Glass Half Full or Half Empty?

 

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The table above presents the equity returns of some of the world’s largest markets since January 2001 against their nominal GDP growth (in local currency) over the same period.

The idea is to examine whether over long periods, equity returns that track nominal GDP growth are an optimum outcome an investor can reasonably hope for. Listed companies ought to, broadly, grow with the economy that hosts them. Returns far above GDP growth would usually mean valuations have expanded or profit margins have stretched, and neither can go on forever. Returns far below GDP growth usually mean something has leaked between the economy and the shareholder: poor capital allocation, dilution, a shrinking share of profits, or economic growth that happens outside the listed universe.

By that yardstick, the picture is mixed.

The lagging majority

Thirteen of the twenty-three markets have delivered equity returns clearly below nominal GDP growth. In several cases the gap is wide. China and Hong Kong, the UK, France, the Netherlands and Italy have all delivered less than half of their respective GDP growth. China is the starkest example. Nominal GDP compounded at over 11% a year while the Shanghai Composite returned about 2.2%. The economy grew enormously, but very little of that growth reached the owners of listed equity.

The divergence could be a result of a multitude of factors. For example, growth can be captured by the state, by unlisted private firms, by foreign investors in other markets, or by the workers and consumers who benefit from it. It can also be consumed by years of poor returns on capital. Shareholders get only what is left.

The leaders, and when they led

Nine markets have beaten GDP growth: the US, Japan, South Korea, Taiwan, Canada, Germany, Mexico, Thailand and, narrowly, India. On the surface this looks like vindication for equities.

Look at when the outperformance arrived, though. In the US, Korea, Japan, Germany and Taiwan, most of the excess return has come in the post-Covid years, and much of it in the last one to five. These are the markets carried by AI, semiconductors, and a general re-rating of earnings.

Japan’s ratio of 7.47 is partly an artefact. Nominal GDP growth of 0.8% a year over 25 years is a very low base, so almost any equity return looks large against it. Much of Japan’s return also came after decades of going nowhere.

A long-run average can hide a lot. For most of the period, these markets did not outperform. They have recently caught up, and then some, and that recent move can be read two ways. It may be a durable re-rating driven by real changes in profitability. It may also be a stretch that will gradually revert.

Only two in sync

Across 25 years, only India and Brazil have logged equity returns in line with GDP growth. India’s Sensex compounded at about 12.0% against nominal GDP growth of 11.5%. Brazil’s Ibovespa compounded at about 9.8% against 10.0%.

I would call this the optimum outcome: equity holders broadly participating in the growth of the underlying economy, no more and no less. It is neither a bubble nor a disappointment.

The question for India

This brings me to the question that matters most to the investors.

Equity returns have lagged nominal GDP growth in most European and ASEAN markets over the past couple of decades. The question is whether India’s recent relative underperformance is a temporary phase, with returns catching up and perhaps overtaking GDP growth, or the start of a longer period in which our market looks more like Europe or Southeast Asia’s.

I don’t think valuations or earnings cycles alone can answer that. My view is that the answer lies in how India’s industrialization progresses. Specifically, it depends on whether we can meaningfully raise our share of global trade, especially in engineering goods and merchandise exports.

The reason is that the markets that kept pace with or beat their economies over long periods, such as Korea, Taiwan and, in recent years, the US, have had globally competitive listed companies that earn high returns on capital. A consumption-led economy can post impressive GDP growth. But if that growth flows into low-margin, domestically focused, or capital-hungry businesses, shareholders may see only part of it. Competing in global markets disciplines costs and capital, and it lets listed companies grow beyond the size of the home economy. If India’s manufacturing and export base deepens, equity returns can plausibly keep pace with GDP growth, or exceed it. If it doesn’t, the European and ASEAN experience is a real possibility.

Some caveats

·         Price indices understate returns. Apart from the DAX, which is a total-return index and so not strictly comparable, these are price indices. Including dividends would add perhaps 2–3 percentage points a year in many markets, and would move several laggards much closer to parity.

