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The Markets: Are We Going To Hell In A Hand Basket?


Portfolios have bled. For those relatively new to investing – and everyone is, really, at some level – this will seem like a nightmare. Stocks fall. And don’t come back up!

Yes bank falls 30%. Then you find out one of India’s largest Infrastructure Financing stories, IL&FS, is bankrupt and horribly managed. And that causes it to default to mutual funds. Some of who have it in their short term funds. Which then sees those funds’ investors, who have been thinking short-term, to withdraw more money. That results in the funds selling other things, and yields in that market rise. Money becomes expensive, and funds don’t want to buy debt from NBFCs.

The liquidity situation leads into another problem – the currency. The rupee has been falling, past 70, past 71 and heads to 73. Foreign investors keep selling, domestic funds are buying. There’s some panic selling by operators in the market.

What to do? This hasn’t happened, in any meaningful way, for nearly two years. The last time, stocks fell during demonetization (Nov 2016) and then very quickly recovered. Before that, it was 2015 to 2016, when something or the other happened. Then in 2013 the dollar rose and there was a taper tantrum. Then 2011-12 when there was high inflation. Then the big kahuna in 2008. Then 2006.

Okay we get a lot of these things.

A helluva lot. Very often. And we still get surprised.

To give you an idea – this correction in the smallcaps has lasted 38 weeks or so and is about the same as the big 2011-12 correction (40% fall). Ignoring 2008, this is about how big a correction has been for small caps. (Click for larger image)

The Markets: Are We Going To Hell In A Hand Basket?

But isn’t today like 2008?

It doesn’t quite seem like that. There’s panic in the markets, but there’s a solid economy behind it even now. (The Indian economy was solid in 2008 as well, but the worldwide panic just steamrolled us. This time, that worldwide panic isn’t quite there)

Here’s what the RBI said today, in it’s statement:

6. On the domestic front, real gross domestic product (GDP) growth surged to a nine quarter high of 8.2 per cent in Q1:2018-19, extending the sequential acceleration to four successive quarters. Of the constituents, gross fixed capital formation (GFCF) expanded by double digits for the second consecutive quarter, driven by the government’s focus on the road sector and affordable housing. Growth in private final consumption expenditure (PFCE) accelerated to 8.6 per cent, reflecting rising rural and urban spending, supported by retail credit growth. However, government final consumption expenditure (GFCE) decelerated, largely due to a high base. The growth of exports of goods and services jumped to 12.7 per cent, powered by non-oil exports on the back of strong global demand. In spite of import growth continuing to surge, high exports growth helped reduce the drag from net exports on aggregate demand. ​​​​​​​

7. On the supply side, growth of gross value added (GVA) at basic prices accelerated in Q1, underpinned by double-digit expansion in manufacturing activity which was robust and generalised across firm sizes. Agricultural growth also picked up, supported by robust growth in production of rice, pulses and coarse cereals alongside a sustained expansion in livestock products, forestry and fisheries. In contrast, services sector growth moderated somewhat, largely on account of a high base. Construction activity, however, maintained strong pace for the second consecutive quarter.
8. The fourth advance estimates of agricultural production for 2017-18 released in August placed foodgrains production at a high of 284.8 million tonnes, 1.9 per cent higher than the third advance estimates (released in May 2018) and 3.5 per cent higher than the final estimates for the previous year. The progress of the south-west monsoon has been marked by uneven spatial and temporal distribution, with an overall deficit of 9 per cent in precipitation. However, the first advance estimates of production of major kharif crops for 2018-19 have placed foodgrains production at 141.6 million tonnes, 0.6 per cent higher than last year’s level. The live storage in major reservoirs (as on September 27) rose to 76 per cent of the full capacity, which was 17 per cent higher than last year and 5 per cent higher than the average of the last 10 years. This bodes well for the rabi sowing season.


So we have growing GDP. Growing manufacturing segment. Agri is ok. Construction is good.

