The crack in US markets was long coming. Lest we forget, this is America’s longest bull run in history and their economic problems are far from over.
So, what caused this euphoria? Liquidity has been at the core of America’s economic problems and solutions. For a decade, America has been grappling with how to deal with the liquidity tiger and euphoria has become the unintended outcome.
Sadly, the cause of euphoria is ETF investing. This was a way of investing that was supposed to mitigate risks. Instead, it seems to have done exactly the opposite. ETF investing created a massive concentration of capital in a basket of stocks. As money kept pouring in, a bubble was created. Now, it seems to be unravelling.
But, Indian markets had a reason of our own to correct. We had too much concentration of financials in our indices. This will need to be fixed and our markets will do so in the coming quarters. In the interim, some pain is inevitable.
We are back to learning basic lessons on concentration risks.
The stock markets capitulated this week. The fears were largely overdone. The sharp dip in OMCs clearly indicates the symptom. The markets are clearly gripped by the fear of loss. And, investors dump every stock where they fear further loss. And the very risk aversion they display is causing huge losses to investors.
The disconnect between decision making and value is stark. Large caps losing almost 30% in just two trading sessions is now becoming a regular feature. The most valuable index bellwether lost 12% in just two trading sessions. The cracks are widening and sentiment could well capitulate unless something calms nerves and eases the fears. Results of the better-performing companies can do their positive bit. But, even that may not last for too long.
Not everything is lost yet. Contrarians will definitely show up in this market. The coming weeks could well be their best outing. A year later, this phase will be part of folklore. But, standing out and counting on conviction is not going to be easy. The time when greed bests fear was never meant to be easy. The coming weeks will prove that for the umpteenth time.
The markets saw heightening volatility this week. The stress was very visible in financials, small caps, and midcaps. The sharp cut in valuations of companies in this place has come as a nasty surprise. What went wrong?
Firstly, investors assumed that growth would last for a long time. Secondly, they believed profitability would hold steady. Third, the assumption was that valuations would remain stable. All three assumptions went into a tailspin when oil, the dollar, and liquidity went out of control.
While all three variables will stabilize over time, market confidence in financials and small caps will not return anytime soon.
This is going to be a big worry for markets in 2019. Indices need new drivers that can replace financials. Investors can’t exit small caps and midcaps. Mutual funds will struggle to hold onto assets when faced with aggressive redemption pressures. This will compound valuation concerns in this space.
Overall, markets need to walk out of their excesses of 2018 with as little damage as possible. This is not going to be easy.
A relatively insignificant event triggered a massive scare in Indian financials on Friday. But, the story does not lie there. It lies in the institutional imperatives clashing with individual investor interests. When there is a problem, either of solvency, liquidity or of risks, it is the bigger investors who bail out first.
The US 64 crisis is a classic example of this behaviour. Retail investors had to wait for years to get their capital back. The loss of opportunity was significant, and strangely, retail investors bore it quietly. The current crisis in a leading infrastructure lender is many times bigger than the UTI crisis. Importantly, it comes with the same symptom of US 64. The lenders run a potential risk of getting stuck without receiving monies for an indefinite period. This is going to make corporates who have parked surplus with such lenders to rush for the exit gate.
It is fair to extend that the debt mutual funds are going to struggle to meet bulk redemptions in an already illiquid market. This was what we witnessed on Friday. While the focus was intensely on which paper got sold and for what reason, we have not got any whiff of which large investor caused this panic. That is where the challenge lies for all market participants and by extension the regulator, as well as the Finance Ministry. We need a strong proactive mechanism to provide liquidity in such situations.
Memory may be short, and most would have forgotten how the RBI and the Finance Ministry reacted to avert a crisis the last time this happened. But, we are going to need much stronger effort and heavy lifting from both in the near future. These are interesting times.
“Prophecy is a good line of business, but it is full of risks.”
These words ring a bell as we approach the end of a decade after Lehman. Predicting almost never brings glory to the person doing it. Even if, by the twist of fate, the prediction is spot on, there will be enough people who will find ways to negate its veracity. Nobody likes accurate predictions as they are glaring reminders of what we failed to do about them.
So, we don’t even hesitate to lie to ourselves. We embark on an elaborate exercise of self-deception, by distorting the sequence of past events, altering narratives, and creating a new spin around inconvenient facts. But history remains objective.
Financial history has an indelible empirical trail. Numbers don’t lie. New narratives surrounding Lehman are mostly excessive personal indulgences. In a nutshell, the world got greedy, American capitalism lost its way, and that led to the meltdown. America can ill afford to simplify macroeconomic risks once again. The pervasive thought process that America needs to save, invest, and borrow sensibly still seems a long way off.
Today, we need to recognise that we can have another meltdown if we refuse to learn from history. Uncontained speculation makes real business look uninteresting. A stock market simply shouldn’t look better than businesses.
