It is time to Under-perform….

When liquidity is awash, it isn’t time to chase performance!

Financial world seems divided. On one hand, we have treasury yields near multi-year lows with some even braving the negative side. On the other hand, equities never had it so good, hitting all time highs in many markets. Take the case of US markets. S&P is near all time high while ten year US yield was near multi-decade low just a couple of weeks ago, though has recovered since then. Contradicting signals, isn’t it?. One is hinting at flight to safety (risk-off) and other is pointing to reckless risk-taking. Negative yields in Japanese, German and Swiss bonds have only added to the puzzle.

In simple terms, negative or low yields in general mean increased risk perception (volatility and flight to safety) or expectation of weak growth in future (low interest rates in future). Of course, that doesn’t tally with the exuberant equities that are extrapolating extraordinary growth or betting on a much saner world. One of them, of course, is getting the future wrong. It is difficult to say which one. Bond king Bill Gross calls it a Supernova in bond markets waiting to be exploded. But he has been saying it for many years now with bond markets proving him wrong for long. Same is the case for bears on the equity side. Markets will eventually see reasons, but in short-term, it is anyone’s guess. As someone famous said, markets can remain irrational longer than you can remain solvent.

While this irrationality lasts, strange things happen. It gives rise to new breed of short-term flows that drives the distortion to devious levels. Some call it “Liquidity” and others call it smart “Carry-trade”. But these are short-term phenomena that vault the valuations to frenetic levels. Power of liquidity can never be questioned and it is unwise to fight liquidity.

That said, fundamentals have much less to inspire. Take the case of Q-1 earnings in India. The season is already midway. Nothing spectacular so far. If anything, it has been an disappointing start with lackluster results from IT behemoths and consumer staples. Woes in private sector banks have worsened with Axis bank’s asset troubles refusing to abate. With telecom expected to follow suit with its dwindling fortunes, earning season may not play to the sentiment of bulls. But that hasn’t stopped them from taking markets to new highs. When liquidity rules, fickle fundamentals hardly matter. When NBFCs are showcased as next sun risers, micro-finances as next master blasters and staffing companies are chased by 150+ times over-subscriptions (in IPOs), you know who rules.

What do long-term value investors do in such an irrational setting?. No prize for guessing. Stay away and sit tight. It is time for under-performance. By choosing not to chase liquidity/ momentum, one gives up on the short-term performance. In a way, short-term under-performance is the price, an investor pays for the long-term out-performance. Investing is often compared metaphorically to Marathon. As in Marathon, these are times to slow down the pace to get prepared for the longer haul. As Buffett quipped, the trait that builds durable success in investing is the ability to focus on process than on proceeds. No better time to remember this than now when greed meter is gyrating high.

Happy Value Investing!

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Climbing Wall of Worries!

A bear market buckles under wall of worries. Bull market does the opposite. That is, wall of worries can’t stop the market that wants to go up. Indian markets may be in such a stage, going by the resilience it has shown in each and every successive negative development. It took Rexit and Brexit in its stride. No exits could endanger this market that wants to move up. Outflows from both debt and equity markets have been manageable and Rupee has shown remarkable stability amid turmoil in pound and dollar strengthening. It is exhibiting all the traits of a classical bull market that conquers and climbs wall of worries at each stage. This is of course with a caveat that any attempt to predict short-term market movements is a tricky one as it can surprise even the seasoned ones.

May be markets are betting on the rising political capital of this Govt. and are preparing for slew of policy actions including the passage of GST in the upcoming monsoon session. Strong pickup in monsoon rains couldn’t have come at a better time. Moreover, robust outlook for domestic flows is one of  the underlying reasons for such a strength in Indian markets. Structurally, money is shifting from real-estate to equities and such a trend is likely to gather momentum in the coming months and years. As a result, market will gravitate towards more actions in the broader market (small and midcaps) than headline benchmarks, given the subdued outlook for FII flows (which favor large cap space) and stronger outlook for domestic flows which dabble in broader mid and small caps. Consequently, trend will continue to favor stock picking as in the previous year.

Moving on, it is not that the weakening global macro, as a result of Brexit, has been ignored completely by the Indian market. It has become far more selective in its support. Markets have started rewarding domestic driven stories while punishing the stocks that are over-exposed to global macro. In this emerging divergence, sectors like IT, metals are likely to under-perform while domestic driven themes like rural, auto, banks, cement, construction, road, defense etc may out-perform.