·         Endpoints matter. Starting in January 2001 means starting near the peak of the dot-com era in some markets and before several others had rallied. A different start date would change several rankings.

·         Index and economy don’t match. A listed index doesn’t mirror its home economy. The FTSE 100 and the CAC 40 earn much of their profits abroad, so measuring them against UK or French GDP is imperfect.

·         The data is approximate. The GDP numbers are broad estimates, so I’d read the table for the shape of the story and not for the second decimal.

None of this, however, changes the central point. Over a very long horizon, equity returns that track nominal GDP growth are a healthy result. Returns well below it suggest value leakage, and returns well above it should make us ask what has changed and whether it will last.

By that standard, India is currently in a good place, but not a guaranteed one. Whether it stays there depends less on the next few quarters of earnings and more on whether we build an industrial base that can compete globally.

Trends to watch

Over the past few weeks, I have been pondering over trends that could take shape in India over the next five to ten years. These are my random thoughts and not forecasts. Some may play out only in part, and a few may not play out at all. But if even some of them do, they could change which businesses do well, and that matters to anyone investing for the long term.

Here are some of them.

Businesses that fail the AI test

Legacy IT services companies are the obvious casualties of AI, but they will not be the only ones. Any business that does not change its systems and processes to use AI in its daily work could end up with higher costs and slower decisions than its competitors. The same applies to people. Young and middle-aged workers who do not learn to work with AI tools may find their skills losing value faster than they expect.

I do not expect this to happen overnight. Companies were slow to take up computers, and later the internet. AI will probably follow a similar path: a few fast movers, a large middle that muddles along, and some that wake up when it is too late. Some of the late ones may not survive.

For an investor:

·         Look for evidence that AI is already part of the work, such as lower cost per transaction, fewer people for the same revenue, or faster delivery. A line in the annual report is not evidence.

·         Be careful with businesses that sell routine clerical or back-office work at thin margins.

·         Do not assume that size will protect a company. A small, well-run firm that uses AI well can compete with a much bigger one.

Homes that need managing

More wealthy families are moving from independent houses to luxury condominiums and townships. Social interactions, security, power, water and upkeep are the main reasons. The shift is clearly visible in the metros and is slowly reaching tier-two cities. Independent houses will remain popular in many places, so I would call it a growing preference and not a complete change.

Running such a township is much like running a hotel. There is security, a clubhouse, housekeeping, maintenance and a concierge desk. In senior living projects, there is also care and medical support. Developers have started to see these as “managed homes” and not just an apartment to be delivered before moving on to the next project. Several premium senior living projects have been launched in the past few years.

I would not go as far as saying that real estate companies will become hospitality companies. Selling homes will remain the main source of revenue. Services will add a substantial and steadier income on top, and perhaps a stronger brand. Running a property well is also a different skill from building one, and a developer who does it badly will damage the brand he has built over the years. Senior living is still very new in India, and it is yet to be seen how many families can afford it at the prices being asked. Remember, PVR and Indigo earn substantial revenue from food, besides their core business of exhibition and aviation.

For an investor: see how much of a developer’s income is recurring, and whether he runs the service himself or hands it to a partner.

Brand owners, not factory owners

Indian consumer companies have traditionally made what they sell. Hotel companies, likewise, have owned the hotels they run. Both are changing. Many hotel companies now run properties that belong to others. FMCG companies have started outsourcing part of their production. Consumer electronics companies buy finished goods and sell them under their own label. Textile and apparel companies have moved in the same direction. The success of contract electronics manufacturing in recent years shows how large this space can become. I will call it manufacturing as a service (MAAS).

I expect more of this, especially in categories where brand, design and distribution matter more than the factory, such as apparel, electronics, home products and personal care. A company that gives up its plants frees up capital and can earn better returns on what remains.

But I do not think most large consumer companies will exit manufacturing altogether. Even in developed markets, many big food and household brands run their own plants, because quality, scale and cost control are central to their business. The shift will be selective.

