Investing in the Current Market

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Dear Friends,

                   The RBI witnessed the end of an Era on the 4th Sep 2016 with Dr. Rajan exciting as the Governor. Technical Prowess and ability to communicate, both are required for the central bank governor role. Dr. Rajan’s major plus point was his effective communication which none of the earlier governors could match. At times, being candid leads you to problems and the governor was no exception. He is Raghuram Rajan and he does what he does! The pensioners across India were worried as the Postal and Bank deposits were getting reduced and the governor used multiple messages including his ‘Dosa’ story to drive the point of real returns vs nominal returns and the effects of Inflation. No wonder he was referred as a Rock Star Governor and many erudite people across the globe, currently (till Sep first week to be precise), refer him as the best Central Banker in the world.

Dr. Urjit Patel, the current RBI Governor who was working closely with Dr. Rajan also has impeccable credentials and even a better hold of Economics than Rajan, going by his academics. But the challenge he would face is to reach out to the people and communicate, which Dr. Rajan was extremely good at and Urjit might fall short, give his personality

The market indices (Sensex, Nifty, Mid Cap, Small Cap, Sectoral – All Caps), seem to be going up day by day and investors who invested significant money during the  23k to 25k phase  of Sensex, a few months back, would have made fantastic returns in a short span of time. All our clients are extremely happy now looking at the returns, their portfolio has generated. But, please remember that the gains are only on paper similar to the earlier period when losses were only in paper. You pull out money from Equity funds whenever your goal is approaching or in case of emergencies when you are unable to liquidate other assets. This is akin to people buying a home and feeling happy when they hear that the prices in that area goes up or feel a little low if the prices go down. Actually, this makes no difference as you cannot move out of your home to book profits or losses (i.e the reason why some advisors do not include the home we live as part of Networth computation). It’s purely a feel good (bad) factor.

I hope you have heard of the Jargon price to earnings ratio or PE ratio. This is one of the most important measures used for individual stock valuation or index (Sensex, Nifty valuation). PE ratio refers to the current price of the stock (as traded in Sensex/Nifty etc.) or index value divided by the earnings of the company or cumulative earnings of index companies per share. Going a step further, EPS is basically the profit that a company makes divided by the number of outstanding shares. Analysts have benchmarks for PE ratio depending on the sector, company performance and if the current PE ratio is lower than the benchmark then a stock is attractive. Similarly based on the PE of the index   (Sensex/Nifty), the valuation is said to be high/low. Let me not go into too much technical details of trailing PE, Forward PE etc.

When the Sensex has crossed 29,000 (swings around 29k) analysts have started claiming that the valuation is high and a another set says India is the only growing economy in the world currently, inflation is in control now, the reforms undertaken by the Modi government has started yielding results, till date there is no sign of big corruption, GST is going to be become a reality and so on, justifying the premium valuation. So, how should the investor behaviour be in a situation and what should be the return expectations?

  1. One could argue that booking some profit (though not selling everything and getting out) when the market is high should be the approach. But this holds good only for direct stock investment. When you have invested in Mutual Funds which are supposedly managed by professionals, we have nothing to worry and can invest either through SIP or Lumpsum and the Fund Managers will take care of the portfolio. Typically, flows into MFs are high when the markets go up because of the investment behaviour, including the new SIPs.

 

       Sir Isaac Newton, supposedly one of the Genius of all times with numerous inventions to his credit, lost heavily investing in a company called South China Sea. He quoted “I can calculate the motion of heavenly bodies, but not the madness of people” 

       So, if you thought that Mutual Fund managers will be able to hold on to cash when huge investments come in and time the reinvestment perfectly in the lowest point, you are wrong. A few star fund managers and even the fund houses (typically the overall direction for investing is given by the CIO (Chief Investment Officer) made this mistake during the 2008 crash and retrace the earlier peak in a few months, the funds holding cash lost the opportunity to invest and some marque funds (till then) were unable to recover for years together. These funds protected the downside better but lost in the upside. But unlike direct equity investing, going through the mutual fund route definitely provides better downside protection, in most cases, as a result of their superior management skills

  1. Take a safe approach and continue with SIPs alone or even stop it and sit on the side-lines. But sitting in the side-lines and waiting for market to come down to 23-24k level might become a foolish idea. Gold crossed 2000/- per gram, few years back which, at time, was the highest price ever. Subsequently once it climbed to the point from which it has never dropped below 2000, if people had waited for Gold to come down below 2000, they would have been just be sitting and gazing at the sun and moon. In Indian Equity market there was point when Sensex breached 16,000 and many thought that they need to capitalize the moment and started selling and exiting the market (I was also one of them). There were analysts and large investors like Rakesh Jhunjunwala (referred as the Warren Buffet of India) who said that Sensex will touch 25000, 50000 and even 1 lakh. I am not sure how many bought his idea and most mocked at him. But his first target of 25,000, has already been breached.

 

  1. If we make Lump Sum investments when the market is high, what is the consequence? Going back to the Sensex targets, as long as companies continue to do well and earnings keeps growing, the valuations have to go up. The chances of making negative returns is there only in the short term but from a long term perspective you will make handsome gains. The difference would be in Return on Investment which would be higher if you had invested when the market was at 23-24 vs 29k. If you get only 8% ROI when you invested at 29k and not the typical number of 15 or 16%, then people think that they had done a mistake. However, I would argue that this is not true as you need to consider the opportunity cost. Instead of getting 8% tax free (after a year), If you wait for a year holding the money in a bank FD resulting in a negative return of 1% (net of Inflation (6%) and Taxes (10L+)), you are better off with 8% or +2% (net of Inflation). I had mentioned in one of my earlier blogs that I had invested Lumpsum money when the Sensex corrected and came down to 26/27 k after touching 30k, and was left with no money to capitalize on the situation when the market came down to 23k at one point of time, I did feel a little low. But now my ROI is positive and was there any other opportunity that could have given me more returns, I would say “No” atleast in my case. The earnings growth of the companies will continue and the percentage of growth might slow down. Revenue increasing from 10 Cr to 20 Crs (100% growth) is relatively easier than growing from 100 to 200 crores in a year.

 

  1. Investors are made to think that Systematic Investing is the panacea for investing in equity. Once you understand the nuances of investing you will find that this is not always true. SIP will not help in a continuously raising market – your averaging will go up. SIP/STP is a solution best suited for people who have only smaller amounts to invest on a monthly basis. For someone who wants to deploy a corpus of say 10L, if he does a 25k/month of systematic investment, then the deployment alone will take 40 months. So, even if you had deployed 10L and sitting with a ROI of 8%, it is still better than getting a SIP return of double digits where the amount is idling in a low return yielding SB or FD or a liquid fund

     

Typically if an investor wants to deploy a huge sum it’s better to take a mixed approach i.e. do a systematic investments over a 1 year time frame and if the instalments are smaller, deploy additional amounts whenever there are opportunities of huge dips in the market

 <Blog # PenguWIN 1041 – Investing in the Current Market>

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