Vijay Kumar Gaba: SmallCap

Showing posts with label SmallCap. Show all posts

Thursday, December 7, 2023

Happy Holidays!

Equity markets are making new highs every day. Other assets like gold, bitcoin, bonds, cash, real estate, etc., are also performing decently. Logically, investors should be happy and looking forward to a great holiday season. However, multiple interactions with investors and other market participants, over the past couple of weeks, indicate to the contrary. Investors appear stressed for a variety of reasons.

Those who are underinvested are suffering from fear of missing out (FOMO). Those fully invested are worrying about protecting their gains, should there be a sharp correction. Those invested largely in defensive large caps (likes of Infosys, TCS, HUL, RIL, Nestle, HDFC Bank, and SBI, etc.) are disappointed to see their portfolios underperforming the friends and relatives who were more adventurous and invested largely in the broader markets. Those who are leveraged are constantly worried about a sharp correction, margin calls, and rising cost of borrowing but are too greedy to cut their positions.

The market participants servicing these investors also have their own stress points. Fund Managers have communication challenges. Those who believe that the market might be running ahead of fundamentals and that incremental investments may not yield the returns expected by the investors are struggling to communicate their honest views to the investors for fear of losing money to competitors. The stock brokers are enjoying the highest-ever volumes and brokerages, but are constantly worried about sharp corrections, margin calls, and leveraged traders losing money and getting out of business. Research analysts are finding it hard to justify their opinions on valuations and future price movements of stocks. Investment advisors are facing the challenge of how to convince greedy or fearful investors to maintain discipline and adhere to the predetermined asset allocation.

Overall, the market participants do not appear happy, or not at least as happy as they ought to be. I am not sure if anyone could help relieve their stress, anxiety, fear, and/or jealousy. Maybe, we should consider incorporating spiritual gurus in the respective investment teams of investors for this purpose.

On my part, I can only say that avoiding some of the market jargon (mostly meaningless and redundant to the investing context) could provide some help. For example, avoiding the following jargon from contemplation, conversation, and considerations could relieve a lot of stress for investors.

ATH (All time high): This is used to imply a strong upmove in a stock or index, usually without a historical or relative context. If Nikkei225 of Japan gains another 15%, it will make an all-time high, but would have offered zero return to someone who bought it in December 1989. Nifty recorded its highest-ever level this week. In historical context, on many occasions, Nifty has fallen 10 to 60% from its then all-time highs. So this ATH is a reason to be happy to be cautious? In relative context, Nifty is up ~13% from the level a year ago; whereas, the indices in struggling markets like Germany (~16%), US (+16%), Japan (+20%) and peers like Brazil (+14%) have done much better. On a three-year horizon, Nifty (+~57%) has vastly outperformed its global peers. So, if we ignore the historical and relative context, this ATH has no meaning.

Largecap, Midcap, smallcap: These are the terms used by different people to imply different meanings. SEBI defines Largecap stocks are the top 100 market cap companies; Midcap stocks are companies ranked from 101 to 250 in terms of market cap; and the rest all are smallcap stocks. By this definition, Companies with a market cap above Rs693bn are largecap companies; companies with a market cap between Rs239bn and Rs693bn are midcap companies; and companies with a market cap less than Rs239bn, are smallcap companies.

However, investors usually confuse it with the current market price of the stock of the company. It is a common perception that Yes Bank (CMP Rs20, Market Cap Rs628bn); Suzlon Energy (CMP Rs38, Market Cap Rs519bn), Vodafone Idea (CMP 13, Market Cap Rs628bn) are small companies; whereas microcap companies like Swaraj Engine (CMP RS2215, Market Cap Rs26bn), Johnson Control Hitachi (CMP Rs1140, Market Cap Rs31bn) Force Motors 9CMP Rs4050, market cap Rs.53bn) are perceived as largecap companies.

Avoiding this jargon and focusing on the fundamentals of a company could definitely relieve some confusion and stress.

Some other similar jargon, which are totally avoidable are Long-term and short-term investments; TINA (There is no alternative), FOMO (Fear of missing out).

Thursday, September 14, 2023

Cook your own meal

Have you ever been to the vegetable market after 9:30 p.m.? The market at 9:30 p.m. is very different from the market at 5:30 p.m.

At 5:30 p.m., the market is less crowded. The produce being sold is good and fresh. The customer has a larger variety to choose from. The customer is also at liberty to choose the best from the available stock. The vendors are patient, polite, and willing to negotiate the prices.