One more thought. The contract units may be smaller ones, located in smaller towns, as this saves on logistics, as they are closer to the consumer. Cheaper labour and land could be an added incentive. If manufacturing spreads to smaller towns, jobs and incomes will follow.

For an investor: before investing in a contract manufacturer, check how many customers it has. If one brand takes most of its output, one decision by that brand can hurt it badly. For a brand owner, check whether returns on capital actually improve after it cuts back manufacturing.

Growth moving to smaller cities

As the growth in jobs and population shifts to tier-two and tier-three cities, and to the fringes of the metros; manufacturing spreading out, better roads and railways, improvement in power, water and sanitation in smaller towns, and popularity of work from home could trigger a reverse migration of labor. High rents and congestion in the metros will push this trend further. The metros will stay big. They may just stop being the only place where the opportunity is.

For an investor: look at companies that sell to, or lend in, smaller cities and are building their business around them. Be careful with companies that depend on the metros alone.

Smaller kitchens

More women may join the workforce in the years ahead, and households are getting smaller and busier. This could change how much time goes into cooking at home. Home-cooked food is too deeply rooted in our culture to go away. But the effort that goes into it may fall. Ready-to-cook and ready-to-eat food, frozen products, cooking pastes and mixes, and food delivery could all grow. In most developed markets packaged food has a much bigger share of what people eat, and India may move in that direction, though perhaps more slowly.

If it does play out, the effects will be wide: packaged and ready food, cooking ingredients, utensils and appliances. For example, demand for small, multi-use appliances may rise, while demand for traditional cookware may slow.

For an investor: watch which food companies are building ready-to-eat ranges, and the cold chain that goes with them.

Mental health goes mainstream

Mental health is one of the most neglected parts of well-being in India. I think this will change. Uncertain jobs, an ageing population, smaller and more scattered families, and loneliness will push up the need for care. Awareness is also rising, and the law already says that insurers must cover mental illness on the same basis as physical illness, though how well this works in practice is a different matter.

The difficulty is supply. We have very few trained psychiatrists and counsellors for the size of our population. So, I expect the growth to come through hospitals adding departments, tele-counselling, wellness programmes run by employers, and insurers. It will probably be a slow build and not a sudden one. Mental health may well join cardiology, oncology, ophthalmology and endocrinology as a mainstream discipline.

For an investor: look at hospital chains and insurers that are building this line of care, and at digital health platforms, but give it time.

Cyber security becomes a core function

AI makes it cheaper for attackers to write convincing fake messages, find weak points and run attacks at scale. At the same time, we keep connecting more of our lives: phones, cameras, door locks, smart TVs, appliances and payment apps. Every new connection is one more door for an intruder. AI will also help the defenders, so this will be a race and not a one-sided contest.

So far, cyber security has been treated as a support function in most companies, something the IT department looks after. I think it will become a core function, in the same league as finance and marketing, with a seat at the board. Regulators such as the RBI, SEBI and CERT-In have already tightened the rules on security and reporting of incidents. A serious breach can stop a business for days, as several companies across the world have found.

For an investor: check what a company says about past incidents, and whether anyone on its board understands the subject. Expect security to become a growing item in costs. India has few listed pure-play cyber security companies, so the opportunity may lie more with IT service providers that build this capability.

How these trends connect

Several of these trends are linked. AI sits behind the pressure on jobs, which adds to the need for mental health care, and also behind the rise in cyber risk. Better infrastructure in smaller towns supports both the outsourcing of manufacturing and the shift of growth away from the metros. Smaller households connect the changes in our kitchens with those in our housing.

A word of caution

Trends that everyone can see get priced into stocks quickly. Being early is often the same as being wrong, and timing is harder than direction. So, I would use this list as a set of questions to ask about any company I own or plan to buy, and not as themes to chase. Is it ready for AI? Does it depend on one city? Could a cyber incident stop it? Is it holding on to assets it no longer needs? I would be happy to hear which of these trends you think will play out and which will not. Please do share your thoughts.

