Vijay Kumar Gaba

 The struggle between Newton's law of gravity and global markets is perennial. Many times it appears that the markets are defying the laws of gravity and breaking out of their orbit. However, in the end, it is the law of gravity that has always won. Notwithstanding the distance covered away from the “fair value zone”, and the time spent in the away zone, the asset prices invariably tend to return to the fair value zone. In the common market parlance these digressions and eventual return to normalcy is described by the phrases like Overbought, Oversold, Overvaluation, Undervaluation, Mean Reversion, etc.

It is important to note that a long time spent away from the fair value zone could be very deceptive for investors. Sometimes it gives an illusion that the fair value zone for the subject asset may have already shifted higher or lower and the current price is actually closer to the fair value zone. The investors lacking in discipline and/or conviction may fall for this deception and buy/sell the asset in the “away zone”. Two classic examples of this phenomenon are the stock price of ITC Limited and IRCTC Limited during 2019-2021.

In the past one year, all asset prices that were trying to defy gravity, without having necessary escape velocity, are crashing back to their respective ground positions. Now since the asset prices are correcting downward, trampling the traders and investors coming in their way, the questions to ponder are:

(a)   When would the asset prices hit the rock;

(b)   Whether the rock will be soft or a hard one; meaning whether the prices will jump higher immediately after hitting the rock or they will get stuck there at the bottom, till the next high tide comes to their rescue;

(c)    Which assets are fragile enough to crash and get destroyed when these hit the rock;

(d)   Which assets are flexible enough not to get damaged by hitting the rock and bounce back faster.

History could be a good guide in analyzing these points and finding appropriate answers. However, 2008-2009 may not be a good reference point in this context, in my view. The crisis began to hurt global asset prices from early 2008 as the economic growth, fuelled by a decade of exceptionally loose credit, started to fizzle out and financial leverage became unsustainable.

The process of adjustment and correction was interrupted by innovative and audacious monetary policies of large central bankers. Surprised and enthused by the "whatever it takes" approach of central bankers, traders and investors made large bets on a faster economic revival. Consequently, many asset prices in fact scaled higher peaks than seen during the bull market of 2005-2007.

As it turned out that the comfort was false. The central bankers did manage to restore stability in the financial system; but the economic recovery remained feeble and unbalanced. The global lockdown in the wake of Covid pandemic has completely exposed the fault lines of the global economy and markets. Consequently, the asset prices are now rationalizing to factor in the prospects of even slower economic recovery and further rise in global imbalances.

The process is expected to be protracted and painful. Nothing will be achieved in a year or two.

The good news, in my view, is that India is decoupling from the global pain, as the painful economic corrections implemented in the post global financial crisis era are now beginning to yield results. In fact, as one of the worst sufferers of unfavourable terms of trade, India could be a major gainer as the global imbalances get adjusted to more fair terms of trade.

I am certainly not expecting any exceptional return from the Indian equities over the next couple of years. However, it is apparent that Indian equities can give normal returns for a much longer period than their peers.

 Before I say anything, I would like to make it clear that I use the terms “investor”, “trader” and “punter” in the context of equity investments, very judiciously.

To me an investor is a person who thoughtfully invests his money in a business to participate in the future growth of that business. A trader is person who is trying to optimize his return on capital by choosing from the best instruments available at any given point in time. It may be bond, fixed deposit, equity stock, gold, crypto currency, foreign exchange, other commodities etc. or a mix of these. Traders do not invest with the objective of “wealth creation”. Their focus is usually earning more than the risk free return while maintaining liquidity of his money. Punters buy financial assets or commodities just like lottery tickets. They get kicked by the prospects of hitting a jackpot someday and do not mind losing their entire capital in the process.

Here we are talking about investors only.

In summer of 2007, the global equity markets were doing great. Most global indices were close to their all-time levels. The global fund managers were exploring the world like Cristopher Columbus. Emerging Markets, BRICS, MENA, Frontier Markets etc were the hot themes. Everyone was deep in the money. Indian markets were no different. Then appeared first signs of sub-prime crisis and a sharp correction occurred in July 2007. However, the losses in correction were entirely recouped in no time and markets surged to their new highs by January 2008. The 14months after that were nothing less than a nightmare. The global equity indices saw cuts ranging from 35% to 75%.

The investors who had conviction in the strengths of the businesses they were invested in stayed the course and emerged winners. The punters lost their entire capital and much more. The traders also lost money.

In July 2007, at peak of the market, one investor invested in the stock of Mahindra and Mahindra Limited; the other investor invested in the stock of Reliance Industries; and a retired person invested in the Gilt Fund that invests in long duration government securities.

If they stayed invested in these instruments till today, the two investors in M&M and RIL stocks would be making about 9.25% CAGR (excluding dividends) on their investment; while the retired person would be making 9.5%.

A plain reading of previous two paragraphs may prompt the readers to jump to many conclusions. When I sent these two paragraphs to some of the readers for their comments, I got many responses. I find the following five responses as representative of the entire sample:

·         “Are you suggesting over a longer time frame, investment in gilt and stocks yield similar returns, but risk adjusted return are far superior in gilt.”

·         “If equities of front line companies have matched the return of Gilt, even after weathering two unprecedented crises (GFC, 2008-09 and Covid, 2020), then next decade perhaps equities will give phenomenal returns.”

·         “RIL gives you excitement’ but M&M is a steady performer.”

·         “If you are a long term investor, do not try to time the market. Over a longer period, returns would automatically get normalized.”

·         “Investment in reliance is like making a fixed deposit in SBI. You can never lose money.”

However, the responses could be very different, if I show the following chart to the respondents. This chart shows the relative performance of the stocks of M&M and RIL from July 2007 till date. The stock of M&M gave the entire return during first seven years (2007-2014) period. The current price of stock is almost same as it was in August 2014. The stock of RIL did not give any return for 9years (2007-2016). The price of the stock in December 2016 was almost the same as it was in July 2007.

A trader would immediately think, “December 2016 was the best time to sell M&M and buy RIL. This way one could have made the 2x the return of an investor.”

But an investor who is convinced about the business prospects of either M&M or RIL or both, the long intervening periods of no return are quite painful. The one who learns to manage this pain ultimately comes winner. The ones who succumb to this pain of non-performance, would sell RIL in 2016 and buy M&M, and end up as total losers.

If you want to fully assimilate the point I am trying to make here, then please talk to someone who had sold ITC and bought RIL in September this year, after getting no return in ITC for 5yrs.