As the day progresses, the crowd increases. The best of the stuff is already sold. Prices begin to come down slowly. The vendors now become a little impatient and less polite and mostly in "take it or leave it" mode.

By 9:30 p.m., most of the stuff is already sold, and poor-quality residue is left. The vendors are in a hurry to wind up the shops and go back home. The prices are slashed. There is a big discount on buying large quantities. Vendors are aggressive and very persuasive.

Customers now are mostly bargain hunters, usually the small & mid-sized restaurants, caterers, and food stall owners. They buy the residue at a bargain price, cook it using enticing spices and oils, and serve it to the people who prefer to eat out instead of cooking themselves, charging much higher prices.

The cycle is repeated every day, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying that all participants are mostly satisfied.

A very similar cycle is repeated in the stock markets.

In the early cycle, good companies are under-owned and available at reasonable prices. The market is less volatile. No one is in a hurry. Smart investors go out shopping and accumulate all the good stuff.

Mid-cycle, with all top-class stuff already cornered by smart investors, traders and investors compete with each other to buy the average stuff at non-negotiable prices. Tempers and volatility run high.

End cycle, the smartest operators go for bargain hunting. Strike deals with the vendors (mostly promoters and large owners) to buy the sub-standard stuff at bargain prices. Build a mouth-watering spicy story around it. Package it in an attractive color and sell it to the latecomers and lethargic at fancy prices.

The cycle is repeated every time, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying that all participants are mostly satisfied.

If my message box is reflecting the market trend correctly, we are in the end cycle phase of the current market cycle. I get very persuasively written research reports and messages projecting great returns from stocks that no one would have touched early cycle or mid-cycle.

The stories are so persuasive and the packaging so attractive that I am tempted to feel "it's different this time." But in my heart, I know for sure, it is not!

If you are tempted to say that I have been saying this crap for almost two months now, I agree unashamedly with no regrets whatsoever.

Have a look at the top 50 price gainers at BSE in the past six months. The earnings of most of these companies are not congruent with the rise in market price. In some cases, it has been even lower. The stories are truly enticing and even inspiring in some cases.

Out of 8500 odd BSE listed companies for which data is available, over 5000 reported negative or marginally positive EBIDTA in the last results. More than 1000 companies trade at EV/EBIDTA higher than 25. In the early cycle more companies trade at lower PE ratios.

Make your own assessment of what I am trying to say.

Tuesday, July 4, 2023

1H2023 – So far so good!

The first half of the year 2023 has been good for risk assets. Despite strong headwinds in the form of aggressive rate hikes, banking sector turmoil, political & geopolitical events and credit warnings, the stock market made a steady move up with very low volatility. Another notable feature of the global market movement in 1H2023 was the stark underperformance of emerging market equities as compared to the developed markets – even though the development markets appeared to be facing serious growth challenges and financial sector stress. The emerging markets like India demonstrated much stronger economic resilience and price stability.

Equities and Crypto recorded strong gains in the first half of 2023; while commodities (especially energy), USD and bonds lost some ground. The rally in risk assets though lacks belief of investors, as underpinned by high cash levels.

Though at present equity markets appear strong on the back of a resilient demand environment, easing geopolitical conditions, controlled inflationary pressures and peaking interest rates – the uncertainty levels continue to remain elevated. The confidence in the economic growth in the developed world remains low, while valuations seem to be discounting a strong economic recovery. Consequently, the conviction in the present stock price levels is low.

India performance – 1H2023

Indian markets performed reasonably well in the first half of the year 2023. Though Indian equities underperformed the developed markets in line with the global trend, it did very well within the merging market universe. The key highlights of the India market performance could be listed as follows:

· The benchmark Nifty50 gained ~6% during 1H2023; while the Midcap (+13.5%) and Small Cap (+11.4%) did much better. Consequently, overall market breadth has been strong.

· The markets were negative for the first four months of the year. It rallied hard in the last two months (May-June) to recoup the losses and post strong gains. Considering this, the rally in broader markets has been furious but lacked larger participation.

· The total market capitalization of NSE is higher by 5%; much less than the gains in indices – implying that a significant section of the market may have actually lost significant value in the past six months.

· The number sector underperforming the benchmark indices outnumber the sector outperforming. The rally was counterintuitively led by the rate sensitive sectors like Realty and Auto; while energy and PSU banks were notable drags. Consumers (despite visible rural demand stress) and pharma also outperformed. IT Services and financials were other notable underperformers.