Why “No” is a default answer

Continuing from the previous week (Just like that)

Have you noticed that whenever you ask your child to break a routine, e.g., wake up early, sleep on time, eat healthy, spend less time on the phone; the default response is mostly “no”! You try to offer incentives or sometimes use threats to elicit compliance, which in most cases is not a durable response.

Try remembering your childhood – didn’t you also behave in the same manner with your parents, as your child is doing with you?

Now recall the response of the government officer, customer care executive, your senior in the office, your housemaid, your car mechanic, et. al. whenever you made a request that was not routine or strictly as per the laid down procedure. Wasn’t the default answer mostly “no”.

In my view, the default “no” is deeply ingrained in our social and cultural consciousness. This could be one of the root causes of several problems afflicting our society. We as a society are not adequately trained to manage exceptions. It is one of the major causes of widespread corruption, avoidable litigation, and mafia.

What a “no” costs

A flat “no” for a small deviation that could have been ignored or corrected leaves you with three choices. You can pay the officer, hire a middleman, or go to court. Say a minor defect in your papers means two more rounds of a government office. Paying Rs 2,000 to get it done today looks cheaper than two lost days, and many of us pay. The work gets done, but the citizen has paid extra in money, effort and time.

The worst damage is slower. You stop trusting the system. Middlemen find a steady business. Bribery starts to look normal, and in the worst cases, the mafia fills the gap.

Why the officer says “no”

Since last week’s post, I have been thinking about why the officer says no so quickly. Part of it is habit. But I think a large part is plain safety. If he says no, nobody can question him. If he says yes to an exception and something goes wrong later, he alone has to answer for it, maybe years later, in an audit or an inquiry.

This is the same thing I wrote about last week: adding a check is safe, and removing one is risky. The officer is not stupid or lazy. He is doing the sensible thing for himself. So, I would not blame culture alone. Culture teaches the habit, and the incentive keeps it going.

Why a simple fix will not do

My answer was simple: review the procedures, build rules for exceptions into them, and train officers to say “this can be done this way” instead of “this cannot be done”. I still believe in it, but there is a catch. If every exception depends on one officer’s judgment, we have only given him more power, and more power at the counter is exactly where bribes come from.

So, exceptions need a written route. A short list of small defects that can be corrected at the counter, such as a missing stamp or a spelling mismatch. A fixed time limit. A record of what was allowed and why. And a senior who must decide within a few days if the officer cannot. With this, the officer is covered when he says yes, and the citizen has a way forward when he hears no.

Teaching children to handle a break from routine is a good idea too. It will take a generation to show results, so it cannot be our only answer, but it costs very little to begin.

What this means for an investor

You can carry the same thought into investing, but I need to be careful here. When you read the management commentary of your companies, you will often find lines like these:

·         The execution of the project was delayed because it rained heavily during the monsoon.

·         Pollution control measures in Delhi NCR impacted the execution of projects.

·         We could not meet margin guidance due to raw material inflation.

·         Forex loss affected the reported profit by 10%.

·         Shortage of raw material due to the war in the Gulf region impacted production materially.

·         Competition from cheap Chinese imports is hurting margins.

When I first read these, I called them excuses. That is too harsh, because some are fair reasons. What matters is which kind of reason it is.

Some of them are predictable. The monsoon comes every year. Pollution curbs in Delhi NCR have been a regular feature of recent winters. Raw material prices go up and down, and currencies move. A company that is caught out by these again and again has not planned well. A forex loss that cuts profit by 10% suggests a large exposure was left open. It may have been a choice, because hedging costs money, but as an investor you should know it was a choice.

Others are not predictable. A war that cuts raw material supply is not something anyone can plan for in detail. Here the test is not whether the shock came, but how the company responded. Did it find another supplier, pass on the cost, or just wait? Competition from cheap Chinese imports is a different matter again. It is not an exception at all. It is a question about the company’s cost position and pricing power, and it depends on your view on the quality of the business.

