Category Archives: Market Wrap

The Need Of The Hour

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

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.

Lock into Debt

The purpose of monetary policy is to manage inflation, facilitate growth, and regulate credit in the economy. The RBI’s Monetary Policy Committee (MPC) has a clear mandate to target inflation and maintain it around 4%.

In terms of bond markets, 2017 and 2018 are like chalk and cheese. 2017 witnessed the after-effects of demonetization. Excess liquidity needed to be neutralized, India’s growth prospects required attention, and inflation was persistently low partially supported by low oil prices. The markets expected the RBI to cut interest rates to boost the economy. By contrast, 2018 records almost neutral liquidity, volatility in the inflation prints, and elevated oil prices. This time around, the market anticipates rate hikes. Yet, the RBI has chosen to maintain the same neutral stance through both years.

Bond yields have moved almost 1.5% from corresponding levels last year. A rise in yields indicates a reduced appetite for bonds. This can be attributed to geopolitical tensions, increase in interest rates in advanced economies like the US, higher oil prices, increased supply of government bond, and expectations of rate hikes. The RBI has raised interest rates twice already this year. We could expect further rate hikes on the back of a higher MSP, increased government spending, higher fiscal deficits, and elevated oil prices.

Now is the time to lock into debt. Bond yields are attractive. Following a sensible asset allocation strategy can help diversify risk and bring balance to an investment portfolio. Constructing a layered debt portfolio requires preparation. The debt market could witness continued volatility, but volatility is an investment opportunity. Prepare now for the chances that come your way.

Seek Safety

Indices do have their own way of peaking out. Up moves and peak outs are connected. What happens around an up move leads to a peak out. The up move must be clearly understood.

So, let us now deconstruct it. Usually, the defensive stocks lead the index movement. But, this time seems different. In the current move, it was infotech that moved first. Then, the beaten pharma stocks moved up. The consumer stocks followed with a swift surge. The financials, a handful of private financials actually, came up with a rear guard up move. Lastly, the commodity bellwethers moved up swiftly.

Most of them were raising monies using the uptrend. They either sold their own stock through a fresh issuance or monetised subsidiaries or intend to sell promoter stock. Clearly, a capital raising intent is very visible.

Broadly, this sums up how NIFTY trumped active managers. But, being too nifty isn’t good for the NIFTY. History has many instances when the NIFTY toppled when it was too nifty, right in the middle of aggressive capital raising by its prime movers.

So, racing the NIFTY maybe a mugs game in the near term. On the contrary, racing to safety maybe a better idea. Decipher how you can achieve safety with the right calibration.

Recalibrate Risks

Risks and returns are always meant to be viewed holistically. But, how many of us do that? An interesting incident only reminded us how little people respect risks.

An investor had been invested in equities for the three-year period between 2014 and 2017. At the beginning of 2018, just as oil prices began to rise and Indian macros started to appear shaky, the prudent move of booking profits in over-valued parts of his portfolio was advised. He went ahead and moved monies to liquid instruments. Subsequently, his returns dipped to the more moderate levels that liquid funds usually generate. But, the investor was still obsessed with Nifty returns. He was dissatisfied that he wasn’t making Nifty returns.

The value of lowering risks and returns was not adequately understood. Making returns seemed to matter far more than managing risks. Where one invests matters. Changing the asset allocation of an investor to recalibrate his risks will always come at a cost. Similarly, even when our approach chooses relatively cheaper parts of the market and advises investors to put money into them, they still run the risk of becoming cheaper.

Returns will be lumpy and investors should learn to always shift their focus on risks while evaluating advice. As long as the advice is sensible and moderated in its risk approach, we should not worry about the returns. After all, markets habitually reward investors who take risks in a disciplined, organized fashion. The key thing to be done now is to follow a disciplined and organized approach to risk taking and deployment of savings.

Returns will follow those who stay mostly sensible when taking risks.

Redo Asset Allocation

At a time when everybody has overdosed on equity, elections are looking imminent, macros are getting challenging, and benchmarks are outperforming portfolios, it makes sense to take a re-look at asset allocation. Clearly, the most important thing now is to get our asset allocation right. A wrong allocation can affect our overall returns significantly over the next few years.

Elections always bring political risk that may impact returns and it makes sense to keep risks within control. The best way to do that is to rejig asset allocation quickly and to gradually return to risk over a period of time. For portfolios that are steeped in midcaps or small caps, this is not going to be easy.

But, what is good for one’s wealth creation is never going to be easy. Rejigging asset allocation requires liquidity in the stocks we want to sell. This is going to become increasingly challenging in microcaps and small caps. This is not going to be easy in midcaps either. The absence of liquidity in trade could worsen over the rest of the year and this represents the greatest risk to our wealth.

A sell-off can significantly impact portfolio valuations with liquidity hurting far more than fundamentals warrant. Ensuring we are protected from that phase can be effectively achieved by exiting the potentially volatile space and seeking safer asset options. That makes reviewing asset allocation the most sensible option right now.

Redux Hour Returns

Stock picking takes far more mind space, time, and effort in every investor’s life. The time dedicated to stock picking far exceeds the time spent on investment strategy. Stock picking and investment strategy are connected in the middle. The reasons are not difficult to decipher. Deep within, we believe that stock picking is all that is required to deliver returns. By extension, if we buy the right stocks, then we think we will be on top of the game. In rising markets, this works very well. The celebrated investors and managers always float on the stocks they picked and how well they performed.

But, there comes a time in every cycle, when it is not easy to create reinvestment. Stocks you sell end up being far superior to the stocks you buy. At this stage, stock picking stops working. Actually, it begins to hurt. What can salvage such situations is a focused, holistic investment strategy. But, that hardly comes naturally or easily.

Developing and practising an investment strategy on which stock picking is an intrinsic essential is what we have long referred to as a process driven investing. But, in every cycle, this process gets dominated by rushed stock picking. This eventually derails the very process itself. The process then needs to be put back on the rails by focusing intensively on the strategy.

Risks need to be treated on an even keel with returns. Investing seems headed into a phase of concerted process redux.

Be Defensive, Stay Contrarian

The genesis for the current meltdown in Indian markets must be understood well and remembered for a long time to come. Interestingly, the indices held steady during this period.  So, what caused this downslide?

Broadly, the markets showed overwhelming faith in smaller companies over the index bellwethers between 2015 and 2017. The poor performance of index bellwethers like tech and pharma during this period contributed to the heavy concentration of investor interest in midcaps and small caps.

The belief that small and mid-cap companies will be insulated from macroeconomic challenges grew on the investor psyche between 2015 and 2017. During this phase, investors gradually moved away from large caps and raised their exposure to midcaps, small caps, and even microcaps. The heavy concentration of fund flows clearly raised returns and valuations in this phase to all-time highs. Valuations spiked up leading to a premium in midcap valuations over even the indices.  This unusual trend persisted for months together. Investors knew this was unusual. But, nobody was ready to go into cash.

It is under these circumstances that valuations in midcaps cracked. With economic macros like exchange rate, oil prices, and inflation turning the markets may be on the cusp of a new trend. This is a good time for contrarian, defensive investing.

Stay Ahead of the Cycle

Market cycles tend to constantly throw challenges at investors. When markets are at cyclical highs, it is extremely difficult to sell and exit. When markets trade near cyclical lows, taking a bold investment call is near impossible. When the markets trade on an uptrend, we tend to keep buying more as the trend grows to its strongest point. Most buying happens around the strongest point and buying momentum refuses to slow down for a while.

What we have seen in early 2018 typified this behaviour. As we are seeing now, the trend slowly changes or breaks down, but investment behaviour refuses to change or adapt as quickly. When the trend breaks down completely, we usually struggle to adopt newer strategies. Our liquidity may be low and the scope to reorient portfolios is also minimal.

The sensible approach would be to gradually reorient portfolios as the trade turns. The markets will give enough time and there would be enough liquidity to buy as well. When extreme lows are hit, the exercise would be near complete and the portfolio will be forward-looking. Investing strategies need to change towards the future and gradually align portfolios with the emerging scenario. This can work well only with a graded approach.

The Crossroads Are Here

The sharp comeback in pharma stocks, the buyback announcement by TCS, and the sustained weakness in midcaps send out clear signals. The markets are at the crossroads. Liquidity and its power to sustain equity valuations have been overestimated. You may wonder why this is happening. As a performance hugging universe, mutual funds have been caught off-guard on defensives.

This is a double whammy as they have already spent two quarters coping with their earlier misjudgment in midcaps. The lack of anticipation and the tendency to avoid risk cut both ways. When one refuses to move away from the herd, it can be costly as the market trends tend to shift away very swiftly. The sharp rally in IT stocks in Q1 caught the MF’s off-guard. Now, it seems to be pharma’s turn.

Clearly, overall capital flows towards defensives is gaining momentum. This puts the growth stocks at the risk of seeing outflows as performance chasing public investors will be left with no alternative but to buy defensives. The coming weeks will see more churn. The markets don’t seem to have the liquidity to even enable requirements of this churn.

Clearly, a lot of public investors seem to be caught off guard right now. The crossroads are approaching at a time when they aren’t ready to quickly decide which way to go.