· Some Adani Group stocks, and Zee Entertainment etc were notable losers on corporate governance concerns; while some mid and small cap IT stocks were amongst the top performers for the period.

· The Capital Goods and Heavy Engineering sector has been flavor for the period. Particularly, the businesses catering to sectors like defense, railways, and road construction did extremely well.

· Indian equities have sharply underperformed the developed market and some emerging market peers like South Korea. However, it did better than BRICS peers and other emerging markets.

· Institutional flows to the secondary equity markets were positive for the all six months. 1H2023 witnessed a total flow of ~INR1562bn, with FPIs contributing over INR696bn. The correlation of institutional flows with Nifty returns however remained poor (~40%).

· The rates inched higher during 1H2023. Policy rates were higher by 60bps; while money market rates were higher on average by 70-75bps. Deposit rates did not see much change while lending rates were higher by upto 65-70bps.

· The overall Indian yield curve shifted lower; though at the lower end (upto 1yr residual maturity) it lifted sharply higher as RBI continued to withdraw accommodation.

· INR weakened against USD (-4%), EUR (-8.7%) and GBP (-9.1%) while it was marginally higher against JPY (+2.6%).

· The economic growth surprised on the higher side with the Indian economy recording a growth of 6.1% in 4QFY23. Overall for FY23 India’s GDP grew @7.3%, much better than the estimates.

· CPI inflation has inched closer to the lower bound of the RBI’s tolerance band of 4%-6% with May’23 CPI inflation number coming at 4.3%. The core inflation remained sticky at 5.4%.

· Corporate performance has shown resilience in recent quarters, with sales growth recovering and margins bottoming.

Thursday, June 22, 2023

View from the top

The benchmark Sensex has recorded its new all-time level today, surpassing its previous high level of 63583 recorded in early December 2022. Nifty50 is also few points from its previous highs. In the past six months, since December 2022, both the indices have taken a huge swing of over 10%.

Optically the markets may appear flat for the past six months, as the benchmark indices are almost unchanged; but a deeper dive would indicate that many material shifts have occurred in the market during this period of six months. For example-

· Nifty50 is almost unchanged for the past six months, Nifty Midcap100 has gained over 9% and Nifty Smallcap100 has gained over 7% in this period.

· The sectors that led the markets to new highs in the post Covid period, i.e., IT Services, Pharma, Energy and Metals have actually yielded negative returns in the past six months; while the FMCG sector has been the best performer in this period.

· Nifty PSU Banks that are the best performing sector for the past one year, have actually yielded a negative return for the past six months.

· Despite the turning of rate cycle upwards, popular rate sensitive sectors like Auto and Realty have been amongst the top three performing sectors.

Despite sharp outperformance of broader markets, average market breadth for the past six months has been mostly negative. The months of January-March 2023 in fact witnessed the worst market breadth in over two years.

Another pertinent point to note in this context is that Indian markets have sharply underperformed the most emerging market peers and developed markets in the past six months. Note that in 2022 India was one of the top performing global markets. This is in spite of net foreign flows being positive in the past six months to the tune of Rs500bn (vs Rs1256bn outflows for 2022).

Taking a comprehensive look at the market performance during the past six months, I would draw the following conclusions:

1. From the sharp outperformance of broader markets it is evident that the sentiment of greed is overwhelming the investors’ fears; and signs of irrational exuberance are now conspicuous.

2. Most of the good news (rate and inflation peaking; earnings upgrades; financial stability; etc.) is already well known & exploited; while the fragility in global economy and markets has increased and hence the present risk-reward ratio for traders may be adverse.

3. From a historical relative valuation perspective – Nifty is currently trading at ~4% premium to its 10yr average one year forward PE ratio. The same premium for Nifty Midcap100 is 14%; while Nifty Smallcap100 is trading at ~2% discount to its 10yr average one year forward PE ratio. The discount of smallcap PE ratio to Nifty PE ratio is presently close to 22%, larger than the 10yr average of 16.5%. The sharp outperformance of smallcap may be a consequence of value hunting and irrational exuberance, rather than greed; and the traders may soon return to Nifty as the valuation gap is filled.

In my opinion, therefore, it would make sense to take some money off the table, especially from broader markets and high beta stocks.

Thursday, June 1, 2023

Greed and Fear

In the first two months of FY24, Indian markets have done well. The market breadth has been strong and; volatility very low. The latest market rally could be described in at least three different ways, viz,

1. The benchmark Nifty50 has gained ~6.5% from the end of FY23; and the broader market indices like Nifty Midcap100 (~12%) and Nifty Smallcap 100 (~13%) have done significantly well during this period, indicating much improved sentiments. This view would imply that presently the sentiment of greed is dominating the sentiment of fear.

2. At the current level, Nifty50, Nifty Midcap100 are close to their all time high levels recorded in the 4Q2021 and again in 4Q2022. Whereas Nifty Smallcap100 is still about 20% lower from it’s all time high level seen in early 2022. So effectively the markets have been oscillating in a wider range after the sharp rally post March 2020 Covid panic lows. This view would imply that since the market is now close to the upper bound of its trading range, traders would be looking to pare their long positions; especially because most of the good news (rate and inflation peaking; earnings upgrades; financial stability; etc.) is already well known & exploited; while the fragility in global economy and markets has increased and hence the present risk-reward ratio for traders may be adverse.

3. From a historical relative valuation perspective – Nifty is currently trading at ~3% premium to its 10yr average one year forward PE ratio. The same premium for Nifty Midcap100 is 14%; while Nifty Smallcap100 is trading at ~2% discount to its 10yr average one year forward PE ratio. The discount of smallcap PE ratio to Nifty PE ratio is presently close to 22%, larger than the 10yr average of 16.5%. The sharp outperformance of smallcap may be a consequence of value hunting rather than greed; and the traders may soon return to Nifty as the valuation gap is filled.

Whatever view one takes, in my opinion, it would make sense to take some money off the table, especially from broader markets and high beta.

Tuesday, May 9, 2023

This summer don’t go nowhere

In the later part of the eighteenth century, St. Leger Stakes, a popular horse race, was started as the last leg of the popular British Triple Crown. The race would be held at Doncaster Racecourse in South Yorkshire in September of every year. Soon it became a fashion amongst the British elite – aristocrats, investors, and bankers etc. – to liquidate their financial investments; escape from London heat, move to countryside to rejuvenate, and return only in autumn after the St. Leger Stakes race was over. This practice was described as “Sell in May, go away and don't come back till St. Leger's Day.”

Later, as the US stock markets gained more prominence over London markets, the adage was rephrased as “Sell in May and come back in October”, to coincide with Halloween.

Various research studies observed there is decent evidence to conclude that stock markets’ returns during November-April period usually outperform the returns during May-October period. Based on these observations of seasonality of stock market returns, many trading strategies were developed that involved tactically moving money away from stocks at the beginning of the month of May to other asset classes, especially agri commodities like wheat and corn which were cheap due to arrival of fresh crops; and return back to equities in October.

In 1990, “Beating the Dow” by Michael O’Higgins and John Downes popularized the investment strategy “sell in May and go away”. Bouman and Jacobsen (2002) popularized this strategy by naming it “Halloween effect”. Later a research paper by K. Stephen Haggard and H. Douglas Witte (2009) had shown investing in a “Halloween portfolio” provides risk-adjusted returns in excess of buy and hold equity returns even after consideration of transaction costs.

However, latest research has shown that the Halloween effect may be weakening. As per a recent Reuter study (see here) Over the last 50 years, the S&P 500 (.SPX) has gained an average of 4.8% between November and April, and just 1.2% between May and October, according to Reuters calculations. However, this pattern fades over a shorter time-frame.

Over the last 20 years, the out-performance of November-April over May-October narrows to 1%. Over 10 years, November-April has underperformed May-October by 1 percentage point and over the last five years, it's underperformed by 3 percentage points. It might be time to find words that rhyme with "November".

Indian markets have rallied strongly in the past 5-6weeks. The benchmark Nifty is higher ~9% from its March 2023 lows; while Nifty Smallcap100 is higher by ~12%. The rally in stock prices has corresponded to some strong macro data and better than expected 4QFY23 earnings. The bond yields have eased materially; RBI has indicated a pause in its tightening cycle; inflation has eased within RBI’s tolerance range; CAD has improved; GST collections are at all time high; lead economic indicators like freight haulage, auto sales, power demand etc. are improving.

The question is what should be the course of action for Indian investors and traders – especially in view of the dark clouds gathering over developed economies. Should they be selling into this rally and wait for better opportunity; or hold on to their positions and build upon these further.

