Early signs?


Earnings reactions in the broader space have started to exhibit an encouraging trend. They are still irrational, but not as irrational as they used to be in the earlier quarters. Earlier, even great results met up with muted reaction from the market, leave alone iffy ones. No longer so. If the results are robust, they get rewarded to a reasonable extent. Of course, market’s negative reaction to even decent results, which is the hallmark of a downturn, is yet to change. This change in its reaction to stronger results, has led to rise in number of stocks, in the broader space, that are hitting 52 week highs for the first time in many months. Though, for now, these numbers are far and few. This trend, if it continues (that is a big if), can bring back some life into the small and mid-cap space in a gradual fashion.

It doesn’t stop here. There is another trend that could be a pointer to life coming back in the broader space, though it is too early to say. Market has made many attempts to gain momentum in the past few months. Every time it makes an attempt, some bad news comes in a miraculous fashion to mar the early signs of momentum. This month, it was SC’s blow to the telecom sector and the sensational turn of events at Infosys. Last month, it was PMC bank that did the damage. If at all there is anything to be inferred from these multiple attempts by the market to gain momentum, it is this – there is bottom in place now and it is question of time before luck runs out for the bad news and for the bears.

Add to this, the positive news-flow momentum that might come from the upcoming budget that is not far away.  The expectation from the budget will be high, given the rising reform-intent from this Govt. Some tweaking either in the long-term capital gains tax or in DDT may be on cards, besides the increasing chorus for cut in personal income tax. This coupled with Govt.’s growing inclination to side-step the fiscal puritan path to accommodate more growth oriented policies, market will start expecting more fiscal measures (stimulus) in the budget. This can help the market to successfully build and sustain momentum, which it has been trying for many months, but in vain. Interesting times to watch out for!!

Haven, not so safe?

Funds rushing to safety, thereby raising a potential risk of crowded trade in safe haven stocks.

The end-game for crowded trade is never cozy. It eventually crumbles and that too in a crucifying manner. We all know that. We don’t need to go too far into the history to get a sense of what happened to such trades. 2017 was one such year where momentum in small-caps slowly morphed into consensual crowded trade where fear-of-missing-out went berserk to create a bubble in that space. In crowded trade, momentum builds in a self-feeding fashion to set-off a bubble. This is probably is what we are witnessing in the select set of stocks in the name of flight to quality amid a brutal bear market in the broader space.

The role of business media in pumping up the buzz can never be under estimated. In 2017, one celebrated small cap fund manager (no prizes for guessing) got the disproportional airtime when small-caps were sizzling to scary levels. Of course, he fell into the seductive trap of new found media attention. Now, it is the turn of coffee-can clubs, who come in prime times and glorify investing into gifted names that are quoting at obscene valuations. Their glib talk, of course masks the fact that this is nothing but hiding in safe havens in the name of quality. They are now larger than life heroes for the business media in general and for the investment community in particular. Sun is shining on them now. What will bring down the binge in the so called crowded trade of quality (few handful of names that even the barber in the neighborhood would tell you how they will not lose money for you) is anyone’s guess.

Investors who chase the crowded trade have reasons to smile as they are proved right in the short-term. More so, when the contrarians get crushed month after month. But they fail to understand that the surest way to under-perform in the long-run is to fall into the trap of being seen smart in the short-term. Cycles after cycles show that contrarians have the last laugh, though they will have to survive the onslaught (having the stomach to digest notional losses and having the ability to pick the “quality” stocks from the beaten down space) by not only staying the course, but also by having willingness to look stupid in the short-term. That is not easy for institutional money managers, esp. when they are measured on daily NAVs. They have few options than joining crowded chorus.

Here is the table which explains the degree of insanity in the valuations of those gifted and glorified ones (TTM PE has expanded sharply for these).


Even momentum investors should be worried to touch these stocks at these scary valuations, however tempting it could be to hide. Having said that, it is not that they will stop rising or will correct in a hurry. Sometimes, the party can go on for long, esp. when there is premium for quality in a polarized market. The more they go up from here, riskier they will become and harder the correction that will ensue in this segment. While price correction may not be substantial, extended time correction can’t be ruled out in this space when optimism returns to the broader space.

It may not be out of place to end this note with this quote from Howard Marks.

“When everyone believes something is risky, their
unwillingness to buy usually reduces the price to the point
where it’s not risky. When everyone believes something
embodies no risk, they usually bid it up to the point where it’s
enormously risky.”

Happy Value Investing!!

Never waste a down-turn!

Invest when pessimism is all pervasive.