So, I would not cut a company’s valuation just because its commentary has a reason in it. I would ask a few questions first:

·         Does the same reason come up quarter after quarter?

·         Did peers face the same problem and do better? If they did, the reason is not the whole story.

·         Has management met its own guidance in the past, or does it keep missing?

·         Does the company hold buffers, such as cash, hedges or alternative suppliers, for risks it knows will come back?

If the answers are poor, I would want a bigger margin of safety before I buy. I do not have a formula for it, and I would be wary of anyone who says they do.

A good system says “no” when it must, and “yes, if” when it can. I would look for the same habit in a good management. I would also like to hear your own experience of the default “no”, from either side of the counter.

 

Expect the unexpected

In the past couple of months, I happened to discuss the market situation with several market participants, including investors, advisors, distributors, brokers and portfolio managers.

Three sentiments were common to all of them. First, the pain of losses. Second, disappointment that Indian equities have underperformed despite resilient GDP growth and decent corporate earnings. Third, anxiety over the trend in bond yields and precious metals prices. Most of them blamed the government’s taxation policies and over-regulation of markets for the present condition, though they also recognized that global geopolitics and the weather are playing a part.

These points have been widely discussed and examined by analysts, so I will not add to them. What stayed with me from these conversations is something else: how little most investors understand about risk management.

Diversification alone does not reduce risk

Most investors I spoke to mistake diversification for risk management. They spread money across equity, fixed income and alternatives, mostly gold, silver and REITs. Then they spread it again within each: market cap, sectors, fund managers, bond duration and so on.

What gets missed is that diversification reduces risk only when the assets in the portfolio do not move together. It is low correlation that does the work, not the number of holdings. Three things follow from this.

·         Market cap and sector spread helps little if the overall portfolio beta stays high. In a falling market most stocks fall together, only by different amounts.

·         Several fund managers do not mean several different portfolios. If their holdings overlap, the portfolio is more concentrated than it looks. Check the overlap before adding the next fund.

·         When the weakness comes from macro and geopolitical factors, correlations rise and most assets fall together. That is what we see now. In dollar terms, gold is about a quarter below its January peak and silver is down by nearly half. Bond yields have risen to multi-year highs, the rupee has been hovering around 96 to the dollar, and the Nifty is down ~15% from its September 2024 peak. The assets that were meant to cushion the equity portfolio fell along with it.

The third point also shows the limit of the idea. No asset stays uncorrelated in every situation. In March 2020 even gold was sold, because everyone wanted cash. So, the question to ask is not only whether the assets are different, but whether they will still be different when it matters.

A fixed return is not a risk-free return

A bond, or a bond fund, that you may sell before maturity does not give a fixed income in the sense most investors understand it. Its price moves with yields, and yields have gone up. Only a bank deposit, or a bond that you will hold till maturity, gives a return known in advance. Even these are not risk free. They carry credit risk, reinvestment risk and inflation risk.

Gold: where did the return come from?

Gold carries currency and policy risk too. Take the period since the October 2025 peak. Gold in dollars is down by about 3%, but in rupees it is up by about 15%. In the same period the rupee is weaker by about 8%, and the import duty was raised in May from 6% to 15%, which adds about 8.5% to the landed price. Put these together and the entire return in rupees comes from the weaker currency and the higher duty. The metal itself gave nothing.

The risks everyone is watching

Most investors and fund managers named the risks that are visible today. A strong El Nino pushing up food inflation, a further rise in crude oil prices, and a collapse of the debt-funded global AI trade leading to a Lehman-like credit event were the ones cited most. These are fair concerns, and seeing a risk is the first step in managing it.

But even for these, there is little action. In India, derivatives are used mostly for speculation and rarely for hedging. The latest SEBI study found that nearly 88% of individual F&O traders lost money in FY26.

The risks nobody is watching

What troubled me more was that none of the participants mentioned an event that cannot be foreseen today. Yet if we look back, the events that hurt investors the most were rarely on anyone’s list. Few expected Lehman to fail in 2008. No list of risks in January 2020 had a worldwide lockdown. Demonetization in November 2016 came without a warning.