My view is that technically markets may be inching closer to the upper bound of the trading range; hence the risk reward for traders appears negative at current price points. However, from macroeconomic and corporate fundamentals viewpoints, the markets seem to be embarking on a structural bull market that may last for over 5years. Therefore—

(i) Traders may lighten their positions and look for lower entry points to reenter. Though the opportunity may present itself much earlier than October.

(ii) Investors may hold on to their existing investments; and look forward to lower entry points for increasing their equity allocations.

In both cases, it is important that traders/investors stay alert and actively look for opportunities, regardless of how hot and dry this summer turns out to be.

Thursday, February 16, 2023

No bear market likely in 2023 as well

It was spring of the year 2022. The news flow was worsening every day. The Russia-Ukraine conflict was dominating the global media headlines. NATO-Russia acrimony was at its worst since the cold war era. China committed to a zero Covid policy and implemented strict mobility restrictions, further impacting the global supply chains. Inflation was beginning to spike and most central bankers were ready to embark on an accelerated tightening cycle.

Back home, the enthusiasm created by a path breaking budget had not survived even for a whole week. Issues like macroeconomics (growth, inflation, current account, yields, INR), geopolitics (Russia-Ukraine), politics (state elections) and persistent selling by foreign portfolio investors (FPIs) was dominating the market narrative. The trends in corporate earnings also were not helpful to the cause of market participants.

By early March 2022, the benchmark indices had fallen substantially from their highest levels recorded till then, between October 2021 and January 2022. The Nifty50 was down ~11%; the second most popular benchmark Nifty Bank was down ~16%, the Nifty Midcap 100 was down ~14% and the Nifty Smallcap 100 was down ~17%. Though technically, the market was still in ‘correction’ mode, sentimentally it did feel like a ‘bear’ market.

Amidst all the gloomy headlines and bearish forecasts, I felt that we are most likely to witness a boring market rather than a bear market in India during 2022 with breadth narrowing. (see here). Since then benchmark Nifty is higher; but it has mostly moved in a range occasionally violating the range on both the sides.

Since the beginning of 2022, Nifty50 (+1%) is almost unchanged and midcap (-3%) have performed mostly in line. Nifty Bank (+10%) has been major outperformers; while Smallcap (-20%) have underperformed massively. The market breadth has accordingly been mostly negative.

Nothing much has changed in the past one year - the geopolitical situation remains fragile; the war continues; inflation remains a worry; economic growth is decelerating; earnings growth is slower than anticipated; rates are higher and expected to remain elevated for long; monsoon is expected to be below normal; and FPI outflows continue. To add to this we are entering an intense election season that should culminate with general elections in March-May 2024.

However, the narrative now is not negative. At worst it is neutral. The war is now on the 13^th page of the newspaper. It is neither mentioned in the prime time news headlines nor does it trend on social media. Central bankers have successfully anchored inflationary expectations and the popular discussion is around peaking of rates & inflation rather. The US and European recessions are not a consensus now. India growth is also estimated to be bottoming above 6%.

Given these fragile macroeconomic & geopolitical conditions; declining optimism over earnings growth; higher debt returns and optimistic equity positioning, it is important to assess what could be the market behaviour in the next one year?

In my view, we may not see a decisive direction move in Nifty50 in 2023. It may move in a larger range of 16200-20600 in 2023, averaging above 17600. We may therefore not witness a bear market in 2023. Smallcap stocks which have been underperforming for quite some time now may end up outperforming the benchmark Nifty50 for 2023; though gains could be back ended.

Tuesday, June 14, 2022

A perfect storm

The benchmark Nifty is down about 15% from its October 2021 closing high of 18477. A broader gauge of the market performance Nifty500 is also down by a similar proportion. However, anecdotally I find that damage to the investors’ sentiments is much worse than what this extent of correction in these indices might be suggesting. There could be multiple reasons for the investors’ despondency. For example—

· Most of the popular trades of 2020-21 that have attracted a whole lot of new investors/traders to the equity markets have lost materially. The Covid trade (Pharma, healthcare); New listed IT enabled businesses like ecommerce platforms and Fintech; popular disinvestment candidates; PLI beneficiaries; self-reliance and import substitution (Specialty chemicals, electronics) have sharply underperformed the markets. A large number of these stocks have corrected 25-75%.