These are golden words, but only with respect to past corrections. But not so golden for the current one. When you read it in the investment biopics or in blog posts about past corrections, these words hit you with such an inspiration that you get locked and loaded for the next correction. But, ironically, when the next correction comes and presents opportunities, one sees more desperation than inspiration. The golden words are no longer cool when it comes to the present corrections. Why?

May be because, one sees happy ending in the past corrections or in investment biopics. But, present corrections are not about past, they are about future. When future is unclear, it is not as inspiring, though we all know the ending will be no different from past corrections. No down-cycles in the past had ended in any other way, however long they were. Yet, narrative is so negative that it numbs one into inaction and more often into despair. It is always both fascinating and amusing at once, to see this diverging psychological trend between past and present corrections.

Now, let us take a look at the below chart.


This is not a complex chart. It is a simple one with a clear underlying pattern that runs for fifteen long years. As per this, every time, when small-cap index has fallen by a significant percentage, the subsequent three-year return for the index has been equally substantial. There is no reason to believe that coming years will be any different. One should expect a sharp bounce in small-caps in the coming years.

If there is going to be such a big pay-off, why there is no mad rush? May be everyone is,

  • Waiting for the cloud to clear
  • Waiting for the bottom
  • Waiting because of inability (emotional) to digest notional losses
  • Waiting for others to make the first move
  • Waiting for stability

No one wants to do the waiting that is most crucial. That is, waiting in the market. That is key to value creation. As they say, money is made in waiting, not outside, but inside the market. As the past cycles indicate, by waiting outside, very big part of the rally will be missed when the music starts. It eventually ends up either as a perpetual wait or as a punishing late entry. Either way one misses out the large part of the upside.

Want to end this note with my favorite quote from Morgan Housel. It said, “All past corrections look like an opportunity, while all present and future corrections look like a risk”. At some point in future, the current correction in small-caps would be seen as a one-time life-time opportunity for sure. Do you want to see it as a missed one or amassed one? Of course, if anyone lets it slip, there will be no one else to blame but himself.

Happy Value Investing!!

Nirmala Put?


There is a new buzz word in the market. When you utter that, bulls get emboldened and bears get panicky. It is not Greenspan-Put or Fed-Put. It is a Put with a traditional and local flavor. Guessed it right. It is Nirmala Put!

With the successful surgical strike on bears with her secretly guarded tax reforms, one is not sure, bears will ever attempt any adventure in future, esp. after losing much of what they made over last few quarters (short-sellers got slaughtered in the so called surgical strike). With Nirmala Put acting as back-stop for domestic issues, bears can at best hope for some global melt-down to get back to their business. If global cues do not favor them, one may be slowly looking at good times, esp. when positive incremental news-flow is on cards from domestic economy i.e. be it auto numbers or discretionary consumption or FMCG volumes etc., sequential numbers are likely to turn positive in the festive season. Good news on the monsoon (so on rural growth) couldn’t have come at a better time. This doesn’t, in any way, mean that the liquidity or NBFC crisis is behind us. The overhang of Yes Bank, DHFL & India Bull Housing etc. will continue to weigh on the markets for a while. But, with strong signaling effect (bazooka) coming from the Govt. that they are ready to go to any extent to revive the economy, such overhangs are unlikely to have a lasting impact

The hope is that the reform measures may not stop with the tax cuts. With Govt. under pressure to raise non-tax revenues so as to end the year with a respectable fiscal deficit, one may see a huge pick-up in pace of strategic divestment (privatization) and asset monetization. One should expect more business friendly measures in the coming weeks and months.

So far, the rally has been limited to the big boys. It is yet to percolate down to the much neglected mortals like small-caps. It is a question of time before the tide turns for the tiny ones. But when that happens, rally will surprise on the upside as it did on the downside. Interesting times to watch out for!

Biggest take-away from FM’s Boost!!


Financial markets are all about signaling, not so much about materiality. The biggest mis-step in the FM’s maiden budget was not so much about any particular measure, but about signaling. By taxing FPI through additional surcharge, they couldn’t have done anything worse on signaling, though materially the amount involved was less than 400 cr. No surprise that it took away 20000cr+ from the equity markets in terms of FII outflows since the time budget was presented (till 23rd Aug).

In a big relief, Govt. last week reversed some of those key mis-steps they had taken in the budget. There were many measures in the so called mini-budget that was announced last Friday. Though there were many steps of merit, the key take-away from the mini-budget is not anything about any steps, but again the signaling effect. It came in the form of Govt’s willingness to listen, humility to accept the mis-steps and ability to do the course correction. In our view this is the biggest take away from the booster shot from FM. This signaling effect can change the medium to long-term landscape of the market quite materially, though global cues will continue to dictate the trend in the immediate term.