So let me stretch the mind a little. I am not saying any of the following will happen. My point is that each is possible, and a portfolio built only for visible risks would not survive it.

·         Rules change overnight. India nationalized banks in 1969 and had gold control until 1990. In May this year, the import duty on gold went from 6% to 15% by a single notification, and the Prime Minister asked citizens to curb gold buying for a year. What if a government under fiscal and currency stress goes further, with price caps, windfall levies or limits on what households can hold?

·         Market plumbing fails. A cyber-attack takes exchanges, depositories or payment systems offline for a week. Positions cannot be exited, margins cannot be paid, and there is no price to act on.

·         A big seller of gold appears. Central banks have been the steadiest buyers. China’s central bank has added gold for 23 months in a row and now holds about 2,400 tonnes. What if it sells 500 tonnes in the open market, roughly a fifth of its holdings and almost five times what it has bought this year? A sale of that size would hit the price and the story behind the price together.

·         Old rivals become partners. The US and Russia are seen as arch rivals, and that perception shapes much of the US–Europe relationship. Yet they fought on the same side in the Second World War and, apart from a short American intervention in the Russian civil war in 1918–20, have never fought each other directly. A thaw has already begun: this month the US waived some sanctions to let Russian diesel reach the market, and Moscow has called it a model for further deals. What if this grows into a durable economic understanding? Europe’s security assumptions, energy flows, defence spending and many investment themes built on the rivalry would need a rethink.

·         The story behind a metal changes. One of the main arguments for silver has been industrial demand, and its largest industrial user is the solar panel. Manufacturers are already using less silver per cell and moving towards copper. Silver used in solar fell 6% in 2025 and is expected to fall another 19% this year. Silver has also dropped by nearly half from its January record of about $121 an ounce. Most of that fall was a speculative spike unwinding, so I do not blame substitution for it. But it shows how fast a price can move once the story beneath it weakens.

·         Europe comes apart. EU members fall out over immigration policy and the union breaks up. Each member becomes a closely guarded jurisdiction, politically and economically. Property prices could fall sharply, unemployment could rise, inflation could stay higher for longer and sovereign defaults could stop being rare.

To most investors these examples may look farfetched, even the delusions of a paranoid mind. But none of them is without a precedent in history, and so none is outside the realm of possibility.

Why risk management gets ignored

Risk management is perhaps the most ignored and misunderstood part of investing in India. Investors mostly lack awareness. Intermediaries limit themselves to regulatory compliance. Exchanges are focused on smooth settlement. Regulators are busy balancing investor protection with the development and orderly functioning of the capital markets. None of them is doing anything wrong; each is doing what its mandate asks. But the result is that nobody owns the job of telling the investor what risk really means.

To me, risk management comes down to three things: holding assets that do not all fall together when it matters, hedging the risks we can see, and keeping enough slack to survive the ones we cannot.

Summary

•       Diversification reduces risk only when assets do not fall together. Check how your assets behaved in bad times, and check the overlap across your funds.

•       A fixed return is not a risk-free return. A bond you may sell before maturity is not fixed income.

•       When you read a gold return, separate the metal from the currency and the import duty.

•       Visible risks can be hedged at a cost. Invisible ones can only be survived. Plan for both.

•       Test your portfolio against a long, deep fall in everything at once. If you would be a forced seller, fix that first.

A closing thought

The Bhagavad Gita (18.14) lists five factors behind every outcome: the seat of action, the doer, the instruments, the many kinds of effort, and fifth, daivam – fate, or the unseen:

अधिष्ठानं तथा कर्ता करणं च पृथग्विधम् । विविधाश्च पृथक्चेष्टा दैवं चैवात्र पंचमम् ॥

Our models and spreadsheets deal with the first four. Risk management is the effort to leave room for the fifth.

