Just four months ago, the markets were showing consensus on the end of the extended market run enjoyed by tech stocks. “Where is the growth? What will happen to Indian tech if automation and Artificial Intelligence take off?”. The cynics were having a field day.
People were clearly mixing up job creation and profitability. The fact that Cognizant had guided positively did not convince analysts, fund managers and investors alike. As TCS came out with its annual numbers, there was a numbing silence among all three sections. Few fund managers had bet on the stock.
We could well see a similar state returning in a bluechip company from another sector. The surprises may recur in more sectors. Writing off a great company will always force us to write back our judgements. In the end, Mr Market is the third umpire who can overrule, recall a dismissed player, and change the fate of your investment game.
As this results season progresses, we are not going to stop being surprised. Many judgements may be tested badly and need a quick revision.
As tech stocks hit new highs and commodity prices spike upwards, domestic investors seem to be ignoring them for now. On the contrary, they continue to pour money into small and midcaps. Several stocks continue to be benign beneficiaries of mindless investing. The entire small and midcap boom was constructed on the bedrock of low commodity prices. The scarcity of good investable paper was another key factor that fueled the boom in small and midcaps. The power of habit is very visible in investing behaviour. But, the constant challenge of investing is to break the mechanical work ethic.
The coming months will see global commodity markets in an extremely volatile phase. As the commodity prices exert upward pressure, it could lead to operating leverage working favourably for commodity producers and higher input costs beginning to hurt user industries.
Our stock markets do not seem to be adequately factoring this. This result season will catalyse a fresh sequence of investment rotation. We will see money moved around as public investors struggle to get their own investment calculus right. Individual investors and advisors will also need to take fresh guard as India heads into a normal monsoon and election year which will also see a definitive revival of the economy. The reform engine of the government will now run in cruise mode and is unlikely to do much except play of course.
It is important for portfolios to capture the emerging economic recovery in their investment choices. Not getting the mix right can prove to be very costly. This results season will certainly trigger a market rethink.
India saw the most number of economic reforms in 2017-18. It was a year when the GST was implemented, the IBC gained momentum, the NCLT saw resolutions getting nearer. More bad loans were moving towards resolution than even before. The government decisively moved on, ensuring Make in India works and DBT gained momentum across services.
Yet, we found that few investors were actually betting in sectors which would see greater traction from these reforms. Instead, markets mostly focussed on companies which were agnostic to government policy and showing steady performance. We focussed more on growth and refused to see turnarounds.
With capital goods, construction, steel, agriculture and infra likely to recover sharply on the back of sustained reforms and public investment, the market seems confused about whether it should shift its strategic outlook. The prediction of a normal monsoon has further reinforced the economic recovery theme.
It remains to be seen how market strategies are redrawn to capture emerging opportunities.
A new financial year brings along newer opportunities and challenges. A financial year which follows an extremely profitable investment year will always have the challenge of delivering comparable performance. After a good year, we expect the next to be even better.
But, when the year gets progressively tougher, then the closing mood sets the tone for the year ahead. If the mood is glum at the beginning of a new year and the follow-up events promise more uncertainty, then the statistics of the previous year will have little or no meaning for the year in store. We seem to be in that phase where the past year really has no bearing on the upcoming one.
So, we need to put behind the past and pragmatically view the future. The future certainly does not promise to be easy and predictable. Actually, it looks far more complex than the previous year.
The alignment between global and domestic markets worked perfectly last year. Towards the close, we seem to be preparing for a year when this compact will definitively be broken. Domestic investor confidence will be tested in the coming year. Early indicators are not as promising with clear signs of a behavioural crack very much visible among domestic investors. If they further lose their faith in Indian equities, we are likely to see our markets come under severe strain. We already know the stance of global investors. They don’t seem to be inclined towards Indian equities. If the strong domestic appetite weakens, we could see the challenges mount for our markets. The wall of fear to be climbed will look suddenly taller.
The first quarter will set the tone and context for the upcoming financial year. Investors must be ready and willing to see the challenges mount and still be willing to make use of opportunities that come their way. General elections are scheduled for May 2019. Advancing them will make the financial year 2018-19 very eventful, interesting and challenging.
“For last year’s words belong to last year’s language and next year’s words await another voice.” – T. S. Eliot
When markets correct sharply, where are you looking? This question assumes special significance as the indices are down 10%+ from this year’s highs. And the lows don’t seem imminently near.
Effectively, we are now in a market where everybody has overplayed their hand. And, when you have overplayed your hand, the day will come when you simply can’t deal. There will be no money left to buy equities. That’s a simple rule of market trade.
We are yet to reach that point in this correction. But, it is almost certain that that point will be hit and even breached. When a breach happens, the pain will be unbearable. Selling will become overdone. The consequences of such breaches will be upon us for an extended period of time. While we warn of such impending pain, it is important to understand that there is a very big opportunity that’s before us.
It is coming at us. Slowly, it will build up and grow. We must learn how to play an opportunity as it grows right in front of our eyes. We must also play it carefully so we are in a position to deal with every opportunity when it presents itself. We should not become helpless spectators on that day when the markets are most irrational. We must keep our hand ready, prepared and willing to deal.
