Gazing into a Crystal Ball….is just gazing

Published On: 11-Apr-2018

I was told I could address any of the following four questions in my article. But why stop at one if you can go for all four?  Especially if all four are linked inexorably in some form.

The questions and the corresponding answers are below -

  1. What lies ahead for the markets in 2018?...Nobody knows
  2. Is this the golden era for stock market investments in India?...How can anybody know?
  3. Will FY19 mark the revival of the earnings cycle?...Maybe
  4. What will be the effect of rising interest rates on the markets?...It depends

The answers may seem less than satisfying, even curt, but there is good reason for that and let me elaborate.

We have witnessed a surge in new investors entering the stock market and I believe it is incumbent upon investment managers to help set their expectations right and educate them on the nature of the stock market. The stock market is a market place in which we get to allocate capital to businesses of our choice. Buying good businesses at a sensible price can enable a diversified portfolio to earn a reasonable return over time. A return, as many of you would be aware has been, higher than other asset classes over longer time frames and has provided the best protection against inflation. The return of the asset class is measured by the return of the main benchmark indices and active fund managers strive to add Alpha over and above the benchmark return.

As these new investors come in perhaps they seek certainty in our answers to questions such as the four above. But it is not possible to have precise answers to the above questions.

The truth is that nobody can forecast the outcome for the market for any given calendar year consistently. The stock market does not recognize calendar years and its returns are not linear like in the case of “Fixed Deposits”. If you ask a 100 people it is likely that somebody will get it right but you cannot establish who that person is before-hand and remember that even a broken clock tells time accurately twice a day. So take all predictions about returns with a pinch of salt. Even better distrust all forecasts. “Nobody knows.”

Whether this is a golden era will be judged by history i.e. post facto. It is impossible to know beforehand.  In 2003 there was no forecast that we would achieve average real GDP growth of 8.7% pa over the next 5 years. Or that the Sensex would rise at a CAGR of 43% from Dec 31, 2002 to Dec 31, 2007. History is always written after the event. What we know as the period of Renaissance and the great enlightenment of Western Europe came to be labeled as such only afterwards. Same for the industrial revolution or the post-World War II boom in the US. These labels are best given after and not beforehand. What we now call the First war of Indian Independence (1857) was named as such nearly 50 years later in the early 1900s. (The British called it the Sepoy revolt of 1857 and maybe they still do). This may well be the golden period or it may not. How can anybody know beforehand? You should make your allocation to the asset class based on your financial goals and not based on forecasts of a golden period.

As regards analyst forecasts I suggest you refer to the history book again. Analysts have been calling for a recovery in growth every year from 2014 and the numbers have not come good. Similarly, during the period 2004-2007 analysts were consistently being surprised by the actual earnings growth coming in ahead of their forecasts. It is not that the analysts are poor at their job. The future is full of surprises - both good and bad. To make a precise forecast for earningsis made all the more difficult by the number of variables and moving parts that go into it. Earnings may well recover in 2019 given the poor growth of the past few years and what looks like will be a weak base in 2018. But don’t anchor to these forecasts, they may or may not be right and the multiple that the market will pay for the earnings will fluctuate anyway. So why focus so much on the forecast?

As regards the impact of rising interest rates - It depends. Determining the causal impact of the changes in one variable on the stock market is challenging because the final outcome is affected by other variables. There may be little doubt that low interest rates have propped up equity valuations in recent times. This is true globally and in the past two years a similar case could be made in India as well. But we cannot be certain of the outcome in the market from a transition to higher interest rates, because the negative impact of higher rates may be offset by other factors.  For example  if the increase in rates is an outcome of higher growth and it is reflected in rising earnings and expanding return on equity-the market may look through it. Also if the animal spirits of the investors rise during this period that may also contribute to the markets ignoring rising rates, at least in the short term. Of course beyond a certain point we do know from history that high interest rates are not good for equities. So the appropriate answer is that-it depends. Correlation is not causation.

In answering the above questions with certainty - with precise forecasts of earnings & index targets we do a disservice to all investors-new and old.  Cut out the noise. Let me be clear, they are perfectly good questions but they should not be the basis of your investment strategy. The data you have seen and read about the superior long term returns from equities as an asset class are a fact. But to achieve them you will have to deal with volatility that is part and parcel of the asset class. How can you do that?

The simple way to navigate equities for most investors is through a Systematic Investment Plan (SIP). A long term SIP is the best way to escape the tyranny of sentiment and fluctuations in valuation. This will significantly increase the probability that that you create a portfolio at reasonable valuations by spreading out your investments over time. A SIP is not a maximization strategy; it merely smoothens your return outcomes and enables you to overcome the behavioral challenges stemming from the intrinsic volatility of the asset class. In addition, to achieve your financial goals, you would have to manage asset allocation in line with the appropriate range. You could also consider hybrid products or products where the Investment manager takes decisions on asset allocation.

As for more active investors- they could combine an SIP or a Systematic Transfer Plan (STP) with more aggressive shifts in asset allocation. Many advisors have developed an asset allocation framework for this. The objective being to buy more of the asset class when valuations are depressed (be aware that this coincides with period when the news flow is very poor) and reducing allocations to the asset class when valuations are rich (news flow may well be very positive). Of course this is easier said than done. In the words of the master- Investing is simple, but not easy.

The above article has also featured on CNBVTV18 as an introductory article as part of the website launch. Refer link here

Disclaimer

Author Bio

Vetri Subramaniam
Vetri Subramaniam is Group President & Head of Equity at UTI Asset Management Company Ltd. He has been in this role since January 2017. UTI MF manages assets of Rs 1524 bn* and the total assets under management of UTI are Rs 3615 bn*. At UTI MF Vetri leads a team of 17 persons including analysts and fund managers. The total equity assets managed and advised by the team are Rs 649 bn*. Vetri has over 26 years of work experience.Prior to joining UTI in January 2017 he was Chief Investment officer at Invesco Asset Management Ltd. He was part of the start-up team at Invesco (then Religare Asset Management) in 2008 and helped establish the firm’s proprietary investment process and the team. During this period the firm established a strong track record. The firm also launched several offshore funds investing into India from Japan, Mauritius & Luxembourg. Vetri started his career at Kotak Mahindra in 1992 after passing out from IIM Bangalore with a PG Diploma in Management. He has worked in equity markets & investment roles at various firms from 1994 including Kotak Mahindra, SSKI & Motilal Oswal. He was also one of the founders of Sharekhan.com (now Sharekhan BNP Paribas) where he led the research & content team. He has also worked as an advisor to a UK Hedge fund Boyer Allan on its equity investments in India during 2003-2007. He is a frequent contributor to the media and regularly speaks on equities and investing at various forums- including the media & educational institutions. * The Month end AUM figures are of 30th June 2018