Prophesying that good times will last forever is never sensible. With that sombre prophecy, here is a solemn moment to the ghost of Lehman.
Rising oil and dollar mean only one thing for the Indian economy – trouble in the near-term. Business fortunes and purchasing power are closely intertwined with oil and the dollar. Inflation could rear its ugly head if both oil and dollar become difficult to manage for the government.
Stock markets are clearly underprepared for a shock on the macro front. The belief that these trends will recede and macros will stabilize is more wishful than objective. Rupee bulls hope for swift government intervention in the form of NRI deposit schemes or bond issuances. Meanwhile, exporters pray for an even weaker rupee. The reality probably lies somewhere in between. Further currency depreciation will create a sharp policy response in the form of stabilization moves.
The coming weeks look choppy and need to be navigated with caution. Choppy times could throw up interesting opportunities. With weakening macros, debt presents a more compelling case. Astute investors must be sensitive to opportunities and swiftly capitalise upon them. Debt books should be built in a measured and staggered manner. Equities will need to be played selectively with caution. The consequences of high oil, a weak rupee, and high inflation on businesses must be factored into decisions.
Investors are always so busy celebrating market highs that they miss the peak out moment. So, most investors tend to wake up long after the market corrects. The only way to ensure one is alert to the market highs is to follow an active-passive approach that is dynamic.
This requires skill, concentration, analysis, process discipline, and action. If these are not put in constant play, active management as a business will end up underperforming very badly. So, the underperformance we now see in the active management of large-cap mutual funds is not accidental. It is the outcome of long years of gradual decay, process degradation, and indiscipline.
Large-cap mutual funds are merely a classic example. And, a very glaring one at that. Advisors and investors run an even bigger risk by being passive over such actively managed mutual funds. The future is definitely not going to be as easy as the past. The message for investors is clear. Active Portfolio investing is fast becoming complicated.
The choice is to beat that complication through a superior investment process or to accept the ordinariness of index investing. This is an hour to make choices on what works for you.
If an asset class is hitting multi-year lows, then we tend to move away from it. On the contrary, when an asset class is nearing multi-year highs, we see the most clamour for it. Investor behaviour tends to shun risk exactly when valuations are very much in favour.
The current investment setting is seeing this happen across asset classes. Gold is near multi-year lows. Equity is near multi-year highs. Several metals and commodities are globally trading at multi-year lows. Yet, investor interest is mostly focused only on equity.
Why buy something when it is near peak valuations? Even if we choose to prefer equities, is it not possible to buy beaten-down parts of the market?
Investors must ponder over these questions carefully and work on improving asset allocation. Clearly, the pendulum has swung from one extreme to another. A decade ago, investors had owned too little equities and too much of other assets like gold and real estate. That balance has shifted significantly swinging predominantly towards equity. A more balanced approach is needed now.
Building portfolios which give due weight to different asset classes will work much better now rather than following an equity-heavy approach. Adjusting the weight is a smart way to adjust risk to more manageable levels.
Opinions are very different from judgements. Investment is a field where we carry both and apply them constantly. Opinions are lighter, presumptive, and easy going. We can like or dislike a personality, a business leader, an industry, or a business. Opinions formed on the basis of instinct rather than inquiry tend to often change and we use our freedom to express them as they keep changing. But, judgements are usually arrived at with more appraisal, inquiry, and analysis. These are formed with a proper formal process and constantly reviewed at desired intervals.
Stock markets tend to mix up its opinions and judgements. This could lead to grave investment errors. The error is usually made by the person receiving it, rather than by the ones making it. So, one should carefully judge what we are receiving and make a clear cut between an opinion and a judgement. It is up to us to use opinions in forming our own investment judgements. But, we should avoid the mistake of simply taking opinions as judgement.
When markets are trading at high valuations this tendency rises to dominate our behaviour. We need to ensure we clearly differentiate the two. Ensuring that we sift through opinions carefully and form our own informed judgements is the need of the hour.
The power of prescience is not something that is easy to practice in our investing. Knowing something in advance can be unfair advantage if it is from knowledgeable sources. So being fair and prescient at the same time is very important. But, there always is the option to independently anticipate what can happen. It was fairly easy to say that ING Vysya bank would someday be acquired by a better bank. Being prescient is always possible. An investor can visualise what can happen beforehand, validate one’s expectations and then wait for events to unfold. In an event driven stock market like India, a lot can happen in one’s Portfolio if we use the power of prescience well. In fact, it is the only way to make our investing proactive. There is a lot that can be done now applying the power of prescience. An array of positive events will unfold over the next two or three years in our economy. There is no better time to use the power of prescience. But, that would mean a lot of application, homework, anticipation, arriving at a thesis and active validation. This is going to be a constant pursuit. But, the power of prescience is going to be a very interesting and positive investment driver hereon.