One fine day is waiting to come at us.
“Investment defense requires thoughtful diversification, limits on the overall riskiness borne, and a general tilt toward safety.”– Howard Marks
Politics makes a huge comeback in the stock markets, exactly when the markets are not ready for it. Unlike other market disruptions which pan out as standalone events, politics sets off a trend resulting in a series of events. Throw in a few economic events from time to time between the political event sequence and you have abundant volatility.
Fear gets freely manufactured and manifests itself in a secular way. Extreme fear rarely spares company valuations. At best, it affects a few companies less or it hits them late. Early volatility tends to hit companies which don’t have strong institutional backers, have higher free float, and have a broad based ownership. It later spreads to all companies when buyers aggressively withdraw and sellers start to queue up.
We still haven’t seen volatility spread and it has remained restricted to pockets. Secular volatility in the markets can make a very different impact altogether. For the moment, it doesn’t seem to be on the anvil.
“The degree of risk present in a market derives from the behavior of the participants, not from securities, strategies, and institutions.”– Howard Marks
The Indian markets started 2018 with an exaggerated sense of optimism. Clearly, headline numbers were lagging the markets. As the market moves towards the end of a financial year, that exaggeration is swiftly disappearing and getting replaced by fear.
We could see an overreaction on the other side too. And, investors with little or no exposure to previous cycles are going to be the most reactive to these trends. The challenge before us is not how we manage our investments but how we manage ourselves.
When investments do very well, we stop managing ourselves. We cease to follow the path of good sense and tend to get carried away. Investments cannot always take care of themselves. They need our active management when their valuations go out of whack. To achieve that, we need to manage ourselves and stick to the path of reason.
The fact that the market was way off the path of reason is now coming home to hurt. While the excess valuations are swiftly correcting now, we don’t know where it can lead to. Stocks tend to become cheaper than we expect them to. We need to manage ourselves well to ensure we don’t let go of that opportunity to invest in equities.
From the need to sell equities aggressively early this year, we could swing to the other extreme where we may need to be buying aggressively. Clearly, we are in preparation hour.
“You can’t predict. You can Prepare.”– Howard Marks
A not so innocuous news report by a global brokerage set us thinking about where we are headed as a market. ” $1.2 billion waiting to get into midcaps says CLSA”.
The logic behind this premise interested us even more than the actual premise. The premise was that mutual fund schemes needed to change their portfolios to comply with certain new regulatory norms. To our minds, this looks every bit like a mindless exercise driven more by compliance needs. The logic of selling what you own with conviction and buying what you need to own by category is surely a blind spot. Impact costs are clearly going to hurt investor interest. They come at a time when fund NAVs carry a lot of price massaging. Clearly, the timing of reform in mutual funds is nothing short of awful. And, the impact is going to badly hurt investors.
Investors must steer clear of midcaps for a while. Let the pain settle down. The coming months are likely to be driven by global factors and volatility. Focusing on micro changes in our markets simply won’t help. This is a time when investors who fail to play safe are setting themselves to be sorry later.
“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological. Investor”– Howard Marks
The FIIs have been persistent sellers of Indian equities. DIIs have bought steadily and supported the market. This explains the index not losing much despite heavy selling by FIIs. The regular domestic inflows are helping DIIs hold the market at higher levels.
In specific areas, like midcaps, we see funds continuously supporting stock prices of companies they are invested in. This is reminiscent of what happened in infra funds through 2008-2010. Domestic Investors kept pouring money into infra funds and were busy averaging down. Fund managers, in turn, supported stock prices. Eventually, the earnings started to wear away causing permanent loss of capital. Investors redeemed with a big loss.
Investing blindly on the basis of past performance is going to cause immense pain for investors. When markets shift towards newer themes and macro trends, investors need to quickly realign. This doesn’t seem to be happening. And, that is the biggest risk to the equity cult in India.
“Risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well.”– Howard Marks
The recent weeks are seeing the trend turn in several areas. Investment flows are looking very different with the persistent selling of FIIs in Indian equity.
News flows are also not looking great in February. For instance, first we had the budget levied long term capital gains tax on equities. Then, SEBI banned overseas stock exchanges like the SGX from using Indian indices to create products. Now, the PNB scam and the risk of its contagion effect on PSBs. Finally, the rising prospect of early elections in end 2018.
But these are more in the nature of reasons to explain market direction. The real reasons seems to be far more serious and structural. The uncertainty of global commodity prices, risks to fiscal discipline being maintained, upward pressure on inflation, possibility of rising interest rates, and the alarming prospect of a return to coalition governance are clearly worrying global investors. The higher volatility in global markets is definitely not helping matters either.
After enjoying decent macro tailwinds for a very extended period of time, we seem to be heading into a phase of macro headwinds. Such a phase inevitably leads to a lot of top down basket selling of the indices by global investors. Events of the past few weeks seem to reaffirm the onset of this selling trend.
Will this trend grow into a flood or will it reverse quickly? We will know in the coming weeks.
“The safest and most potentially profitable thing is to buy something when no one likes it.”– Howard Marks