The non-institutional investors have a tendency to chase popular trades. The beta (correlation with the benchmark index) of their portfolios is therefore much higher than a well-diversified portfolio. Obviously, the losses to their portfolio may be much higher than the extent of fall in the benchmark indices. To make the matter worse, the visibility of recovery of their losses is much lower, as the rationalization of the valuations in the popular trades may be more permanent in nature. We might not see loss making new age businesses; commodity chemicals; generic pharma and API makers; and electrical appliance assembly units etc. trading at crazy multiples in the next few years at least.

· Most equity and debt mutual funds have yielded negative or nil returns in the past 6 months. The real return on bank fixed deposits has also been negative for the past six months. The global and domestic markets are indicating that the probability of any reversal in this trend is very low for the next few months at least. The New investors, who have not experienced a genuine bear market (e.g., 1990s) may be feeling nervous about losing their hard earned wealth.

· Nifty Smallcap 100 has lost close to 28% from its January 2022 high; almost twice the losses in benchmark Nifty50 or Nifty500. The actively managed portfolios that have more smallcap stocks (high growth at reasonable valuation) may therefore be suffering more damage than what the benchmark Nifty is indicating.

· The macro environment (both domestic and global) has deteriorated in recent months, especially after the war broke out between Russia and Ukraine. It appears that the measures adopted to arrest the macroeconomic deterioration may be friendly to the equity valuations. The rate hikes, liquidity withdrawal, fiscal tightening etc. have diminished the visibility of growth capex. There are early signs of consumer demand destruction in discretionary spending due to inflation and higher rates. The investors may be fearing even deeper correction in sectors like cement, metals, consumer electronics etc.

It is important to understand that the markets are caught in a perfect storm – (i) Liquidity is shrinking; (ii) cost of capital is rising which requires target valuations to moderate; and (iii) growth environment is clouded which requires earnings forecast to be downgraded.

The best strategy therefore would be to (a) hold nerves and not panic; (b) review the portfolio for any corrective action that may be needed once the storm passes and the sea becomes calmer. It may not be a good idea to go out on the deck and try catching some fish.

Friday, June 3, 2022

2022 - Fear trumping the greed

The prices of publicly traded financial assets like equity shares and bonds etc., is materially influenced by the sentiments of fear and greed amongst the market participants, at least in the near term. The sentiment of greed drives the participants to bid higher prices for a security, even though the economic fundamentals underlying that security may not fully justify such price. Similarly, the sentiment of fear prompts the market participants to offer the securities held by them at relatively cheaper rates. The equilibrium of sentiments of greed and fear keeps the markets stable & healthy; whereas dominance of either sentiment induces excessive volatility and irrational pricing in the markets. Extreme dominance of either sentiment usually marks the peak or bottom (as the case may be) of a market cycle.

If we examine the current equity market behaviour, it appears that the sentiment of fear is gradually becoming dominant amongst the market participants. The following five signs, for example, indicate that relatively weaker participants might be moving to sidelines or even withdrawing from the markets. This is usually indicative of the beginning of the process of a market cycle completing its downward journey. The actual bottoming though may take some time and further downward move.

Market activity shrinking

In the past six months, the market activity has cooled down conspicuously. The volumes in INR terms as well as in terms of shares traded and number of trades executed have remained on the lower side, indicating shrinking participation in the market.

At peak of the market in October 2021, the average traded volume in Oct’21 was over INR4000bn; however in May’22 it contracted to was below INR2800bn. Similarly, the number of trades in Oct’21 was over 130bn; whereas in May’22 only 108bn trades were executed on NSE. In terms of number of shares traded – in Oct '21 83.58bn shares were traded on NSE. In May’21 the number had contracted to 43.91bn, almost half of Oct’21.

Volatility persisting at higher levels

Since the benchmark Nifty recorded its all-time high level in October 2021, the implied volatility (popularly called the fear index) has persisted at higher levels; even though it has eased in the past 10 days.

Broader markets underperforming

The market breadth has remained negative in eight out of the past twelve months. The market breadth on NSE was worst in at least the past twelve months. In fact the market highs in October 2021 were recorded with a negative market breadth and high volumes; indicating a distribution pattern in the technical analysis parlance. Nifty50 has corrected ~10% from its latest closing highs; whereas Nifty Smallcap 100 index is down ~23% from its latest high levels; even though the smallcap high (January 2022) was recorded 3months later than Nifty (October 2021).

