The year 2022 turned out to be as per expectations with the benchmark indices rising by low single digits in India. This was a huge outperformance over the world indices where many markets declined 10-20%. However, the performance was not secular with wide divergences in sectoral performances with many favorite sectors and stocks falling by the wayside and other sectors and stocks emerging. That’s the nature of unpredictability of the stock markets. As I sit to write today there is a huge consensus in India as well as worldwide that the first half of 2023 will be tough for the markets and then eventually as inflation and interest rates peak, we will have a good second half. This by itself makes the case for a strong performance in the first half of the year.
The broader logic for most to be negative for the first half of 2023 are related to the view that the slowdown and fall in corporate earnings due to higher interest rates and slower growth is not completely build into the stock markets and as earnings flow through we will see more selloffs. There is merit in these arguments however as I write we have already seen a decimation of growth stocks in many parts of the world with the technology heavy Nasdaq Composite near its 52-week low and stocks like Amazon, Meta, Microsoft, Alphabet etc. down 40% for this year and Tesla down 70% plus. Also as expected we have seen a huge sell off in Cryptocurrencies as interest rates have gone up. In India also we have seen most of the loss-making new generation companies sell off big time as the focus shifted to profits.
As a contrarian investor I would be more positively inclined towards the first half of 2023 as such a huge consensus rarely plays out. As such we have to look at opportunities to invest in. The Indian Economy will continue to grow at 6-7% for the next 10 years (can be more if many structural issues are resolved). In this situation significant opportunities will be created as the economy evolves. There will be more rapid development of infrastructure, people will look towards a better quality of live as the per capita income goes up and cyclically various stocks and sectors will do well. The best structural play for India today is the health of the lenders i.e., banks, NBFC’s etc. where the balance sheets are the strongest in several decades. This makes them capable of supporting strong growth. India’s overall profile in the global landscape has also been improving leading to India being seriously looked for outsourcing and manufacturing beyond IT Services. The indigenization thrust also creates huge opportunities in the manufacturing space across the board.
In the near term the increase in interest rates and rising cost of capital creates challenges for growth if inflation does not come down soon. As of now the higher rates are not impacting growth very adversely simply because of the fact that in India we have been used to high inflation in the past and lending rates are still in single digits which is quite well accepted. The overvaluation of the market comes down slowly as markets don’t move as the GDP keeps on expanding continuously. For example, this year a 6% real growth combined with a 7% inflation expands the GDP by 13% while the overall market has not done much. The probability that the next year will be similar is high as things stand now i.e., overall returns in single digits given the fact that our market valuations are still 15% above historical valuations at a time when interest rates are still moving up.
The good part what we see as value investors is that central banks are withdrawing and are likely to accelerate the withdrawal of a huge amount of liquidity that was generated during the Covid crisis and prior to that. This takes care of speculative bubbles. Phases of high speculation take away the distinction between luck and the skill of investing as riskier assets move up more and faster than genuine growth companies. This creates a false impression in the minds of people about their abilities as investors. For example, there was a phase for nearly 4-5 years where almost zero interest rates globally combined with huge liquidity led to valueless assets like Cryptocurrencies, NFT’s, SPAC’s etc. do much better than companies that actually do something. Similarly, such phases create speculative bubbles in commodities, real estate etc. which actually hurts the real economy. It is actually quite surprising that the bursting of many of these bubbles has not impacted the real economy much this time as compared to previous bubble burst periods. The US Fed has already reduced the balance sheet by nearly $ 500 billion. Valueless assets should see further value compression as liquidity becomes tighter over the next two years.
Normally rising rate period are better for defensive stocks where debt is not an issue on the balance sheets. However, this time the difference is that many stocks of these sectors actually outperformed during low interest rate periods which took the valuations to all time highs. Even now valuations of many of these stocks and sectors is much above historical valuations as well as market valuations.
Now given the fact that the view is for single digit returns in 2023 what should be the investment strategy. The first clear strategy has to be not to take too much risk as to outperform in a market which might not move up too much requires identifying low double digit return companies instead of trying to identify high risk “Multibaggers” which in most cases do not perform. It will also be good to keep some cash on the sidelines to invest when markets give opportunities like it did this year when the markets fell 15% in a short period of a few weeks. Such periods will keep on coming and are the ideal ones for investors. Many are afraid of a secular decline in equities after the overall big move from the lows of 2020. I am not inclined towards that view given the currently available information.