There’s more – they say Industrial growth is good, even in Non durables (which is discretionary).

And then, inflation is low. At just about 4%. Even the RBI doesn’t expect it to be very high – though the dollar can be a pain in the neck for inflation later.

If everything’s hunky dory with the economy, then why did the market fall?

Does The Reason Matter?

Markets rise and fall all the time. And it’s easy for me for say, but I can tell you it’s as gutwrenching for me to watch a portfolio suffer, just as it is for you. But we all will learn from people who have suffered through a number of falling markets, or learn in the school of hard knocks. This is a mid-term exam in that school, at best.

If you were around in 2008, you saw the most horrible part of markets. And in that, you saw how people would tell you, all the time, that it was going to get a lot worse.

And then, there was this one guy. He told me about some “fundamental” people in his firm. They were buying. From September 2008 all the way to December 2008 – this, btw, was a near 50% fall – they bought stocks.

I asked him: How can they buy in this market? Why won’t they just wait for a lower price?

He told me what they told him. “The market will not be like this in 5 years. Even if a few of my stocks work out, they’ll do well enough to make up for the rest”. And they bought in size.

I couldn’t imagine it. The market revisited the lows in March 2009. Imagine, buying and watching your stocks go down another 50% and yet, continuing to buy. And then watching them rise a little and fall again. And still, holding on – a year later, in 2010, I realized something – literally everything was up more than 2x from the bottom.

That’s got nothing to do with being a fundamentalist. That has everything to do with behaviour. If markets are in the doldrums, and things look horrible everywhere, things can get a lot worse (a 50% further fall in your stocks). But if you don’t panic and sell it all, you’ll probably make out better.

Reasons for falls don’t matter. What matters is just one thing: How you react.

The If-Else Construct: What Would I Do?

Another friend told me this: Angels can fly because they take themselves lightly. (His name is, quite aptly, Joy)

Whatever big conviction you have, please remember that it’s all supposed to be held lightly. Conviction is for marriages, or your love of your kids, where you’ll fight, sometimes to your dying breath, to protect and nurture. Conviction is for stuff you’re so confident about that you simply can get it right, like when you’re learning to ski and you keep falling and you just stick with it and at some point your body just gets it.

But having insane levels of conviction in the market is usually counterproductive. You see it in the survivors, because all the graveyards are under the ground.

So my point is: Get yourself an opinion and be willing to change.

Yeah, the economy is good. What if it isn’t? Oh, then will it stay that way? Yeah? Forever? A couple years? Then it comes back?

So, if things are gonna get bad from here – and we don’t exactly know how long or when it will touch bottom but it’s going to get better, then perhaps this is the strategy: Buy every day from now till then. At some point, you’d have bought at the bottom. And when things get better, your average buy price will be much lower than today.

But why not wait, then? Because you don’t know if this is the bottom. If this is, then the strategy will still work. If it’s not, the strategy will still work.

What if things don’t get better? Then it doesn’t matter, does it. You won’t have a job, there will be riots on the street, and the last thing you’ll care about is your portfolio. You have to, at some point, be an optimist.

Oh wait, what if the economy gets better but my stocks don’t? Then shift. Because it’s fine to be wrong. This is the time that tells you what you bought wrong. And something else that’s probably better.

But now, the specifics.

The Dollar is at 74!

Yes, and surely, someone will benefit.

Tech players?  They’re hedged, you say. Their customers will demand lower prices, because they know the USDINR equation, you say. That’s true, but who do they sell to? Mostly the US. The US economy is doing well. There’s hardly much unemployment. Which means they’ll be happy to outsource a bit more, and while they might demand lower rates, they will have more business. It’s one thing to say I will have to cut my billing rate from $20 to $18 per hour because the customer demands it, but it’s entirely something else to say I can now sell 2x the number of hours. And to more customers. Because at Rs. 74, it’s attractive.

