Vijay Kumar Gaba

The benchmark Nifty 50 crossed the 16000 mark for the first time this week. Predictably, the moment was celebrated by media and “market influencers” with gaiety and fervor that is usually shown at Nifty50 crossing every subsequent thousand (K) mark. The fact that from 10k to 11k - it is a 10% rise; whereas from 15K to 16K it is just 6.67% rise, is usually disregarded in celebrations and recounting of the journey from one ‘K’ mark to the next “K’ mark.

It is also mostly ignored that Nifty, like any other statistical number, is meaningless in isolation. It must be juxtaposed with some “other” statistical number to derive any inference. The selection of this “other” number, however, usually depends upon what the data user wants to conclude. If the user wants to feel good about the current Nifty number, a comparison with an inferior set of statistics is preferred (e.g., Nifty has performed better than gold over past decade); whereas if the user wants to show the current Nifty number in a poor light, a superior set of statistics may be chosen to compare (e.g., Dhaka DSE30 has outperformed Nifty50 by 150% over past one month).

However, if the idea is just to celebrate, like drunk dancing in the wedding of a distant relative, a statistical number may be used in isolation.

Nifty: Drunk dancing in a wedding

In past 25years, Nifty return pattern has been quite erratic. From one ‘K’ to the next ‘K’ view point, there have been three instances of very fast journeys (2006-08; 2017-18 and 2020-2021); and there have been two long journeys (1993-2003; 2008-2015).

But this data may actually mean little for an individual investor, considering that-

·         The average vintage of investors in Indian market may be less than 15years;

·         There have been four massive draw down of over 25% each in these 25yrs, where many investors may have given up with little or even negative returns;

·         The point to point return in Nifty from any randomly selected date means little for individual investors. It is the actual return that matters;

·         Anecdotal evidence suggests that maximum investors take or increase their equity exposure in the rising market only. The largest inflows by household investors are usually seen during the last phase of an up move. Also, the exposure of household investors to Nifty ETFs is not significant, so change in Nifty value may not actually reflect the return earned by an average household investor; and

·         Most household investors prefer to invest in mid and small cap stocks with ‘multibagger’ return potential. The rate of failure in this segment is extremely high. There is decent chance that most household investors have underperformed the Nifty returns over this period.

For a majority of the household investors, therefore, celebrating a milestone in the 27yrs journey of Nifty is mostly like drunk dancing in the wedding of a distant relative. It gives a momentary high, dirty cloths and a painful hangover, the next morning.

Good, Bad and Ugly

The Good: Increased household participation in equity investing is a good sign for everyone – corporates; investors; market participants and the government. The channeling of household saving to productive sector, against negative real return yielding deposits or unproductive assets like gold is always welcome.

Another good thing to note about Indian equities is that Nifty has outperformed the global peers in INR as well as USD terms during past 12 months.

The Bad: However if we accept that (a) most of the household investors were already fully invested in March 2020; (b) the new investors have not made meaningful allocation to equity and are just testing waters; and (c) A large number of investors have withdrawn money from mutual funds and other professionally managed investment scheme and invested directly in equity (as indicated by the data of larger retail participation in daily trading activity and persistent outflow from mutual funds over past 15 months) .then we could easily assume that not many investors have made 100% return from the lows of March 2020, even though most of those who stayed invested through panic would have been saved from losses and made decent return on their investments. Also it would be reasonable to assume that the current portfolios of many investors are dominated by stocks with relatively poor quality of balance sheet, earnings profile and sustainability.

The Ugly: The ugly part is that the small and midcap stocks have massively outperformed the benchmark since Pandemic lows of March 2020. Not all small and midcap stocks are poor quality. But a large part of these stocks are either poor quality or represent highly cyclical businesses. This kind of divergent performance has usually ended disastrously for investors. As of now, there is no reason to believe it will be different this time.

Nifty returns vs Investment returns

We can put the Nifty returns in perspective by taking example of these two household investors ‘A’ and “B”.

Investor A is an ideal investor. He is 40yrs old; started investing in 2006 (Nifty 3966) when he joined his first job; has a portfolio that is mostly aligned to Nifty (mostly large cap funds and some direct equity); invests his surplus savings (Rs5,00,000/year) at the end of every year; and has not sold anything in 15years.

After 3 full market cycles, this investor would have earned a return of 11.55% CAGR as of today. The rate of change in Nifty in this period is 10.13% CAGR.

