While the markets were focused on equities, yields on the 10-Year gilt quietly rose to cross 8% again. With other asset classes like real estate not doing much, and returns from equities clearly slowing down, debt makes a clear comeback as an option for conservative investors.
Over the next few months, investors can build a compact portfolio with the right mix of equity and debt. In fact, this is a good time to re-look at asset allocation, carefully rejig the allocation to each asset class, and build both debt and equity portfolios for the medium term. Importantly, choosing investments must be done in a way that ensures long-term tax efficiency.
Debt investments must be chosen keeping in mind a longer time horizon. Locking into higher returns from debt investments must happen when interest rates trend higher. This requires a carefully crafted investment strategy. Equity investing must also ensure choices are aligned to medium portfolio out performance.
Past performance will now tend to confuse our choices. One must learn to think beyond past performance and focus on what lies ahead.
“Large caps look inexpensive compared to small and midcaps.” A value investing peer said this in a rather complaining tone. To investors who made most of their wealth buying small and midcaps, these are troubling times indeed. The situation has remained so for the past year. Investors have been struggling to cope with this. Stocks were expensive and people were buying them as if there was no tomorrow.
Nothing contrasts this frustration more starkly than the bold and aggressive SIP flows into the same space from retail investors. Investors have been pouring money into this space based on past returns. While experienced investors struggle to deploy money in the space, public investors were partying with the monies of the retail investor. But, the first signs of cracks are clearly there. For starters, stocks which were not owned by mutual funds have corrected sharply. This gives a false impression that fund owned stocks are safe. But, there is more to this than meets the eye. Fund owned stocks in the midcap space will correct when the funds are not in a position to support their prices. It is fairly safe to assume that day shall come.
Meanwhile, the market struggles to find defensive investments in equity. Portfolios will take an increasingly defensive stance and returns over the next 12-18 months will probably see better traction in defensives. Aggressive investment strategies will probably take a break. The time is ripe to stoutly defend portfolios.
Participation in equity markets is viewed as a secular trend. Being invested is not the same thing as being invested in the right place. Even within the equity market, where you are invested matters. For instance, one could still have been fully invested in equity markets without owning a single tech stock in 2000 and a single infra stock in 2008. Keeping a reduced ownership of financials and midcaps and yet being fully invested in 2017- 2018 may well be the contemporary equivalent of that behaviour. Outcomes could have been dramatically different for the consistent contrarian.
Domestic money has been a serious determinant of every bull run of recent times. This bull run is predicated upon how aggressive domestic flows are directed and where they are headed. The end of this bull run also arises from this direction, actually from its reversal. So what actually happens? After long periods of continuous inflows into a particular segment of the market, we started seeing the flows go the other way. The catalyst could be from anywhere. And once the reversal happens, more people will get caught by buying the dips.
Strangely, in both 2000 and 2008, there was ample scope to be a determined contrarian and succeed at it. The answer lies in relying on top down investing when the bottom up trade goes over the top. This is easier said than done. The current phase is also looking to become a top down dominant trade again. The sad thing is that nobody seems ready and willing to bet on it. The winner will clearly take it all.
Rising oil is something nobody has factored into their investment calculus. So, there will be a need to rewrite the whole math. When the market is forced to suddenly revisit its math, it is more likely that the rework will be aggressive. So, the market reaction will tend to be kneejerk. For sure, there will be a sense of urgency.
The sharp bounce we saw in technology stocks at the prospect of a weakening rupee is a recent instance of this behaviour. Now, we are staring at costly oil. This should mean a weaker rupee, tighter forex reserves and higher inflation. India has one more decade of enduring the pain of oil. By then alternate energy will clearly grow and electric technologies will de-risk our economy significantly from oil. But, the intervening years will see the pain come and go.
Should we read too much into the oil price trend? Will it impact our macros severely? The government has a number of options before it. It certainly has to take decisions that will help soften the double blow from the spike in exchange rate and oil price. When it does, there will be other consequences. Striking the right balance is critical.
In the past, governments failed miserably at this. While oil is a risk, it is also likely to help the much-awaited earnings recovery for the index. We remain a commodity heavy index and there is definite scope for earnings of biggies to grow. But, that is contingent on the quality of governance. Populism will clearly spoil the party. One thing is certain. Those companies that saw earnings expansion purely due to cheap oil are going to see their party end abruptly. The stock market seems ill-prepared for that event.
The week was eventful and that is putting it mildly. Globally, we saw the Iran deal getting called off by the US. Oil prices predictably spiked. Several domestic banks reported their worst numbers in recent history. Provisioning norms enforced by the RBI seem to have taken a toll.
The political fever reached a high almost touching the point of delirium. The polarized media lost its emotional bearings at the very thought of an inimical electoral verdict. Defensive stocks became all the more expensive. Small caps and mid-caps got further sold down. Bad news and rumours were brutally punishing stock prices. But, there were silver linings too. The early pre-monsoon showers were generous and well spread out. The south clearly is going to have a very good monsoon. Sowing will probably be the highest in Indian history. Agriculture seems to be in the middle of a great phase of change.
How does one bet in the middle of all these trends? A simple approach would be to step aside, focus on industries, sectors and companies which are set to benefit from the way the world is changing. Ignore past performance and focus on how the performance grid is moving. Take positions where performance will soon emerge. Lie in wait. Easier said than done, right?
The coming weeks will probably see a big deal announcement. This is going to be in a space where investors constantly doubted valuations. If the rumour mills are to be believed, this deal between a potential buyer and Flipkart, India’s leading online retailer will be one of the biggest deals of all time. Importantly, it signals the beginning of a phase where investment flows directly into Indian businesses are going to become bigger and better. Further, digital businesses will see renewed thrust, focus and investment.
The decision by SEBI to let stock exchanges work almost till midnight is another gamechanger. This move will signal the coming of age of digital financial firms. Domestic digital services are clearly going to be never the same again. They are entering a credible phase of extended growth, big-ticket investments and business transformation. The irony is that these firms are hardly represented in most portfolios and remain still very much a private equity pocket borough. That they need even bigger pockets now, is certainly not music to ears of domestic investors who already feel left out.
“ No rule always works, the environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable. ” ― Howard Marks
Interest rates are a great leveller. They always set the trends of the equity markets. But we have two sets of rates to contend with, domestic and global rates. Domestic interest rate trends are constantly shifting and puzzling. Just when the trend seems set to rise, something happens which softens the trend. Signalling by the government also plays its part in softening the trend just when rates harden up. The absence of a guidance only makes matters worse. But, US interest rates are clearly heading north. We are guided on both the trajectory and extent of rate hikes. The guidance is unambiguous.
Markets constantly play on rate expectations and actual impact. When expectations are more benign than impact, markets tend to gain. When the actual moves hurt more than the markets anticipate, we are going to be in for a negative surprise. While the US markets are not likely to surprise, the domestic debt markets never fail to surprise the equity investor. We will have more worries coming our way from the domestic macros, rising US interest rates, and the debt markets in 2018. If and when the markets climb the dual wall of worry, it could end up being a huge positive surprise for equities. But that could still be a long way off.
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.