Would this apply to pharma too? Perhaps.

Or to, I don’t know, other exporters? Possibly.

You won’t know for sure. But someone’s going to benefit. There’s also the import substitutors. You import something because it’s cheaper to import it. Now the local guy can make it at a lower cost because the USD has gone up. So you’ll buy from the local guy, and that “substitutes” imports. But the local guy benefits. If he’s listed, you might be a party interested.

(If you’re wondering: Give me names dammit, tell me what to buy! This is not the post for you. This post will have nothing of that sort)

What if you’re wrong? If they don’t benefit? Well, if the whole set of exporters do not benefit from the rupee at 74, then yeah, this theory is wrong. So you might want to have different themes too.

What If the stocks have run away already? In this market, there will be some stocks that go up even at these times. You don’t have to buy them, unless you just want to buy them as part of a basket and hang on.

Wait, The RBI Didn’t Cut Rates! Dollar Will Fall More!

Let’s get some context here.

How do rates work? Read our post at: Why the fall to Rs. 70 is not a big deal.

Exchanges rates can be based on inflation differentials between two countries. But there’s also the carry trade. If the short-term interest rates – say 3 month rates – in the US are at 2% and in Indian rates are 6.5% then I should be able to borrow in the US and lend in India, risk free and weather out a 4.5% fall in the exchange rate.

But will you do this with a 10 year bond? You’d have to wait 10 years to recover this arbitrage and too many things can happen. No, most of such arbitrage happens only in the short-term.

And guess what India doesn’t allow foreigners to buy, too easily: Short term government bonds.

Oh, they did change that recently. In a notification, they have allowed foreign participants to buy short term bonds, but only if it’s less than 20% of their portfolio. But such restrictions are a pain – why would I take exposure to longer term bonds when my aim is to make a carry from short term interest rates?

And then, there are restrictions on how much you can hedge, what you can hedge on (exchange versus bank) and major reporting requirements. This is just too much of a pain.

If you don’t allow people to do the short term arbitrage between rates, then there is no reason for your exchange rate to narrow if you raise rates in India. Why would the exchange rate of the rupee go up because you raised interest rates at all, if the short term speculator cannot bring dollars in to hedge the interest rate and normalize currency?

So, the dollar falling and the lack of the Indian rate cut has nearly no correlation. In fact, it makes India attractive. Because India was grappling with high rates. Today we have 1 year bonds at 8%. And inflation at 4%. That means you can make a real return of 4% risk free. That’s insane. We had negative real rates in 2011. Inflation was 9% and bonds were at lower returns.

When you have negative real rates, you want to raise interest rates.

When you have positive real rates, why raise?

Especially when you know the dollar isn’t going to come down because of your raising rates?

Especially when you realize that inflation, even with the dollar rising, is benign, and expected to be? (You can be strict and say “Abeyaar if we see inflation we will raise rates ok!” in a stern voice. That is perfectly fine.)

So yeah, the dollar is rising. But please don’t conflate it with rates.

And What About Regulations on NBFCs?

NBFCs fell like a ton of bricks today. Because apparently RBI said they are accessing the Commercial Paper market and they shouldn’t.

But that’s not what the RBI said.

They said, that look we had an issue with IL&FS. Which is an NBFC.

Such NBFCs were using the Commercial paper market (short term loans) to borrow. And then they would roll over loans. And finance infrastructure projects. Which are long term. So how can you finance a long term project with short term rollovers? We will bring in regulations.

But before that: what is a rollover of a commercial paper?

Let’s say you’re IL&FS. You have a road. It gives you money 10 years later. You need money to build the road. You can borrow at 10% for 10 years. Or you can borrow at 7% for three months, and then borrow again for another 3 months, and use the money to repay the first loan, and again and again. This works as long as people are willing to lend to you.