Of course, for bears, there is no shortage of ammunition. Besides US-China trade war hiccups, there is a new found love with the inverted yield in US and its association with recession. It is another matter that not many inversions were followed by recessions (at least we had two such inversions in the last 4 years), though all recessions were preceded by inverted yield. Having said that global bears have their hands full to keep the markets edgy in the short-term. For India, having under-performed the global markets quite significantly this year so far on account domestic mis-steps, some catch-up (to cover this year’s under-performance) may be on cards, esp. if the festive season brings the much needed turn in the news-flow for the economy!!


Simple questions, no easy answers?


Downturns are no less exciting when it comes to anxious questions from investors. As a money manager, one gets pushed around by questions which may not have a clear short-term answer and yet have a broadly right long-term answer. Thought we should address couple of such questions through our monthly newsletter.

The most common ones that we face in a challenging environment like the one we are currently in,

  • Even if the Govt. takes measures to reverse some of the mis-steps, with no one willing to lend or take risk (liquidity/risk cycle broken), what will trigger the liquidity up-cycle for the real economy?
  • If nothing much is going to happen in the short-term, why not wait till things stabilize?

As any fund manager would concur, the first one is a more interesting one because it involves understanding of how the critical parts of engine works in the economy. With Govt. rolling back some of the mis-steps, it has also become a more relevant one.

Before proceeding to answer how liquidity cycle will turn, let us first understand what caused the severe choke in the liquidity cycle. What started as a usual risk-aversion on NPA crisis got aggravated by Govt’s overdrive on corp. cleanup, which further got accentuated by the cyclical slowdown in manufacturing esp. in autos. It is the confluence of these factors coming together than any one factor that pushed the economy into deeper slowdown. When all of them are playing out together, it appears as if it is apocalypse for India which is not surprising. But the impact on economy is huge because there is risk-aversion in each and every stage of the liquidity chain. Take autos for example. How fear of deeper slowdown results in serious risk-aversion in each link of the liquidity chain like bankers cutting down exposure to dealers/auto consumers, auto dealers cutting down on stocks that they carry (destocking), consumers in-turn postponing buying on unknown fear and so on. If one looks at the auto retail numbers and whole-sale numbers, one can see how dealer destocking has amplified this slowdown seriously. For e.g. in Aug, while the retail sales at the consumer level came down by 11%, the whole sale numbers at the OE level came down by over 25%+. The difference is on account of dealer destocking. Not to forget, when some bit of confidence comes back, the dealer re-stocking itself will optically boost the numbers at the OE level leading to dramatic change in the narrative in the media (flashing headlines like auto industry bounces back with a vengeance etc. will resurface mysteriously). Time for such change in news-flow is not far away.

Since people attribute, mistakenly though, to a single factor like Govt’s clean-up drive for the choke in the economy, naturally, they also think that this will never reverse as Govt. is unlikely to lose its grip on the clean-up. But in reality, over time, in the next few months, two of the three factors that caused the slowdown will reverse to give the required bump-up for the liquidity. This coupled with falling lending rates and rising liquidity in the system, will eventually de-clog the flow in the liquidity chain. Basically, the point is that the liquidity cycle will come back in full force once a bit of positive news-flow starts coming in. It looks like the “turn” in the auto demand in the festive season (even if the growth is just optical on low base effect, though better than expected monsoon is likely to revive rural consumption in the second half) could bring the initial trigger for the “turn” in the liquidity cycle.

Agreed, why not wait till we see some visibility of that turn? That brings us to our second question. Yes, one can wait for sure. But the challenge is, market doesn’t wait. It discounts far ahead. How do investors deal with this? Only way to deal with this, is to buy on pessimism without worrying about quotational losses in the short-term. How does one logically convince oneself to do that? Here is where our usual question we put to our investors who are in such a dilemma. If you have an opportunity now in which there is risk of 20% quotational loss in the short-term, but 2X gains in the medium to long-term (1 to 2 year), when would you buy? Of course, the answer is easy if one can time the bottom. Since it is not possible to time the bottom, one has to choose to buy now in spite of the risk of 20% notional loss. In theory, even this option sounds easy. But, when there is pessimism and uncertainty all around, it is difficult to execute this on the ground. The reason is, in such times, it is easy to get carried away by the fear that the risk of loss may be much higher, though it is still notional.

In conclusion, it all comes back to the same old understanding that, to execute value investing on the ground, one may not have any option but to buy when there is maximum pessimism without worrying about any trigger. Of course, it holds good in the top of the market as well (selling when there is all around exuberance). Both are difficult to execute (emotionally), but that is the only way to create long-term wealth. In that sense, in hindsight, this downturn will, most likely, go down in history as a one that threw a great life-time opportunity for long-term patient investors. Don’t miss it!!

Happy Value Investing!!