Sector wise also YTD 2022 only Financials (1%), FMCG (1.5%), Auto (5%) and Energy (14%) sectors have yielded positive returns. IT Services (-22%), Realty (-15%), and Pharma (-12%) have been the worst performing sectors.

Valuations are now more reasonable

As the sentiment of fear has started to dominate the markets, the valuation excesses are now correcting. The 12month forward PE Ratio of the benchmark Nifty Index is now closer to 5yr average level. The price to book (P/B) ratio for Nifty has also corrected sharply from the higher levels seen in October 2021.

The valuations are now closer to “fair value” zone, a pre-condition for completion of the down leg of a market cycle (bottoming). It is however important to note that in many cases it has been seen that the earnings estimates are materially revised lower. In that case the “fair value” curve may shift sharply downward.

Global markets – sentiments most bearish since March 2020

As per the Bank of America’s (BofA) proprietary Bulls and Bears Indicator, the global fund managers were most bearish in May 2022, since the Pandemic outbreak (March 2021).

Thursday, May 12, 2022

Those mid and smallcap stocks!

I have been married for more than two decades now. In all these years I have deliberately maintained a safe distance between my personal and professional life. My wife Anandi, a post graduate in Hindustani Classical music and an amateur poetess has never shown any interest in the matters relating to finance. She finds it too “dry and mundane”. Last few days though have been a little different. To my surprise, Anandi herself started a discussion on stock market. At once, I could not fathom why she would be suddenly interested in what she always believed to be the mired world of finance and investments. But soon I realized the catalyst of this change- it was her cousin brother Anuj, who has apparently lost heavily in the recent collapse in the stock market.

We had a long discussion last evening. I am sharing the following excerpts from our discussion with readers. I believe many may find it relatable and useful.

“Anandi (in an unusually hoarse voice): What are these small and midcap stocks? Do you also invest in small and midcap stocks?

Me (visibly startled): Are you OK? Why would you suddenly want to know this ‘silly’ jargon?

Anandi (clearing her throat): Those people are saying that it is end of road for these stocks!

Me: Who people?

Anandi: Those people on TV.

Me (wondering): But we do not have TV in our home!

Anandi (in the lowest possible note): Vrinda (Anuj’s wife) was telling me. Anuj is very tense these days. He remains glued to TV the whole day, shuffling between various business channels. He does not even allow kids to watch cartoons. Apparently, he has incurred huge losses.

Me: But when we met three months ago, Anuj told me that he is doing very well. He even proudly claimed that he has made over 200% returns on his portfolio last year.

Anandi: He was actually doing well. In fact he bought Vrinda very expensive diamond jewelry on her birthday. They were even discussing buying a bigger flat this year.

Me: Then what went wrong?

Anandi: I do not know exactly, but Vrinda was telling me that he bought some ‘small and midcap stocks’. Some ‘bad people’ manipulated the prices and he practically lost his entire wealth. He may have to borrow money against their house to pay for the losses.

Me (shocked): But even ‘bad’ stocks have not lost more than 50-60% in this collapse. How could he lose more than his investment?

Anandi (confounded): I do not understand all this. You never taught me all this. Vrinda knows all about stock markets. Tell me you don’t buy any ‘small and midcap’ stocks!

Me: See Large cap – midcap - small cap; long term ‑ short term; value investor – speculator etc. is nothing but jargon created to unnecessarily complicate the process of investment and compel investors to make mistakes. Even if we accept the popular jargon, most small and midcap stocks are not bad. In fact, many of these stocks become large cap stocks in due course. Stocks like HDFC Bank and Havells were smallcap stocks 15-20years ago.

Anandi: Then why is everyone sounding so skeptical about small and midcap stocks these days!

Me: No, not all people are skeptical about these stocks. In fact, the term ‘small and midcap stocks’ as it is being used in common parlance is a vague term, which does not mean much. I think Anuj may have invested in some stocks trading at a low nominal price. Some of these stocks may be manipulated by some unscrupulous people to cheat the gullible investors. The economic behavior of these investors is easily overwhelmed by the forces of ‘greed & fear’. Anuj must have been coaxed by the lure of huge profits in a very short period, and taken leveraged positions in these stocks.

Anandi: What is this ‘economic behavior’?