Just like that

Until a few years ago, the baggage tags on all hand baggage were mandatory for all air passengers. The security personnel must stamp these tags for security clearance. Often you lost the tag while waiting for your flight; or the security personnel missed stamping the tag and you did not notice it; or the wet stamp ink got erased before you reached the flight gate. The security personnel at the gate would not let you board the flight and you had to scramble to get the tag stamping again. Then one fine morning some bureaucrat decided that hand baggage does not need to be tagged and stamped. Maybe an old parent of some top bureaucrat or politician or judge was made to run to get a tag stamped, which triggered this change in the mandate.

A rule that irritated passengers every single day went away with the issue of a simple circular. I wonder why it took so long, and what else is still waiting.

We face many similar situations in our routine life which makes us wonder why these rules exist and who will take the decision to change these rules to make our already stressful lives slightly easier. For example, have you ever been in any one or more of the following situations:

Rules that nobody looks at again

The missing stamp. A form or an application for your business goes to the bank or a government office. It is complete, signed and the figures are right, but the rubber stamp is missing, so it comes back. In most cases the stamp tells the clerk nothing that the signature and the company name do not already say. It stays because it is on the checklist.

The tree. A tree stands on a busy road and chokes the traffic. Court orders and tree protection rules do not allow it to be removed, and I understand why, because our cities have lost far too many trees. But a jam that runs for hours every day burns fuel, wastes time and adds to pollution too. I have not worked out the numbers, but I doubt the tree is winning that trade. The rule says no, and seems to have no easy way of saying yes with conditions, such as shifting the tree or planting many more elsewhere.

Rules that are fine on paper, but not at the counter

The barricade. A police barricade narrows the road and slows everything down, but nobody is checking anything. Cars crawl through a barrier that has no one to stop them. We pay the delay and get no security.

The security check. At malls, hotels and office buildings, it can take 20 minutes to clear the “security check”. The guard asks you to open the trunk, looks at it for a second and shuts it. He does not seem to know what he is looking for, and most of the time he does not even look at what is stuffed inside. Call it anything, but not a security check. We go through this almost every day.

The bank and Aadhaar. Your passport and driving license carry the address of your hometown. Your bank account, phone connection and LPG connection were given on the basis of your Aadhaar card, which carries your current address. Now the bank refuses Aadhaar as address proof for re-KYC. This refusal may not be strictly as per the RBI rules, but is common in practice.

Offices that do not talk to each other

The address loop. You move to a new city and rent a house. Now the address has to change in your passport, bank account, driving license, LPG connection, phone connection, voter ID, mutual funds and so on. Each office wants a document that another office issues, and the order in which you do things decides whether you get out at all.

The repeat test. The doctor at a hospital or clinic does not accept the reports from another hospital or an independent lab, and wants you tested again at a lab of his choice. Sometimes he has a fair reason. The report may be old, or the method may be different, and a treatment decision should not rest on a stale number. But when it is a routine test from a good lab done last week, the repeat is only an extra cost. From the patient’s side, I cannot tell which of the two it is, and that is the real problem.

The jam that was not there

You are stuck in a long jam. After crawling for half an hour you reach the end and find nothing at all that was causing it. You just drive away. Traffic people call it a phantom jam. Hours ago someone took a wrong turn or braked a little too hard, and the one behind braked harder, and the wave kept travelling backwards long after the first driver was gone. A small mistake somewhere, and thousands of people paying for it for hours.

With great powers comes no accountability

These instances reflect, inter alia, on the efficacy of our governance system, awareness of our society and how we look at the process of reforms. I would not say the whole system is broken. My reading is narrower. Making a rule has an owner, but removing one has none. An officer who adds a check is safe and often has no accountability. An officer who removes one carries the blame if something goes wrong later. There is no incentive for reforms.

I shall be happy to hear the views of the readers before I write more on this subject next week.

 

De-rating of Indian equities – cyclical or structural? - 3

As observed in my previous two posts (see here and here), I am inclined towards the view that the derating of Indian equities, compared to its historical averages, is partially structural.

