This series comes after 4 long months during which market behavior was nothing less than volatile. Post the reforms process initiated by this government in Oct-12, the markets rallied sharply in hope of improvement in macros as well as business environment. The big differentiating factor from previous short rallies of 2012 was that even low quality mid-caps started participating in the rally. While it would have been only natural to assume that economic recovery was on cards, what most of us do not know is that this rally was also aided by benign global liquidity that followed the quantitative easing plans of the US and European Governments.
The rally soon peaked and the decline started once the realization dawned that implementation of reforms process is extremely slow and macro improvement is still far away. Multiple events have happened in the past two months. National budget has become increasingly irrelevant for the markets, and India’s GDP growth slowed to 4.6% for the third quarter. Very few could have imagined India’s GDP growth falling to such levels from the 8%+, a level we have always imagined as our birth right!
The question as always is – What does an investor do in such a situation? How can he trust the markets with so much volatility in prices and sentiments? Surprisingly, the solution to such a complex problem is remarkably simple and clichéd – invest for longer horizon and invest in quality stocks. In this backdrop, it is important for every market participant to reassess his expectations from the stock market:
1) India’s macro problems will be resolved only slowly. As an illustration, it’s been six months since the reforms were announced but we are yet to see a large FDI proposal. Similarly, coal issue is yet to be sorted out as negotiations on pool pricing issues are still underway. The only scenario where we resume a high growth path within one year is a sharp decline in oil prices.
2) It’s not going to be an era of secular under-performance, there will be winners and losers. The macro slowdown will not impact every company in a similar manner. Some companies will continue to grow faster than system and post above average earnings while some companies will be decimated over the next two years. Needless to say, you should be invested in the potential winners. Experimentation with low quality stocks will generally leave a very bitter taste in the mouth for the next two years. Just as an illustration, DB Realty went up 70-80% in the yearend rally and subsequently fell 50%, leaving you worse off. You would have had a similar experience even with strong brand names like BHEL, L&T and SBI, given that their businesses have slowed down and face significant headwinds.
3) Volatility will be high, your conviction will be tested on multiple occasions. Markets take cues from multiple global and local factors most of which are uncertain. Hence there is good probability that markets may rally at one point on good news and may sell off with even more vigour on a bad news immediately after the good news. Investing based on ‘prediction of market movement‘ will be extremely unnerving. There will be times when good stocks would also be punished and such occasions should be used to increase your exposure to them, rather than getting jittery.
Markets may not fall sharply from here but upside movements are more likely to be stock specific. Also, it is not the best time to buy into high risk sectors like PSU Banks, power generators, real estate, aviation, infrastructure and they are best avoided.
Trivia – The portfolio that fell 50% in two weeks
For most Indian’s including the well qualified working professionals, stock markets are typified by a Gujarati or a Marwadi friend, uncle, relative who has lost a lot of money in market crashes. A lot of them believe that investing in stock markets is synonymous to gambling. One such event has occurred in the past two weeks, and detailed analysis of it can help in rationalizing this image and highlighting the fact that there is a method to the madness that happens in the stock markets.
The stock market witnessed an unusual event in the past two weeks. A host of mid-cap stocks fell 30%-50% in a period of two weeks, leaving a lot of investors badly bruised. Weak market sentiment, leveraged positions, operator activity, etc played their role in the fall but the bottom line was that investors in those stocks lost 50% in a short span of time. A cross section analysis of the fall reveals that it was not difficult for an average investor to avoid being caught in such a situation.
Gambling has many forms and the most basic definition I came across was “betting on anything that you don’t understand well is gambling”. So declaring stock markets as a gambling den based on few people you may know or few incidents that other people narrate to you is similar to an American tourist visiting only Dharavi in Mumbai and reinforcing his belief that India is a poor country, hungry country, dirty country!
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.