While it is good to have 5-to-10-year views on companies we need to take advantage of deep overvaluation and undervaluation. All of us need to understand that with the growth in derivatives, expanding retail participation and a bigger trend towards herd investing the kind of moves in stocks that we see these days are much more rapid that earlier years. Information availability and dissemination is very fast, fads catch on fast, and stocks move faster than in the past on both sides. Essentially moves on the upside and downside happen much faster now which means that investors need to be more ready to act than in the past. In this situation the long-term investing thesis in single stocks is challenged. As investors we do not have unlimited capital and as such, we have to use timing in the market along with time in the market as a thesis.
I am also against the trend these days of Fund Managers making long presentations on their portfolio companies and giving 5-to-10-year stories on them. Remember we are not the promoters or managers of those companies. We are just looking out for ourselves and our investors and as such might need to sell a stock at any time. It could be due to overvaluations, finding a better idea, an overall negative view on the markets and many other factors. In a way we are rent seekers and capture that and move ahead. If we get wedded to our portfolio stocks, then we might not be able to sell even when we know we need to sell. Only marry your wife, with stocks just have love affairs (long term or short term) with the ability to break it at any time.
There are many facets of investing. Different investors can do well with different strategies, and it is each to themselves as long as they are able to implement their strategies properly. Moreover, investing is more of an art than a science. At every price there is a buyer and seller i.e., someone thinks it’s a good price to sell and others think its good to buy at the same price. How many times you are right and what you make when you are right determines how well you do. However always remember, valuation paradigms have been built over decades and excessive overvaluation as well as undervaluation never lasts. The worst thesis which is hurting many investors globally is that “Some” stocks are Buy at Any Price. Well, if that was the case then why would we bother to do research, estimate earnings and cash flows and try to identify future outperformers. If a stock was a buy at a 20X Price to Earnings ratio and then gets rerated higher and due to frenzy reaches a 100PE cannot continue to be a Buy. Discerning investors actually use such opportunities to sell or trim holdings. Its also important not to chase high returns. For example, as I sit to write this piece today the average 5-year return of various category of Mutual Fund schemes is as below and you will find it very interesting.
Then the question you need to ask yourself is, what’s the use of taking higher risk and it will be a valid question.
Also, as an equity investor we need to recognize that equity returns are no linear i.e., they are not straight line and they come with volatility, periods of strong performance and periods of losses, periods of euphoria and despair. Many ask me why don’t I do seminars and classes to teach investing? While it is easy to reach theory it is impossible to teach the emotions and behavioral aspects of investing. If I have to teach it will be in a business school spread over months with significant interactions etc. Even then it will not be possible to transmit more than 25%. Infact IIM Indore had engaged me to do such a course and I had also made the content ready. However due to paucity of time I have not done it till now. The time will come at some stage. Anyways it’s a separate topic as we are talking of the markets here.
Let’s also briefly touch on some other asset classes. Gold has been a big underperformed in USD terms since the emergence of Crypto’s, NFT’s etc. This year it held its ground. However, from the perspective of the Indian investor due to the rupee depreciation Gold gave good returns. I expect gold to do well going forward as its very under owned at this stage. Real Estate in India is coming out of a deep slump which lasted a decade. The next few years should be good. However real estate is very region specific so one needs to be in the right place. Many large cities might not see much appreciation. After years debt investing is also becoming attractive with FD rates up at 7-8%, there could be minor upticks in these rates from here but not of a huge magnitude so for these looking to lock in rates next 3-6 months should be good.
The most talked about and discussed words today are recession, inflation, interest rates, Covid resurgence, earnings slump etc. This is hardly a recipe for negativity overall for 2023.
I look forward to 2023 with caution as well as optimism. The combination will create opportunities to invest in a way where we can do well. There is nothing like consistently outperforming markets. Fund Management styles will outperform at some points of time and will lead to underperformance at other times. How much we can outperform when out style works and how less we underperform when it doesn’t determines long term performance. India is now mainstream due to our sheer size and democracy, longer term foreign investors and MNC’s will have to allocate more and more to India which will be good for all equity investors in the long run. India is a country of huge number of unique listed businesses which can be invested into. Indian Markets are now up for 7 years at a stretch, a record of sorts. Can we do 8? I would certainly bet on it at this stage