One fine day in August 2018, they weren’t. So you went bust. Because your road thingies aren’t yet done and dusted, and you still have to wait for “cash flow”. Financing this with short term loans is insane. (Financing it with long term loans is also insane, if you’re IL&FS, because they mismanaged most of these projects and should not be allowed anywhere near a road, but that’s a differnet story).

But think about, say, Bajaj Finance. It lends for people like you to buy, say, a smartphone or a TV. Rs. 50,000 paid over 10 months. Something like that.

It needs to borrow that 50,000.

Should it take a 10 year loan?

Well, no. Maybe a 10 month loan then? That works. That’s commercial paper. You can’t do a 10 month bond. You have to do a CP.

So if Bajaj Finance has 10,000 such loans of Rs. 50,000 then it can take a 50 cr. CP. For 10 months if it likes. And that’s fine. Because it’s matched. In fact I’ll go one step ahead.

Let’s say you’re paying 5000 rupees per month for 10 months.

If 10,000 such loans exist, then Bajaj Finance gets back Rs. 5 cr. each month for 10 months.

Technically they could have 1 CP of 5 cr. for 1 month. Then 1 CP of 5 cr. for 2 months (meaning they return the money after 2 months). And so on.

(You can adjust this for defaults, and interest rates charged and fees earned etc. but you get the drift)

Take a housing finance company. If it has 100 cr. of loans that pay back 10%, then it gets back Rs. 10 cr. per year as interest, plus some principal.

So if it has 10 cr. borrowed in the Commercial Paper market, why is that a problem? They’ll get the cash flow in, and pay the CP back. So having 10% of a long term cash flowing asset base, issued in CP is fine. Just that you shouldn’t have 50% when your cash flow is only 10%. That’s a challenge, and you can change rules for that.

That’s what the RBI said.

But that’s probably not what the market heard.

So they’ll blame the fall in Bajaj finance on the potential change in RBI stance. The real, and perhaps too simple, reason is that Bajaj Finance was overvalued to some extent and it’s correcting to a more realistic number. How boring.

There’s opportunity here, you see. If markets fell because of some RBI statement that isn’t going to hurt these NBFCs, but they are hurt in terms of stock prices much beyond what they should be, then isn’t that something worth a shot? Think again – in two or three years, if things were back to better times, would you imagine that none of these stocks will bounce back?

But There’s Absolute Panic!

When there’s a flood, there’s panic. Too much happening. Dollar. IL&FS. Emerging market rout. Govt. tinkering with oil companies. Government thinking of elections. Government. (That should be enough)

The Chinese curse is: May you live in interesting times.

Because in interesting times, you have too much information. And in the current situation everything is deemed to be bad news.

Blood is (not literally) on the streets. And that’s when you have to force yourself to sit back and think about what happens now.

There are people that have borrowed money using stocks as collateral. When the stocks fall, they have to pay more margin, or the financer will sell stocks. Such financiers will not care about the price of the stock. They’ll just sell.

A player who’s taken leverage from his broker to buy a stock that’s hit lower circuit. The broker will demand payment. No money to pay. The broker can’t sell that stock because lower circuit. So broker sells whatever else is there. Good, bad, ugly, doesn’t matter.

Everything must go. It’s a fire sale.

And if someone’s selling not because he wants to but because he has to, it’s a distress sale.

Think of when a shop says “going out of business” sale? They want to sell everything. Even at rock bottom prices. Because everything must go, cos they have to hand over the property the next day. That’s where you get some opportunities.

I don’t know if today’s the day, or if there is more coming. I think there’s more coming, because you never ever underestimate the power of panic. if you’re investing for the next ten years, then your focus should be on the opportunity and the way to harness it.

The best Indian policies have come in the worst of times. We do our best with the backs to the wall. My view is to stick in there and keep at it for the next few months. Whatever’s down is already down and can go down more. I don’t know how long it lasts. All I know is that such times don’t last.

Picture credit: Mathew Schwartz


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