Investor B is also a household investor, 40yrs old, started investing in 2006 (Nifty 3966) when he joined his first job; has a portfolio that is mostly aligned to Nifty (mostly large cap funds and some direct equity); invests his surplus savings (Rs5,00,000/year) at the end of every year; but is not as disciplined and confident as the Investor ‘A’. He easily gets influenced by the forces of greed and fear – sells during panic and buys in euphoria.

He started in December 2006 and exited in December 2008 (post Lehman); redeployed the sale proceeds and new savings in December 2010 (Post QE) and exited in December 2016 (post Demonetization); again redeployed in December 2017, did not get panicked in March 2020, and is still invested. This investor would have earned 7.9% CAGR on his investment, though his net principal amount invested is same as Investor ‘A’. (For the sake of simplicity, dividends and cost of investments have been ignored in these calculations)

Nifty returns: A realistic expectation

The jargons like long term and short term are frequently used by the market participants, without providing any context to it. This jargon may have entirely different connotations for different set of investors. For taxation purposes, it refers to less than 12 months (Short term) and more than 12 months (long term). For risk capital investors (VC, PE etc.) this may relate to life cycle of a business; and for stock traders it may a technical swing lasting between few weeks to few months. Also, for a portfolio (diversified mutual fund etc.) investor this could be different than the investor holding a direct stock.

If for the sake of simplicity, we assume long term to mean 5 calendar years, Nifty returns (rolling 5yr CAGR) were very volatile for first 20years (1995-2015). Since then the volatility has reduced materially, with this number stabilizing close to +/- 12% range. This is despite poor economic growth and large drawdowns on demonetization, GST, Covid etc.

 

 The benchmark indices are scaling new highs every week for past seven weeks as least. The sharp recovery in markets, from deep correction in March, must have surprised most market participants. Many who panicked and sold off in summer are wondering whether it’s time to “Buy” again. Many who remained invested are wondering whether it’s time to ‘Sell”.

The broader question therefore seems to be, whether we are in a new bull market since April 2020, and the stock prices have a long way to travel north before any meaningful correction sets in; or it is a bear market rally that is normalizing the steep fall in March 2020 in the wake of total lockdown announced post outbreak of pandemic.

The last bull market started from August 2013 and lasted 5yrs till August 2018. In case we believe that it is new bull market that would mean that the bear market that started in August 2018 ended with panic bottom of March 2020.

However, if we believe that March 2020 panic fall was an aberration and the current sharp up move is just normalizing that aberration, and the regular bear market will play out after this normalizing cycle is completed in next couple of months. In this case we shall see markets stabilize around in 11500-12100 range and then decline gradually for some time. We had seen a similar situation in 2006-2009. In May 2006, markets corrected 25% in 3weeks as the first signs of subprime crisis emerged. But then markets rallied almost 100% (from lows of June 2006) in June 2006-January 2008 period; only to bottom around June 2006 levels in March 2009.

The moot point is how do we decide what state the stock market is in at present! The signals from the markets are indicating that regardless of the one way move in the market, the popular opinion is divided.

For example, the following are some signs indicate to a bull market:

(a)   Many IPOs since March 2020 have got tremendous response from investors.

(b)   Analysts are either ignoring bad news or finding positive angles in bad news . For example, consider the following:

·         One of the key argument for support of consumption related stock was the government support to the rural population. However, the news of PM-Kissan disbursement not happening (see here) was given a positive twist to imply that fiscal situation may not worsen after all.

·         M&M subsidiary SsangYong default on debt was given a positive twist to imply that M&M is sticking to its commitment of not investing more capital in loss making subsidiary.

·         Despite concerns over rising defaults on unsecured loans after the forbearance period ends, the valuations of many consumer focused NBFCs have breached the red lines. Analysts are supporting these valuations in the name of business consolidation, potential bank licenses etc.

·        S&P forecast of 7.7% contraction in India’s FY21 GDP was widely reported as “upgrade”.

 

(c)    All sellers are seen regretting almost immediately after the trade, as prices rise further before the payout is received.

(d)   Traders, investors and even fund managers are searching for stocks that have underperformed the peers, and betting new money on them in the name of “value”.

(e)    The social media timelines are overwhelmingly populated with success stories of popular traders and investors. The cautious investors are being guilt shamed by taunts of “I told you so”; and “I bought xyz in March 2020 and made return of $$$% in 9months”.