Me: Our behavior is the sum total of our habits and attitudes. Our economic behavior pattern also reflects our habits. Habits such as austerity, extravagance, procrastination, punctuality, disorderliness, meticulousness, laziness, diligence, etc., all affect our economic behavior. A lazy person procrastinates on important decisions like transferring money from savings bank account to fixed deposit and renewing his insurance policy. An extravagant person immediately spends whatever he earns, rather than saving money for rainy days. A diligent person keeps track of his income, expenses, and investment and is often able to gain from opportunities that a lazy person would surely miss.

Some of these habits we acquire from our environment, and the others we develop over a period of time. For example, a person born in an extravagant family is less likely to be austere, whereas a person born in a family with an army background is more likely to be punctual and orderly. Similarly, a person employed in a high stress job is more likely to be disorderly in personal life. An entrepreneur is more likely to be meticulous and diligent than an employee.

We need to closely scrutinize our habits whether self-developed or acquired from the environment and change those which we find are not conducive for wealth accumulation.

Before we make any investment strategy we need to take a self-evaluation test, to understand if we are actually making investments or just playing a game of dice. When deciding to put my money into any instrument, we must ask ourselves “Do I understand the implications in terms of risk and rewards? Or Am I just making impulsive investment decisions?”

An ‘investor’ invests his money only after properly weighing the risk and rewards. The objective of such investment is to “Earn a sustained stream of returns, and/or Make capital gains over a period of time; without bargaining for abnormal gains in the short term.” These extraordinary gains may incidentally occur in the short term.

On the contrary a ‘speculator’ would aim to earn abnormal gains in the short term, taking a very high risk on his capital. A trader would target to gain from the cyclical market trends taking buying and selling as his normal business. The approach, skills and aptitude to be a speculator or trader are altogether different than those required for an investor. The same holds true for the risk-reward equation also.

It is important to maintain a balance between Liquidity, Safety and Returns on our savings. If someone goes beyond his/her risk tolerance limits and borrow money to gamble in stock market, his/her position would be the same as Anuj today.

Anandi (apparently confused and lost): I do not understand much of what we have discussed, but for God sake, avoid investing in ‘those small and midcap stocks’.

Tuesday, February 15, 2022

A visit to the markets

The markets have been in a punishing mood for the past couple of weeks. Especially after the “path breaking budget”, the markets seem to be adjusting to the RBI’s rather tepid growth forecast for 2HFY23. Obviously, the RBI does not share the enthusiasm of the government over public sector capex triggering a virtuous cycle of growth led by private sector investment.

The narrative of geopolitics (Russia-Ukraine conflict) and Fed tightening scaring the markets does not sound credible.

Russia and Ukraine have been at war for three decades, since the dismantling of the USSR. Eight year ago, in 2014 Russia annexed one of the larger provinces of Ukraine (Crimea) and markets have not cared much about that, just like it has learned to live with the perennial conflicts between Israel and Philistine; US and Iran, South Korea and North Korea, India and Pakistan; etc.

The US Federal Reserve started winding up its asset buying program (QE) last year and announced its intent to hike policy rates once QE ends in March 2022. There is no surprise for markets in this. There is overwhelming empirical evidence to suggest that Fed rate hikes that control inflation but do not hurt the growth have been usually benevolent for equity markets, especially emerging markets. The most hawkish forecasts are projecting the Fed policy rates to peak at much lower levels as compared to previous rate cycles. Building a disastrous outcome for markets like the 1980s or 2000 due to Fed rates may be inappropriate since in those cases rates peaked at 20% and 6% respectively, as against 3.5% worst forecast this time.

The argument of money debasement and hence rates peaking at lower level is actually favorable for equities, since it allows higher valuations to sustain for longer.

Another popular narrative on the street is that the ongoing correction may be a great opportunity to buy. Millions of experts on social media are saying with the benefit of hindsight that all such corrections in the past were great investment opportunities which people regretted later.

I see their point, but would like to understand where we stand in the current market cycle? If the current market is not complete yet, we may experience material pain in the coming months. In the past two market cycles (2006-2009 and 2016-2020), the market had given up most of its gain towards the end. In fact, the smallcap indices ended both the cycle with net losses. In the current cycle we are close to 10% off from highs recorded so far in the cycle. Both Nifty50 and Nifty Midcap are more than 100% higher from the starting point whereas Nifty Smallcap is 200% higher from the starting point. Never have the market cycles have ended like this.

We certainly have a long way to go in this market cycle. If the peak has already been recorded, we may see 25-50% correction in broader markets; else we may have some distance to move north. More on this tomorrow.