How do you make returns in a slow grinding market?

It may seem odd to ask this question when the news-flow on India macro is getting better by the day. If one leaves out the mixed signals that are coming on the strength of rural recovery, the rest of the economy seems to be on a meaningful mend. High-frequency indicators like manufacturing and services PMI, traffic and port data, auto numbers, business confidence survey numbers etc., are pointing at a healthy growth for the coming months. Sometimes one may wonder whether the headlines that are getting flashed in financial dailies in India these days befit the times that we are in globally. No one needs to be told that we are in a liquidity-driven downcycle globally. Yet, headlines in India seem to be at odds with what is happening elsewhere. Here goes some of top ones that hit the channels last week:

  • India’s forex reserves rise to reach a 9-month high of $586Bn.
  • 10-year bond yield slips to 7 months low of 7.10%.
  • Rupee outperforms most Asian peers in April as inflows rise.
  • Rupee to inch towards 80 to a dollar on narrowing CAD (Current Account Deficit).
  • Economists rush to dial down CAD forecasts by multiple notches to 1.6% for FY24 from earlier 2.4%.

This is so different from the fragile days of 2013 down-cycle when everything from currency to stocks to bonds crumbled. Such is the contrast in scenario for India now with its macro standing out as a bright spot in a murky global macro.

Such a relatively stable macro should have been a sweet spot for Sensex and Nifty, right?

Not really, if one goes by the returns these benchmarks delivered in the last eighteen months. Nifty has been moving all over in the last one and half years, only to stay stuck in the same place. It has been struggling to go beyond the 18,500 level it scaled in Oct’21.

The logical question then, why are Indian markets not gaining momentum in spite of stronger macro here? 

Financial markets are a different beast. They gain momentum when FII flows gain momentum. Given the expectation that the elevated rates in US are likely to stay for a longer time on continuing inflationary challenges, it is unlikely that flows to EMs will gain momentum any time soon. We don’t know when the tide for flows will turn. Only in hindsight we will know. But unlikely any time soon. Here, it may be pertinent to note that even if the Fed goes for a pause in the next policy meeting because of worry on financial stress in the system (regional bank failures etc.,), rates may stay elevated for a long time to come given the challenges for Fed to achieve its inflation target of 2%. 

In such a scenario, given that the markets are unlikely to change their course, one should expect the following trends:

  • The market will continue to gravitate towards value (this shift started happening from Oct’21).
  • Growth and expensive stocks that got punished post the Oct’21, will continue to drift direction-less (or will become less expensive).
  • The market will reward stock-specific actions as it has been doing since Oct’21. Of course, there will be a pause in those whenever there are dislocations from either internal or external events like Adani saga or SVB crisis. But, overall, directionally, since the market will reward value, it will continue to witness stock-specific actions for a foreseeable period.

Investment managers who follow bottom-up stock-specific strategies will still be able to find opportunities in this direction-less market for alpha creation at a portfolio level. Our own experience in the last one year offers evidence of this. Basically, markets at Nifty/Sensex levels have not done much in the last one year. But by following this bottom-up stock-specific model through a phased deployment (capitalizing on the reoccurring volatility), our value strategy has delivered mid-teen absolute returns for portfolios that got initiated last year. Given the negative returns in the benchmark small-cap index over the last year, the alpha creation in the portfolio viz-a-viz the index has been significant.

Basically, through this approach, one can ride the expected volatility with much less pain and at the same time, be ready with a high-quality portfolio for much larger gains once the dust settles on the Fed interest rates and inflation, that is, when the momentum returns to the market (when flows start gushing). Best of both worlds as one might say.

Happy Value Investing!!

This article of mine was published in the online edition of Economic Times (07/05/2023). Glad to share the link:


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