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.
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.
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.
Volatility has struck debt and equity markets in equal measure in 2018. Valuations continue to remain an area of concern with respect to equity markets and volatility will continue to persist until earnings match valuations. This is a global phenomenon and is not restricted to domestic equity markets. Meanwhile, investor appetite for debt has reduced.
Our core strategy team has been working on attractive investment options within the fixed income space. Our strategies are expected to outperform traditional investments like fixed deposits (one-year) by 1% to 1.5%. Hedging your portfolio through proper asset allocation will help mitigate risk. To explore your investment options please get in touch with your relationship manager.
Positive growth indicators and tame inflation are facilitating the Fed’s policy to hike interest rates. Globally, advanced economies are expected to follow the same cue. Interest rate hikes across the board could induce volatility in emerging markets like ours. More importantly, threats of a trade war, rising crude oil prices, geopolitical tensions, and protectionist sentiments could further pose threats to stability. Currencies are expected to weaken, as countries compete for exports and try to manage deficits.
The RBI’s neutral policy implies that a data-driven approach will be followed when it comes to managing the economy. Any adjustments will be made in a calibrated and gradual manner. The focus is on resolving stressed assets, improving transmission of policy rates, keeping inflation within the target range, and fostering an environment for higher economic growth.
Bond yields have remained at elevated levels for a variety of reasons. The government breaching its fiscal deficit led the market to believe that there would be an oversupply of government bonds. Markets anticipated that the government would borrow more heavily in the current year. However, its announcement to restructure the borrowing program by following a more staggered approach using instruments of varying maturities has pleasantly surprised investors.
The recent scheme recategorization has created a more transparent and investor friendly system to understanding the classification of mutual funds.
Risk management always plays a central role in any investment strategy, especially when it comes to debt. A well-constructed portfolio should be able to weather uncertainties and deliver returns. To discuss hedging strategies through asset allocation, do feel free to reach out to our team.
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
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