Memo 27 – Market View: Feast & Famine at the same time!

Feast and Famine at the same time

The only thing that is predictable about the stock markets is its unpredictability in the short term. The stock market indices not only touched new life time highs, and they did so in the face of India’s worst bond market crisis. However, there was no celebration this time. As a matter of fact, stock & mutual fund portfolios of most investors are nowhere near all time highs. “Josh” among investors is low to say the least 🙂

The key reason for the above disconnect is the narrow nature of stock market rally, where-in stock prices of only 25-30 large companies have surged sharply. On the contrary, prices of most other large, mid & small sized companies are 5% to 40% below their highs. Usually, markets behave in such a manner whenever it believes that there is large uncertainty ahead. For now, the uncertainty pertains to election outcome & ability of bond markets to recover from risks posed by ill-health financial entities like IL&FS, DHFL, Reliance Capital, Yes Bank, etc.

Do election outcomes really impact your investments?

India has a reasonable institutional framework to ensure that no government can either do much good or damage in a short span of time. Also, the relationship between economy and government is self-correcting – if government actions damage the economy too much, its own tax revenues are impacted and it will eventually lose people’s mandate. The base case growth of Indian economy is ~6% and government actions can at best add or shave off 1% to the base number.

The noise, information bombardment, and excitement around elections force us to believe that it is a very important factor for our investment decision. Based on performance of Modi government, there could be 5-10% movement in stocks on either side in the short term. But we all know that over time, stock prices reflect the earnings delivered by the underlying businesses. A bad business will not do well even if Modi wins and a good business will not collapse even if Modi loses.

What are the new trends that are emerging?

Debt mutual funds too can give losses: People invest in debt mutual funds in order to earn slightly higher returns than bank fixed deposits. Mutual Funds in turn invest in bonds of various companies to generate high returns. However, the bond market crisis resulted in many defaults and mark-downs and many MF investors will witness “principal losses” or “lower than FD returns”. If your MF schemes have exposure to Essel Group, Eveready Group, IL&FS, Anil Ambani Group, etc, chances of sub optimal returns will be very high.

Retail bonds are giving once in five year opportunity: Thanks to the bond market crisis and tight liquidity environment, many NBFCs have started tapping retail investors like us for borrowing. Many highly rated NBFCs with sound business models are offering 9-11% interest rate. One can allocate some portion of their fixed income portfolio in retail bonds (selection of NBFC is crucial, consult your advisor).

Select NBFCs & real estate developers will reach new heights: Although both these sectors were at the epicentre of the crisis, the good players have been unaffected. These players will gain market share in times to come and create good wealth for their investors. Stock prices of some of the good NBFCs & developers are already making new highs.

Trivia: Talking long term vs. being long term

Over the past ten years, we have got many formal & informal opportunities to interact with working professionals and discuss about investments & personal finance. As a rule, whenever we are asked about investment in stocks, there are two questions that we unfailingly ask:

Question 1: Are you investing for the long term of the short term?
Question 2: Have you ever witnessed 20% loss in any activity in your life?

Answer 1: Majority, if not 100% of the people we meet say that they are in the game for long term. So unanimous is the response, as if the other answer will lower their self-worth! Most of them do start investments with long term outlook of 5 to 7 years and have reasonable expectations of 12-14%.

Investor expectations from stock investments

Year 1 Year 2 Year 3 Year 4 Year 5 Avg returns
Returns 14% 14% 14% 14% 14% 14%
Emotions Happy Happy Happy Happy Happy Happy

Answer 2: The answer to the second question, too, is a re-sounding NO. Most of the salaried class never suffers loss of money. They may spend it, waste it or save it, but they never lose money; worse case they only lose the opportunity! Unfortunately, investments in stocks and bonds can result in temporary or permanent losses. Since the prices are available regularly, the losses are visible on regular basis too and they hamper with your long term resolve.

Over last 25 years, Indian stock markets have delivered 14%+ returns. Ideally, that should have delighted the investors. However, majority of investors have failed to enjoy those returns because they could not continue during the tough years. Long term is an emotional game rather than a numbers game. No doubt that most of the investors are dejected about their recent performance rather than being excited about the opportunities that bad times provide.

Year 1 Year 2 Year 3 Year 4 Year 5 Avg returns
Returns -10% 14% -12% 55% 22% 14%
Emotions Unhappy Hopeful Fearful Delighted Happy Happy

Feel free to reach out in case you need professional help with your investments!

P.S: Equity as an asset class in extremely rewarding in the long term, however, only individuals who can bear interim volatility should invest in stocks. Kindly consult your investment advisor before acting on advice provided here.