“All good things must come to an end, so that better things can happen”
For long term investors like us, falling markets are time for mixed emotions. The fear of mark down in portfolio values is interspersed with hope of buying long-awaited stocks at attractive prices. But this time, the emotions are tilting more towards relief that falling markets will bring sanity back to the world of business & investing. Relief that focus is changing from âgrowth at any costâ to âgrowth with profitsâ; that speculative areas of the market like meme stocks, cryptos, unicorns, etc will get lesser attention; that every new company or IPO or tech start-up will not be touted as the next big disruptor.
One can ascribe various reasons for the market correction like inflation, tightening by US Fed, Ukraine war etc, but the most common reason for any stock market party to end is that the prices had run-up far ahead of business fundamentals. It is hardly surprising to see the poster boys of the pandemic party i.e. tech stocks, new-age companies, chemicals, cryptos, etc seeing the steepest fall. The point of this article is not to bash up these stocks & their investors but to see if this phase offers any insights or opportunities for the future.
Insight 1: Excesses never go unpunished!
It would have been impossible to imagine in Junâ20 that exciting companies like Zoom, Facebook, Shopify, ARKK Innovation etc, would end up giving lower returns than boring but stable companies like Nestle & Dabur. In India, similar value erosion has happened across many themes â new age stocks like Zomato, Cartrade, Nazara; narrative stocks like Neuland, Sequent, Solara etc; super expensive stocks like Bajaj Finance, CDSL, Dmart, Divis, Dr Lal; 2nd rung companies like Lux, IDFC Bank, etc. History is again trying to teach us the same lesson “what comes easily also goes away easily”
Insight 2: It is never all good or all bad!
Itâs rarely the case that all pockets of the market are in bubble zone or in value zone at the same time. There are always pockets that one should be careful of and pockets that one can be optimistic about. In the Indian context, the bubble was in start-ups, new IPO listings, pharma, chemicals, commodities, electric vehicle & green energy related stories and many export-oriented stories. Correction has begun but it could still be some more time before they reach their fair values.
On the other hand, there is little euphoria in sectors like banking, auto & ancillary, durables, industrials, real estate, resources, etc. These spaces can do well once Indiaâs informal economy recovers from the Covid shock. Sectors like home improvement, travel and fashion should continue to remain evergreen.
Insight 3: Inflation is here to stay, prepare for it!
In all our past articles, we have never spent much time on macro topics like inflation, currency, interest rates or money supply since all those indicators were benign. But something has structurally changed in the post-pandemic world which makes us believe that inflation deserves deeper attention. This time, inflation stems from demand as well as supply factors. On the demand side:
The stimulus packages of the western economies have created excessive demand for electronics, cars, homes, home interiors, energy, etc. Also, the developing countries like India, Brazil, Vietnam etc, are fully opening up post pandemic and the postponed demand is coming back.
Chinaâs geopolitical dealings during COVID and US & Russiaâs cold war-like behaviour recently have exposed the fault lines in global supply chains. Many countries will strive to have self-reliance in areas like food, energy & electronics and build factories, power plants and strategic storage reserves. This will consume a lot of resources.
On the supply side, the stickiness seems more glaring as it comes from deeply entrenched structural factors that have no immediate solution. Europe is facing record shortages for things as basic as gas & electricity. Below are some of the supply side reasons:
The ESG focus & clean energy narrative ensured very little investments have been made in conventional areas of mining, oil & gas exploration, refining, blast furnaces, etc. Even if we decide to start investing, it takes years for these projects to start production (A copper mine takes at least 10 years from conception to first batch of production).
China had a big role in controlling global inflation in the past 30 years. Government incentives, cheap labour and relaxed environmental regulations ensured that China supplied cheap goods to the whole world. But that is changing now, as labour costs in China are rising rapidly (thanks to one-child policy, the average youngster is much more affluent v/s their parents who worked long hours in factories). Also, as affluence in Chinese society is rising, they are demanding cleaner cities and the government is responding by tightening environmental laws.
For the sake of our environment, we too were hoping that the era of fossil fuels would soon come to an end. But the reality is that renewables contribute less than 5% of global energy needs as of today. Electric Vehicles contributed to only 3% of total cars sold in the US in 2021, remaining 97% will still need gasoline while they are on the road for at least a decade or so. Also, letâs not forget that the clean energy transition will need a hell lot of steel, aluminium, copper, cobalt, nickle, lithium, polysilicon, etc â all of which requires more mining and smelting activity.
Clearly, the world stopped investing in conventional sectors way ahead of time and there is little option but to revive some of these investments. Stocks in these sectors are cheap and could get a fresh bout of life. Another consequence of high inflation could be that many consumer facing companies will not do as well in this decade as they did in the previous decade.
Trivia â Normal inflation vs aspirational inflation!
In a growing country like India, inflation has always been around, like the background music in a restaurant â you wonât notice it unless itâs too loud. Our folks will occasionally whine about rising prices of tomatoes, Amul butter, petrol, etc (canât resist mentioning the scene from 3 idiots at Rajuâs place) but it hardly affects their or our consumption patterns. Our earlier generations hedged themselves against inflation by buying physical assets like gold, house or land and it worked well for them (until 2014). Unfortunately, itâs not so straightforward for our generation to ape this.
Firstly, land & residential housing is still over-valued in most of the cities and may not deliver 6-8% returns. Secondly, the inflation rate for the young affluent class is at least 2-4% higher than the 6-8% rate published by RBI, courtesy the subconscious aspiration to keep upgrading our lifestyles. We have all witnessed this from close quarters â brand domination in bathroom shelves has changed from HUL to Body Shop to Forest Essential; wardrobes have changed from Fashion Street/Chandni Chowk to FabIndia & Zara; cars have changed from Maruti to Morrison Garages; healthcare has shifted from local doctor to Metropolis or Max or Apollo; vacations have evolved from native place to Taj & Airbnb.
A striking feature of this âaspirational inflationâ is that it is extremely persistent till we reach our 50s. Very few can break-out of the cycle of aspirational inflation, so itâs best to acknowledge it and plan for it. An elderly investor enlightened us in 2014 that one need not be scared of aspirational inflation, rather it can be the best hunting ground for ideas for long term investing. We wrote about this in our 2014 article. Between then and now, stocks of more than a dozen companies that provide better housing, food, fashion, vacation, etc have given higher returns than the aspirational inflation number!