering December with the highest level of confidence.
Leverage is at an all-time high. We have seen most market favourite stocks regain price losses effortlessly and go on to make some new highs. Nothing seems to bother domestic sentiment. The Gujarat polls also seem to have been factored into valuations. We see investor confidence quickly absorb bad news and move on.
This is no ordinary scenario. Rarely have markets shown such gumption. December which is usually a nervous month, hardly looks threatening. There seems to be all-round domestic consensus on almost everything. Such a setting is usually perfect for an unexpected event.
The Gujarat poll seems to have raised expectations of a decisive win for the ruling party. Clearly, the market seems to be too sure. This sense of assumed certainty is usually a lose-lose situation. A win, as expected, for the ruling party will probably be already factored into the markets. This makes a decisive market rally very improbable. On the contrary, a shock loss is not something the markets are ready to quickly absorb and discount.
With fundamentals not supporting present valuations, too much is prefaced on liquidity and flows. Now, that is what we can call the perfect setting for a surprise market move.
December has been a month never found wanting for surprises. This December may not disappoint.
“All bubbles start with some nugget of truth.” – Howard Marks
December is always a defining month for the equity markets. It is the vacation hour for global fund managers. They take stock in December and adopt changes in their strategy for the coming year. Similarly, domestic fund managers also take stock of the emerging macros and realign their strategies.
December and January usually witness very different investment behaviour from the same investors. The question before investors this December is simple. Will we see a significant shift in investor strategy in 2018? Willchoices change dramatically? This will start to show in December itself, as savvy investors realign their portfolios towards what they believe will be the dominant themes of 2018. We will also get an inkling of global fund allocations, the outlay for emerging markets.
A top down trade in the stock market has somehow been elusive. Investors have largely bet upon thematic schemes among micro, small, and midcaps. We should get some clarity on how the top down trade will play out. If we should see weakness at the index level, then December promises to be a test of our market’s resilience. We will clearly know the latent strength still residing within the successful investment themes of 2017. It will become evident if there is investment fatigue in some of them. Knowing the market’s fickle nature, a rotation of themes cannot be ruled out.
The favourites of 2018 could well be very different from those of 2017. The market always tends to do things we don’t expect it to do. This time will be no different.
“There’s only one way to describe most investors: trend followers.” – Howard Marks
Companies are raising capital at a pace like never before. Promoters are selling their shares at a frenzied pace. Mostly, the buyers are domestic mutual funds. The target segment is restricted to midcaps and small caps.
Clearly, retail inflows are placing strong compulsions on fund managers to deploy money quickly, as holding cash is outside their mandate. This has created two conflicting trends, both connected down the middle. Firstly, private holders of large positions feel that inflows will become even stronger leading to significantly higher valuations. So, they feel that their own selling can wait. Secondly, promoters of overvalued, quality companies feel that this is the best time to use the supply scarcity to create liquidity for themselves.
These two are contradictory trends. But each stance carries a built-in calculation. The prerogative is to make the best out of the larger institution’s compulsion to deploy money. But, this clearly qualifies as a serious risk to public capital.
The onus of protecting public capital clearly falls on the investors or advisors. The current stream of placements is a counter-intuitive warning.
“Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity.”– Howard Marks
An upgrade of India’s sovereign rating right in the middle of one of our history’s toughest economic reform programs is clearly a shot in the arm. It is a booster shot for global sentiment on India, capital raising exercises by government and companies, and domestic sentiment. This will further speed up reforms and public investment.
But, should the markets runaway? Possibly not. The markets need greater evidence on the ground to become more expensive than they already are. Current valuations of several market-leading companies are already discounting much of the good news.
And, the spoiler could be in the form of public issues that mop up much more liquidity. IPOs could play spoiler. Mutual funds are also mobilising huge sums in already overvalued categories and themes through their IPOs. This could lead to misallocation of capital. Corrections usually follow such misallocation of capital and are triggered by an accidental scarcity of capital on a temporary basis.
Measured investing is the need of the hour.
“Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.”– John Bogle
Indians don’t fancy financial products much. A mutual fund, ETF, or ULIP is supposedly meant for investors who don’t have any idea about equities. If one can’t choose the right stocks, he is perceived as a candidate for a mutual fund scheme. Investors genuinely believe that these products don’t have the potential to deliver big returns. Whereas the underlying assets in these products, stocks, can.
So, people think that personal portfolios of stocks can deliver more returns than funds. Everybody forgets that they too construct a portfolio of stocks which may not perform as well as their best stock picks. Aggregate performance of an individual investor may not actually be far ahead of the best performing fund scheme. Every portfolio will inevitably have stocks that don’t perform or even fail. This can retard overall returns.
Fees could be one reason why returns moderate between the underlying and the derived. But then, we have ETFs as low fee options. Why do we shun them as being investment unworthy? It is in the way portfolios of ETF schemes are constructed. A well constructed ETF can deliver competing returns. India’s ETF industry badly needs a well constructed ETF. That moment is before us. We have a very interestingly constructed ETF before us.
This is a John Bogle moment for the Indian public investor. Be at the Vanguard of a new revolution.
“When everyone believes something is risky, their unwillingness to buy usually reduces the price to the point where it’s not risky.” – Howard Marks
Every market opens up newer investment opportunities. There will always be businesses that nobody wants to own. Or at least, only a few people would seek to venture into them. Businesses that are shunned often drift in valuations, until they reach extremely attractive levels. Then, an event or news or policy causes a sharp reversion to mean.
Usually, the reversion to mean happens so swiftly that it catches everyone unawares. The duty of a contrarian investor is to spot such reversion opportunities and ensure that he invests early enough to catch them right. There is no other way to catch such opportunities.
This sharp reversion is happening in telecom, pharma and PSBs. It only reaffirms the long-held belief that you can’t predict. You can only prepare.
It may well be time to prepare for future reversions in sectoral valuations, thematic fortunes, and cyclical preferences. The markets will continue to see dynamic churn going forward and one must keep his investing ahead of the times.
“Large amounts of money aren’t made by buying what everybody likes. They’re made by buying what everybody underestimates.” – Howard Marks