On the other hand, the following signs point to the possibility that it is a bear market rally that is normalizing the excesses of March 2020.

(a)   There is no particular theme or trend in the recent rally in stock prices. Stocks from diverse sectors like Bajaj Finance and Kotak Banks have become most expensive stocks perhaps globally, while ICICI Bank and HDFC Bank have lagged. Tata Steel has reached peak valuation while Hindalco has lagged. Tech Mahindra has ralled hard, while Infosys and TCS have lagged. Asian Paint has outperformed HUL massively. RIL has outperformed Bharti.

(b)   Domestic mutual funds have faced redemption in past couple of months. Domestic institutions have been net sellers so far this year, while foreign institutions have been net buyers.  However, there is no clear pattern in the flows, indicating tentativeness and lack of conviction. Overall net institutional flows have been marginal ($3.5bn) YTD.

(c)    Most of the rise in market has occurred due to valuation rating and not supported by earnings or forecast of earnings growth.

 

(d)   Last week the top gainer in NSE500 included some companies facing survival issues.

Personally, I am more inclined towards the second view (bear market rally). But I would leave it to readers to apply their own wisdom and decided their strategy.

 

The brokerage firm, Sanford C. Bernstein in a recent report highlighted some noteworthy points. The firm evaluated whether the recent sharp fall in economic growth would mark the end of the slow growth cycle triggered by the global financial crisis a decade ago; and beginning of a sustained high growth cycle leading to a multiyear bull market in Indian equities.

The issue is relevant from many points. But as an investor, I find it more pertinent in view of the current market sentiment. The huge divergence between the macroeconomic data and equity markets has disturbed even seasoned investors. The common investors on the other hand are swinging wildly between the opposite polls of greed and fear. Each one percent rise in equity prices ignites the greed and slight fall in prices imposes the fear. Obviously, swaying by these extreme emotions, not many investors/traders are able to maintain their composure and losing money. The rising volatility in the prices of precious metals is making the situation worse, as many investors are getting avoidably distracted by this.

The cited report highlights that the previous strong macro cycle in India was during FY04-10; after making a low in FY01-03 period.

The present macroeconomic conditions resemble the lows of FY01-03 in many aspects. The socio-economic redundancies caused by the radical reforms initiated in 1991-1995 period led to massive buildup in bank non-performing assets and unemployment. The asset prices were also collapsing. The people rejected the extant political regime and lack of an alternative led to 3 general elections in 3years (1996-1999). To make the matter worse we had consecutive poor monsoons in 1999-2002, leading the rural economy in a poor state.

The capacities build post 1991 and a second set of radical reforms during 1991-2003, finally started yielding results from 2004. Strict fiscal discipline, controlled inflation, falling interest rates, rise in household savings, and rising exports helped the economy to revive. The global recovery leading to resurgence in services exports was a key factor in the economic recovery as it created unprecedented wealth effect in the Indian middle class. Demand for automobile, housing, commercial real estate etc had an immense positive impact due to developments in IT sector, construction of highways and SEZs.

The commitment to reform was very high. The government did not hesitate in divesting number of monopolies like coal, power, oil & gas, civil aviation, mobile telephoney, roads, ports, airports, etc. The best part was the execution of reforms. Many PSUs were disinvested, with ministers not hesitating a bit on potential corruption allegations. MNREGA cemented these macro reforms by transmitting the benefits to the bottom of the pyramid.

The cited report, rightly highlights that the execution on reforms by the current regime is not inspiring. "With lower returns, limited access to resources, private sector is not keen to participate in Infra and the easier Infra catch-up build is already behind. Smart cities, mass transport systems are new scripts, but execution is weak and volatile. Inability to scale-up manufacturing and focus of Indian companies on traditional products makes it difficult for exports to scale-up meaningfully."

Moreover, the household savings are declining structurally and leverage rising. The geopolitical considerations mean that the subsidies from China, in the form of cheaper imports may also be not available. The exports which supported the previous up cycle in Indian economy and markets are not likely to see any quantum jump in short to midterm. Import substitution is a tricky business and impacts the competitiveness of Indian businesses in the short term.

The report concludes that "the new scripts are interesting, can help create some jobs, but are not game changers – we expect a rebound in macro in 2HFY21/ FY22 but currently see less room for a multiyear bull macro cycle."

I mostly agree with the prognosis.