By Prashant Jain
Global and domestic equity markets have seen significant correction and most major indices are down about 30%. There is panic, negativity and pessimism all around. These sentiments remind me of the golden words of legendary investor Warren Buffett: “Be fearful when others are greedy, be greedy when others are fearful.”
It is not the first time the markets have seen such a correction, nor will this be the last one. The table here highlights major corrections in Indian capital markets over the last two decades triggered by global factors and the subsequent returns over the next five years. The healthy returns on investments made around these difficult times suggest something very counter-intuitive — the best investments are made in toughest of times.
Why is it so? This is because around times like these fear and short-term thinking dominates, markets move from optimism to deep pessimism relatively quickly, leveraged positions get unwound and markets overreact, creating a base for good returns of the future. It is interesting to note that while markets have corrected by about 30%, the impact of coronavirus on economy/corporate profits will be far less, especially over a year. Hence, it is reasonable to conclude that the value of businesses has not changed meaningfully. It is only the prices that have corrected sharply. If the prices have fallen but the business values have not, then can bargains be far behind?
The fall in equities, and even bonds, is mainly due to massive FII selling. This is probably happening because India is clubbed with emerging markets (EMs), whose economies are significantly dependent on exports and/or are net exporters of oil. The sharp fall in oil prices will impact several net oil-exporting EMs like Saudi Arabia and Russia significantly. Export-driven economies like China, Korea and Taiwan will also be impacted due to a sharp slowdown in consumer discretionary spending globally due to coronavirus. The impact on these countries is, thus, for real. Because of challenges in other EM countries, deterioration in world growth outlook and sharp correction in equities, it is natural to expect FII outflows, especially from EM-focused funds. As India has received allocation from EM funds, it has also seen significant outflows. This has clearly impacted Indian equity and bond markets. The unique thing about India is that it actually stands to gain in this environment. This is because exports are a relatively small portion of our economy , and the sharp fall in oil prices is a big positive for India.
The disruption in global supply chain due to the challenges in China has highlighted the risks of over-dependence on a single country. Thus, many global MNCs are likely to consider diversifying their manufacturing operations away from China with a sense of urgency. India is likely to emerge as a key beneficiary given its lower costs, large pool of skilled manpower, large domestic market, improving business environment, concessional tax rate of 15% for new manufacturing units, etc. The simple message here is that while the current environment hurts most EMs, India actually stands to gain over the medium term. Hence the deep correction in Indian equities is an opportunity that investors should not miss. In fact, similar corrections in the past, that is, 2001 and 2008, which were a result of challenges outside India, provided good opportunities to those who were able to look beyond the noise.
It will be, however, naive to conclude that there will be no impact of Covid-19 on the Indian economy. The impact on consumption — discretionary and even non-discretionary, though to a lesser extent — will be felt for some time. Given that India is a services-led economy, and given the impact on airlines, retail, travel, tourism, etc, there should be impact on wages, especially of the lower income groups. This could result in a slightly more prolonged effect on consumption. But as the weight of these sectors in the Nifty50 is limited, the impact on broader markets should be limited.
Large banks should be not affected much — credit growth was in any case low and peak NPAs and provisioning costs are behind us. Besides, the environment is supportive of large banks that have the dominant weight under financials in Nifty50. Further, capex, utilities, oil refining & marketing, and pharma should feel low impact over a full year. IT could feel some impact of travel restrictions, economic slowdown, etc. Though it benefits from a lower rupee and higher offshoring. Thus, most sectors are likely to be minimally impacted at least over time, but their stock prices have also fallen in tandem with other stocks.
What should investors do? The current volatility is a reminder of the real nature of equities — unpredictable, risky, hard to forecast and prone to throwing surprises, especially in the short run. This is also a reminder of a few time-tested rules that investors must follow: 1) Invest only risk capital in equities, that is, the portion of wealth that can be spared for 3-5 years or longer and on which volatility can be tolerated, both emotionally and financially. 2) Never borrow and invest, avoid futures & options (except for hedging). 3) Maintain diversified portfolios of direct stocks or invest in mutual funds.
Those who have observed these rules should be able to see through these difficult times. Ideally, where risk appetite permits, investors should go a step further and use this deep correction to their advantage by increasing exposure to equities/equity funds. At times like this, it is only the perceived risk that is higher, not the real risk. It would also be advisable to invest in 2-3 phases over the next few weeks or months.
One significant tranche should be deployed now because markets are down about 30% and there is a high likelihood that as we gain control of this, things will come back to normal. The other portion should be kept on hold for now — just in case the situation becomes worse — and should be invested either way over few weeks or months.
An interesting learning from the markets over last 3-4 cycles across three decades is that leadership in the markets has changed only in downturns. Old economy to IT in 1992, IT to old economy in 2000, infra & others to FMCG, pharma in 2008 — all these transitions took place in market downturns. Will this correction also result in a leadership change in equities?
Only time will tell, but I feel that it is more likely than not, as years of under-performance of share prices, despite reasonable business performance in sectors like utilities, pharma, oil & gas, capex, and large corporate banks has created good value. Direct investors should, therefore, be careful when buying stocks that are down sharply after years of strong returns because if there is indeed a trend change, then what worked in the past may not, and what did not work till now may finally do.
In conclusion, the hint for the smart investor is hidden in corona itself — Kyo Rona? Invest Karo Na. As Sir John Templeton rightly said: “It is impossible to produce superior performance unless you do something different from the majority.”
(The writer is CIO, HDFC Asset Management Company . The views expressed here are as of March 23. The views are based on internal data, publicly available information and other sources believed to be reliable but involve uncertainties that could cause actual events to differ materially from those expressed or implied in such statements. Stocks/Sectors referred above are illustrative and not recommended by HDFC Mutual Fund / AMC. The Fund may or may not have any present or future positions in these sectors. The above should not be construed as an investment advice or a research report or a recommendation by HDFC Mutual Fund/HDFC AMC to buy or sell the stock or any other security covered under the respective sector/s. In view of the individual circumstances and risk profile, each investor is advised to consult his / her professional adviser before taking decisions regarding investments in any securities. HDFC Mutual Fund/AMC is not guaranteeing any returns on investments made in the Scheme(s). Past performance may or may not be sustained in future. Neither HDFC AMC and HDFC Mutual Fund nor any person connected with them, accepts any liability arising from the use of this information. Mutual fund investments are subject to market risks, read all scheme related documents carefully)