The cyclical factors like El Nino, geopolitical uncertainties, inflation & rising bond yields in developed economies, lack of domestic investment opportunities in currently popular themes like artificial intelligence, semiconductors, etc. may be responsible for the poor performance of Indian equities to some extent. Statistically speaking, reversion to the long-term averages may also be a factor in correction in the equity prices from September 2024 high.

However, a part of the derating could be structural and we may not see the benchmark indices trading at 20-22x PE ratio in the short to midterm. Sub-optimal execution; lack of growth accelerators; a weakening perception about democratic institutions; policy unpredictability; stagnant real wages clouding demand acceleration; waning demographic dividend; and poor risk appetite of private enterprise does not augur well for any material rerating of Indian equities in the short to midterm.

Let me be clear about what this does not say. It is not a call that markets will fall. It only means that I should not count on rising multiples to do the work for me. If the PE ratio stays where it is, returns will have to come from earnings growth and dividends. And if the cyclical part turns out to be bigger than I think, I will have been too cautious. I am ready to pay that price.

Investment strategy adjustments

Over the next three years, I am considering the following changes to my own investment strategy.

·         Cyclical equity as a separate asset class. Besides strategic equity, I will add cyclical equity to my standard asset allocation. To begin with, both will get equal weight. Strategic equity is the long-term core. Cyclical equity is the money I put to work only when the cycle in a sector turns in favor. Since this part will often sit in cash waiting for a trend, my actual equity exposure will frequently be lower than the headline number.

·         Lower growth, higher cost of capital. For most companies, I will moderate my terminal growth and raise my cost of capital assumptions. This brings down my fair value benchmarks. Fewer stocks will look cheap, and that is how it should be if I do not expect multiples to expand.

·         No buy and hold for direct equity. I will keep this strategy only for diversified mutual funds. With a single stock, holding through a full cycle without a view on the multiple can give back all the gains. For direct equity, I will need a clear exit point, either when the thesis plays out or when the price crosses my fair value.

·         More patience with cyclicals. This applies especially to materials, industrials and financials. Instead of staying invested all the time, I will prefer to hold cash until a definite cyclical trend emerges in a sector. Then I will take concentrated, sizeable positions. I will miss the first part of the move, and I accept that. The bigger risk is concentration, so I must size each position in a way that a wrong call is survivable.

·         Avoid consumer staples. I will stay away unless a compelling opportunity emerges, like gross undervaluation or a special situation. Staples volumes depend on the average household, whose real income has not grown much, and the stocks rarely come cheap. I will focus on aspirational consumption only, where the spending comes largely from upper-income households.

·         Avoid companies that earn most of their revenue from government contracts. When one customer is the government, the company has little say on pricing, payment timelines or policy changes. This fits poorly with my concern about policy unpredictability. It also means that my industrial exposure will be limited to companies driven by private demand.

·         Avoid public sector monopolies and oligopolies. In these companies, the interests of minority shareholders are not the first priority. Pricing, dividends and capital allocation tend to follow what the government needs at that point in time. The risk of competition emerging from the private sector is also very high in these companies.

·         Avoid services and consumption companies with unusually high gross margins that are open to policy restrictions like price controls. Very high margins invite the regulator sooner or later. Private hospitals are one example that comes to mind.

What could change my mind

I do not see these adjustments as permanent. If real wages start rising, private capex picks up, earnings growth accelerates for several quarters in a row, and policy becomes more predictable, I will have to admit that more of the de-rating was cyclical than I assumed. I will review the framework once a year, and sooner if the evidence changes. But for now, I will stay with my current assumptions.

Summary

·         A part of the de-rating is structural. Do not depend on PE expansion for returns.

·         Lower fair values mean being fussier about price. Holding cash is a decision, not a failure.

·         Hold diversified funds for the long haul. Hold direct stocks only with a clear exit plan.

·         In cyclicals, wait for the trend to show up, then size up, but keep position sizes survivable.

·         Be careful with businesses where the government is the main customer, the owner or the regulator.