Friday, October 23rd, 2020
One of Warren Buffets favorite dictum is –
Rule 1: Don’t Lose Money
Rule 2: Don’t Forget Rule 1
For quite some time now many markets, including the NASDAQ, have been making all-time highs propelled by the FAANG stocks and many biotech companies. In India too the markets have moved up, but in an extremely skewed pattern. A number of major financial stocks are still 30% to 50% below their peaks but the overall indices are at all-time highs of 32 to 33 times the earnings. Such valuations were witnessed in 1999 and 2007. It is common knowledge that these years preceded the major crashes in Indian market history.
At one end of the spectrum, you have stocks which are extremely expensive relative to their future growth expectations and the other end is exactly the opposite—cheap stocks with good future prospects. Momentum and not pure fundamentals have been driving the rally. The dictum –Valuations don’t matter for quality companies- has made the costly stocks even costlier.
GROWTH stocks are now overvalued and may not move higher, but there is value in the quality of cheap stocks. The indices overall do not have much room to move higher but a careful stock-picking of VALUE stocks can yield returns going forward. Corrections will be as usual a part of the journey.
So to heed Warren Buffets advice
Two Cs — CASH & CAUTION are important going forward.
The expectation of returns from this level is muted, to say the least.
To understand the cause of the current situation we need to go back to March 20 when the Covid 19 crisis blew into India and triggered a spate of lockdowns and disruptions, bringing the already shaky economy to a standstill. The common response globally by the monetary authorities was to push large amounts of liquidity into the system. This pushed the rates down to an extent that negative rates prevail in some economies. 69% of $ six trillion Eurozone countries debt yields negative returns, (Yields on German 10-year bunds last week was -0.62%.)The Indian central bank reacted no differently. Debt moratoriums and interest rate reductions were announced.
In some major economies like the USA, UK, and Japan, Direct Fiscal support too was announced to all citizens and businesses across the board. A combination of fiscal and monetary stimulus prevented a possible global depression. The pandemic rages on and the vaccine is still not in sight, and the probability of a second wave looms large while we wait for normalcy to return.
In the midst of all this turmoil, some segments of the economy like home products, consumer goods, automobiles have smartly bounced back. The probable reason for this is that pockets of surpluses have been created. During the lockdown travel, dining out, discretionary purchases have been curtailed. Vacations, jewelry purchases, have been postponed or canceled. Marriages have been postponed, celebrations are non-existent. Government employees and cash surplus corporates have not cut down on salaries. Some corporates have cut down on expenses and some now want to make WFH a permanent feature.
On the other hand, government spending is at an all-time low, almost no fiscal stimulus like the western countries was given. In fact, the hike in fuel duties negated whatever little was given. So getting back to 5% to 6% growth is extremely unlikely for the next 2 to 3 years. The Atmanirbhar program to encourage and revive manufacturing is no doubt is laudable, but will push the cost to consumers and therefore contribute to inflation.
While the second wave has started playing out in some economies their stimulus is pushing their DEBT TO GDP ratio to an all-time high and to the extent that the sovereign ratings are adversely affected. The United States of America has already crossed the 100% mark while in India it hovers around 82% even without the fiscal stimulus.
All this adds up to the situation of weak demand, lower GDP, lower or even negative growth rate for corporates. This in turn should bring the stock prices from euphoric levels to realistic levels. The liquidity prevailing in the system will also dry out sooner or later depending on when the FIIs decide to pull out.
The asset classes to be invested in now are a mix of GOLD (preferably in ETF, or units), and medium-term debt portfolio.
For the not so risk-averse —direct equity with strict targets of profits and loss are an attractive option. However, as at a portfolio level ( eg. Equity oriented funds) are simply no-no.
It is difficult to predict when the markets will take a U-Turn and therefore a conservative approach will underperform the broader markets for some time. However it is better to be safe than sorry and be reminded of Buffet’s dictum—Don’t Lose money.