How do you stay invested when the tide is expected to turn turbulent?

Since the beginning of pandemic, outcome from Fed meetings has been a predictable affair. Rate reductions and accelerated bond-buying had become the regular feature of such meetings. No surprises. Predictably, markets got used to that luxury of lavish liquidity and they in turn prospered. Globally, reflation trade took the center stage to push markets to new highs. Fast forward to June meeting, things are not as certain now. In this meeting, Fed signaled that they may raise interest rates in 2023, sooner than what was earlier forecasted.

In this backdrop, though markets initially reacted to the Fed’s surprise, soon regained its stability to look forward to another milestone. With markets climbing each wall-of-worry to break new levels, esp. the broader ones in India, the question of “To stay invested or not” has come back to hit investors with its full force, esp. when the memory of March brutal fall of 2020 is still fresh. As investors grapple with this challenge, esp. in sensitive small-cap allocation, we try to examine this in this piece, in as much objective manner as possible, giving enough allowance for our category and anchor bias (being a small-cap focused fund). Here we go!

First, the questions that keep investors awake in late nights…

What if, in the next Fed meeting, they advance the timeline further for interest rate hikes? Not to forget that they advanced it by a year in the recently concluded Fed meeting. What was earlier scheduled for 2024 got advanced to 2023, citing inflationary concerns. Will this mean a quicker unwinding of bond-buying program, cryptically referred to as “tapering”?

What if, the expectation on quicker tapering leads to unsettling of markets, given that the market crash that the taper tantrum caused in 2013, still haunts much of the investment community?

What if, oil starts to boil triggering inflation and fiscal worries for India? And, so on…

Best way to examine above questions is to ask counter questions and check where it leads us to. Now let us flip the coin from wall-of-worries to hall-of-hopes (not empty ones)!

What if, Fed prepares the markets well this time for the eventual rate hike/tapering unlike 2013 when it was a big surprise? Going by markets’ anticipation of rate hikes by late 2022 or early 2023 (and tapering by late 2022), that job is being well done by current Fed chairman. By far, one thing is clear. This time, markets are preparing ground for the eventual normalization of monetary policies. Nasty surprises are unlikely. Not to forget that even in the 2013 mayhem, within six to eight months, markets were back on course to make new highs (in 2014) and US bond yields which spiked initially from 1.8% to near 3%, came back to sub-2% in early 2015 on Fed’s back-stop. Basically, one can count on Fed for its intervention, if there were to be any dis-orderly adjustments or manic melt-downs in the markets (notoriously termed as Fed’s Put). One might argue that though markets recovered post 2013 tantrum, in that nasty six months, emerging market currencies and bond markets were bruised to result in some long lasting pains for some countries. But such a painful plot is unlikely to play out this time, given the strong balance sheets and dollar reserves of central banks in emerging markets (remember India is sitting on all-time high forex reserves of $600bn+).   

On the question of oil, as seasoned investors would know, it is unlikely to structurally stay high given the EV push, threat of swing production from shale gas, OPEC’s normalization of production cuts and upcoming Iran deal. That said, in the short run, it might test the nerves of the investors with speculators driving the prices higher.

But the bigger “what if” question is on India’s long-term prospects. This is where the focus has to be for the investors instead of fretting themselves with all those macro distractions which we had diligently detailed above.

What if, the current low credit-cum-capex cycle coupled with low corp. profits-to-GDP, sets off a huge expansion in the domestic economy in the coming years? That is, break-out in capex cycle, amply aided by credit cycle turn (with NPA clean-up nearing end), can fuel the next cycle of economic expansion with capex and consumption feeding each other in a virtuous manner. Hardly can anyone rule out that prospect, esp. when India’s investment cycle has gone through a decade-long decay. Early signs of such a turn are already visible, if one goes by the capacity additions that are being planned in steel, cement, power, ports, renewables and other infrastructure related sectors. In this context, it is worthy to note that the steel industry is operating near 100% capacity as we write this. Cement is not far behind. For the first time in many years, one notices big-ticket project announcements from India Inc. in a fast-paced manner.

On the GDP front, India hasn’t done much for last 5+ years. One or the other disruptions (mostly self-made and manufactured) caused the GDP growth to slip in a secular manner in this period. Looking at in a positive way, five years of growth is what we need to catch up. That is a big tailwind for the economy (or call it cumulative pent-up demand of last 5+ years) and it will lead to all round resurgence once we are through with the pandemic waves. Growth will surprise across the spectrum, esp. if one factors the positive impacts from past reform actions like IBC/GST/RERA/DBT/MPC and from the ongoing initiatives like PLI, Privatization, Asset Monetization etc.

Here we come to the final question. When such brilliant prospects are on cards for Indian economy, would anyone tinker their allocations, esp. in the broader markets, fearing short-term jitters that may or may not happen when Fed starts tightening? It should be amusing to anyone, when seasoned investors start cutting their small and mid-cap allocations in the name of rationalization just when the broader economy is about to take off. That is a real pity, if these actions are being taken more out of fear of what happened to broader segment in 2018-20 bear cycle (out of recency bias). Counter-intuitively, coming out of the bear market should be the biggest tail-wind (cyclically speaking) for the future prospects for the broader space. Current strength and resilience in small-caps amid ferocious second wave, in a way, is hinting at a much stronger action in the future in this space, something similar to what markets saw in the 2014 to 2018 upcycle. Investors should be prudent enough not to miss out on these remarkable prospects for the broader markets, in the name of rationalization (of small-cap allocations etc.) or fearing short-term corrections which are part and parcel of any structural bull market.

Happy Value Investing!!!

This article of mine was published in the online edition of Economic Times (30/06/2021). Glad to share the link: