Good returns are seldom made on investments made in good times.
Rather, good returns are typically made on investments made in adverse times.
There is a fair value for listed companies, just like for companies that are not listed.
In good times when the stock markets are doing well, companies typically trade above
fair values and in adverse times when markets are not doing well they tend to trade
below fair values. In the long run, markets do not sustain at either overvalued or
undervalued levels, rather move close to fair values. This is why investments made in
adverse times typically yield above average returns and vice versa.
Key challenges facing the Indian economy
It is true that the economy is currently passing through a difficult phase. However, this is
neither the first nor will it be the last time the economy is facing challenges. Besides, the
problems facing the economy are such that should get resolved over time and through
some specific steps.
The following is a summary of the key concerns that the economy / stock markets are
faced with:
High Fiscal deficit: This has been the key concern in India over the last few years.
Fortunately at one level and unfortunately at another, this is an issue that is of our own
making and therefore the solution is in our reach too. Though some steps have been
taken in the last budget, the real solution lies in eliminating / sharply reducing the diesel
subsidies. Despite several disappointments on this front over last several years, there is
hope that this will be tackled on a priority basis as the dangers of not tackling this are
hidden from none.
High Current account deficit (CAD): The worsening of current account deficit over last
few years from 1.3% of GDP in FY08 to nearly 3.8% in FY12 (market estimates) is almost
entirely on account of increase in gold imports from 0.4% of GDP in FY08 to 2.3% (E) of
GDP in FY12. Looking at the sharp rally in gold prices over last several years, investor
behaviour that is so typical of such situations, significant moderation in USD gold prices
over last year and sharp moderation in recent gold import volumes, it appears that the
highest gold imports are behind us. If this is indeed the case, then as and when gold
imports revert closer to longer-term average of 0.5% of GDP, the CAD should get
addressed progressively in the current and over the next few years. The sharp INR
depreciation should also moderate CAD in FY13 and beyond by making exports more
competitive and imports costlier.
Depreciating INR: This is a result of high CAD and of poor investment sentiment leading
to weak capital flows. Though forecasting currencies is harder than stock markets, it has
been experienced that when there is a consensus in one direction, that is where the
turning point often is. A nearly 25% depreciation in less than one year of the currency
of a large economy like India is not a small movement and it appears to be excessive.
What could also come to the help of the INR is the expected improvement in CAD in
FY13, any policy steps that improve investment sentiment, notably reducing fuel
subsidies and / or any moderation in global crude oil prices.
European Crisis: Though the way forward of European crisis is hard to figure out, most
would agree that the impact of the European crisis on the Indian economy and
therefore on the equity markets over long periods should be much less than on other
countries. This is so because India’s exports / investments in the stressed economies of
Europe are miniscule.
Between April 2010 (when Greek Government debt was downgraded to junk status) and now,
other than the markets of countries that are stressed, Indian markets are one of the
worst performing globally across both developed and emerging markets. This indicates
that the Indian markets are probably impacted more by India specific issues and not by
the European crisis. It is interesting to note that DAX (German stock market index) is
marginally up in this period whereas India is down 10%.
GAAR : This appears to have been commented upon sufficiently to assume that this has
been discounted by the markets.
In the face of so many issues and adverse news flow almost on a daily basis, it is easy to
forget the several strengths of the Indian economy. These are large availability of
natural resources other than oil, favourable demographics, rising incomes, high
household savings rate, low penetration of consumer durables, rising competitiveness
of exports due to sharp depreciation of INR (particularly vs Yuan), slowly but steadily
improving infrastructure, etc. Though these strengths seldom make headlines, they are
intact and should lead to continued economic growth in future as they have in the past.
Global crude prices are correcting rapidly. OPEC and Saudi officials have openly
remarked that they are comfortable with Brent Crude at $100. Negotiations with Iran on
nuclear sanctions are also reportedly progressing. If oil prices stabilize at lower levels,
pressure on fiscal / current account deficits and INR will quickly ease. Lower interest
rates will then be a natural outcome and will support a much-needed revival in Capex.
The current problems facing the economy are not insurmountable. The solution lies in a
few difficult decisions. As difficult changes typically take place in difficult situations
when there are no easier options left, it is hoped that we will not have to wait for long.
With few such steps and over time, it should be possible to put the economy back on
the rails fairly quickly.
Difficult markets or bargain markets?
The stock markets are passing through a difficult phase. The values of the listed
businesses as indicated by the Sensex are down by 20% between 2008 – 2012 (presently
SENSEX level is 16000 compared to 21000 seen in early 2008). This is despite a nearly 60% growth
in the GDP (15% CAGR) and therefore a similar growth in the fair values of businesses over
the same time. Consequently, one year forward P/E multiples have come down sharply
from over 20 times in FY08 to below 13 times presently. These are nearly 20% below the
long term averages. Further, the P/E of the Sensex based on FY14 (E) EPS of 1475(source : BOFA ML) is nearly 11 times, which is close to the lowest multiples that Indian
markets have traded at in the past.
Bargains are available only in challenging environments / in markets characterized by
weak sentiment and seldom when the going is good / sentiment is strong. That’s why,
from an investor’s perspective, a more appropriate way to describe the current
markets would be bargain markets and not difficult markets.
God and Equities
The couplet by Saint Kabir, a much loved and revered saint of 15th century who lived near
Varanasi – which many believe is the oldest city in the world to have survived continuously.
This couplet reads as follows:
Dukh Mein Sumiran Sab Kare, Sukh Mein Kare Na Koye
Jo Sukh Mein Sumiran Kare, Toh Dukh Kahe Ko Hoye
It means the following:
[ In anguish everyone prays to Him, in joy does none
To One who prays in happiness, how sorrow can come ]
Stock markets and God do not have much in common. Probably, that’s why, the above
does apply to stock markets but in reverse.
An adapted version of the above for stock markets would be as follows:
[ In good times everyone invests, in adverse times does none
To the wise one who invests in bad times, wealth should come ]
The moral of this is that remember God in good times and equities in bad times. If this
is done, then chances are one will avoid both - bad times in life and poor returns on
investments.
Its tomorrow that matters
By the end of June or shortly thereafter, Greece will either be in Eurozone or it will not
be. Over the same timeframe, steps if any, that are undertaken by the government to
resolve some of the issues facing the economy will also be known. Irrespective of what
happens, markets should discount these outcomes fairly quickly.
It is true that the economy is currently battling twin deficits, but that is known to the
markets. What will determine markets of tomorrow, are the deficits of tomorrow and
expectations thereof, both of which chances are will be better and not worse than
today.
Times such as present, when the markets are not doing well should actually be looked
upon as a window of opportunity for savers to invest more into equities, so that when
the good times come, there are meaningful investments in equities to reap the
benefits from. The lower the markets are, the bigger is the opportunity and the longer
the markets remain depressed, better is the opportunity for savers. In a lifespan of
investing of say 30-40 years, it is unlikely that the markets will provide many such
windows. In the last 20 years there have been only 3-4 such windows.
Finally, what has taken several pages, Sir John Templeton conveyed more effectively in
one line:
“Bull markets are born on pessimism, grow on skepticism, mature on optimism and
die on euphoria.”
Needless to say, pessimism is all that one sees all around.
