Without the need to re-invent the wheel, we borrow a few words from a renowned global fund manager to describe the investor psyche that has broadly contributed to the sharp decline in prices of almost all asset classes in the last four months – “too much confidence, too little fear” led to a sort of bubble in gold, debt, commodities and select pockets of stock markets. Over the past four months, the Indian currency depreciated 10% vs. the greenback; most debt funds lost 5 to 10% of their value overnight, catching the wealth managers and their HNI investors pants-down; gold crashed 20% leading to an initial buying euphoria and subsequent disappointment; unregulated commodity markets saw the worst ever settlement crisis, shattering an easy source for HNIs to earn 18% annualized returns and the darling of stock markets – the private banks fell like a pack of cards. Each of these categories was perceived to have low risk and high probability of returns. While this expectation played out in favor of the believers for the past few years, its back has been badly broken over the last three months. Residential real estate has largely been spared of such a painful correction, but given the macro environment in India, it’s only a matter of time before it enters into steep correction. The bear market in stocks is underway since the last two years but the bear market in gold and property may just have started.
While we have been talking about India’s macro problems since almost eighteen months now, it reached its nadir recently as currency collapsed and interest rates reversed northwards. The seeds of this currency collapse had been sown a few years ago – India’s supply side started crumbling since 2009 – power projects have been stalled for want of fuel, road construction has reached a dead end on land acquisition issues, food prices remained high as investments in agriculture and irrigation continue to be neglected. At the same time, spending power of Indians remained high, fuelled by freebies distributed through various government programs including MNREGA. Thus we are in a situation where consumption exceeded production and we were forced to import more and more, year after year while exports continued to lag and this dichotomy reached its tipping point in July-13 as currency markets lost confidence in India’s ability to refinance its foreign debt and import obligations, resulting in 10% currency depreciation in a span of week.
The implications of these events for you are rather simple to comprehend – higher living costs, higher borrowing costs, lesser bonuses and fewer jobs for the young generation whose spending habits and aspiration levels are way higher than the current working population. The pertinent question that lingers in everyone’s mind is that are these changes permanent? Although the short answer is no, the infallible India story has surely broken down and it will take a few years before India sees 8% GDP growth and the consequential prosperity. To start with, the government needs to get its act together and ensure that supply side issues in infrastructure and food are sorted. At the same time, the Government will have to refrain for indulging into heavy social spending in the run up to national elections and take bold steps that can arrest currency fall. Our contribution can be limited in saving our jobs, improving our productivity and saving more money so that you can buy cheap assets in the turbulent times.
Luckily for us, things don’t change much and we continue to hide in the same old philosophy of being stocks specific. Except that we should be even more frugal in our buying prices. Would like to re-iterate that ‘individual investors should not look at markets as a homogeneous entity; instead they should focus on companies that have can survive cycles and sustainably grow their earnings’.
Which sectors/ themes do we like?
We will continue to classify real estate, infrastructure, PSU Banks, power, metals & mining as high risk sectors and add private banks to this category. The risks in Axis Bank, ICICI Bank, Yes Bank and IndusInd Bank could play out over the next six months and large exposures to these should be avoided. The FMCG & IT sectors continue to remain safe havens but we fear the formation of price bubbles in this space. Buying HUL, Nestle, GSK, TCS, HCL, etc at current levels won’t help you beat market returns for the next few years. Instead, you may be better off taking some risk in the portfolio in the form of a small exposure to a basket of potential turnarounds. The trick is to allocate a very small portion of portfolio to these turnaround stocks so that you earn decent returns even if only two of the five stocks turn around!
Gold may not give meaningful returns in foreseeable future and should be bought only on very sharp declines. Real Estate, the infallibility of which is so well entrenched in our psyche, should witness some downside. Pockets of Mumbai, Gujarat and NCR could witness sharp corrections. Individuals who are yet to buy should keep liquidity by their side – as a discount sale could soon be in offing for those who have cash to pay instantly. Finally, remember that recession is the best time to build a portfolio and your next two years should be precisely directed at doing that. Perhaps, the returns in the subsequent three years will help you achieve you retirement faster. Please remember that you won’t get the upside of equities without bearing the pain of the interim downside.
Trivia – The Confidence Effect
The sharp fall in stock prices of companies laden with some debt over the last two months had its latest victim – we happened to get a distress call from an investor with little more than two years of investing history, complaining “Is stock market less safe a place than it used to be?” Again, we searched for answers through teachings of some of the greatest all time investors and reverted to the distressed investor that probably, stock markets were never a safe place in the first place. Humans have the inherent tendency to shun uncertainty and vouch only for things they feel confident about. While this helps in getting a good night’s sleep, it is important to sit back and analyze the source of the confidence. The world is an uncertain place, be it the stock markets or the everyday life and a lot of times, our confidence is not based on thorough due diligence but only to give our self a false sense of safety. This is not to say that confidence is a bad thing, but false sense of confidence will lower your abilities to grapple with failure. On the contrary, identifying the risks will surely leave you better prepared to accept failures.
To illustrate the point, never has the quantum of personal loans and credit card outstanding in our banking system been so large. It just goes to show that our generation (the 20s and 30s) is far more comfortable with debt than our parents were. A lot of it stems from the confidence – that the young generation is educated, well employed and possibly more optimistic. While the source of confidence is not entirely shaky, I think the earnings risks to this generation are not too different than the previous. If we are better educated, there are millions more competing for the same jobs. Salaries can’t be extrapolated to eternity as increasing number of companies follow the hire & fire policy and increasing globalization brings a lot of foreign problems to India. Debt remains as risky as ever. Would quote Michael Lewis here “Leverage buys you a glimpse of prosperity you haven’t really earned. Jobs are contingent, but debt is forever”. This is not to scare you from taking debt, but to realize the risks that come along with it.
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.