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Apocalypse?

The Apocalypse – An epic disaster film of faith, released in 2007, as a giant asteroid headed for Earth triggers a series of events signalling a complete destruction of the world.

Sounds familiar? Well, it certainly does, after reading the constant news flows and social media messages, over the last couple of weeks, and its ensuing impact on world economies and stock markets. The NIFTY cracked by more than 30%, in a mere matter of weeks, which probably is one of the steepest and fastest falls ever. And so has been the case with global markets. Psyched by fears of an economic slump, thanks to the rapid spread of CoVID-19 and the ensuing oil war between Russia and Saudi Arabia, global indices plummet as investors rush to dump stocks. Looks like the markets are trying to factor an apocalypse Picture 1

Screen Shot 2020-03-20 at 1.56.37 PM

Screen Shot 2020-03-20 at 1.26.27 PMsource: http://www.tradingeconomics.com

 

While it is the front line index (NIFTY) which faces the whiplash this time around, the broader indices (mid cap and small cap) have been under pressure for well over 2 years now!

Screen Shot 2020-03-20 at 1.31.37 PM
source: http://www.finance.yahoo.com

If my memory serves right, this probably has been the longest (and most painful) stretch of under performance by the mid/small cap indices, since the start of the bull run in 2003. Scores of mid/small cap stocks have already been victims of the bear carnage, with a majority witnessing their market caps shave off by more than 50-60%.

With the index now having cracked sharply, in this short period of time, some of the usual questions that resurface in our minds:

  • has the index bottomed out?
  • should I buy new stocks/add to my existing positions?
  • will they slide further?

Well, I wish I had the precise reply.

It is a well-known (and hard learned) fact that it’s virtually impossible to time ‘tops’ and ‘bottoms’ in the market.

Whoever has managed to do so may kindly pass the due credit to their ‘luck  factor’. Based on my observations and inferences from past cycles, I would like to share some of my thoughts on what ‘could’ potentially act as indicators to signify a change in trend and what one should do at such times. The indicators I’m referring to are largely qualitative in nature and is open to individual interpretations though. But you will get the drift.

Very early in my career, I was told that stock fundamentals and stock prices generally tend to decouple (a) when market peaks and (b) when market bottoms. Essentially, these are the zones in which indices change their past trends.

  • At market peaks, everything looks good. The economy is doing ok, companies are reporting strong numbers, earning estimates are pegged higher, mutual funds see increased retail inflows etc etc. So essentially, a feel-good factor backed by huge institutional flows keep driving stock prices higher. And there’s complete euphoria. In such a situation, when stocks start retreating, investors generally tend to be in a state of denial and the declining stock prices don’t make sense. “why are stocks coming down despite improving company fundamentals and outlook?? Buy the dips” is the general investor sentiment.
  • Likewise, at market bottoms, fundamentals (company and/or economy) look susceptible and things look problematic. Companies start toning down their guidance, economic indicators show stress, estimates are readjusted downwards to factor the earnings miss, job losses and a declining stock market threaten to dampen consumer sentiment further as they rush to redeem monies invested with mutual funds etc etc. And there’s complete panic. In this situation as well, when stocks and indices start moving up, it stops making sense. Investors tend to be in a state of denial. “prices going up even when everything is so scary? this is a mere dead cat bounce rally, kindly exit into the rally” is a general investor sentiment in this phase.

At all other times (directional market) fundamentals and stock prices seem to go hand-in-hand (largely).

Given that background and the current context, some of the typical qualitative indicators that could imply a change in the downtrend could be:

  • when a series of earnings upgrades is replaced by frequent earnings downgrades, it implies that we are somewhere there
  • when investor confidence is badly shaken and the number of ‘next Warren Buffet’s’ dwindle, it implies that we are somewhere there
  • when you get a reply “bhagwaan ka naam”, instead of a dozen multi-baggers, to your question “kyaa lene ka?”, it implies that we are somewhere there
  • when your local paan waala/milkman/security guy go back to their professions, instead of taking stock market lessons and collecting stock tips, it implies that we are somewhere there
  • when your father’s/relative’s tone changes from “this IPO look good to invest” to “stay away from stock markets, it’s very risky”, it implies that we are somewhere there
  • when retail investors stop asking for ‘the next multibagger idea’, it implies we are somewhere there

 

Screen Shot 2020-03-20 at 11.49.10 AM

 

 

 

 

 

 

And so on and so forth.

However, there is another interesting trait I have observed in the past 2 cycles; correlation of news flows and stock prices. When stock prices stop reacting to news flows and rather moves in the opposite direction, it signals a change in the market trend as well. For instance, if stock prices (or indices) tend to move up despite the continuation of negative news flows around the stock or the economy, it may imply a bottoming out signal. And vice versa. In either of the instances, there is a disconnect between the news flow and stock price which baffle investors. Mr. Market has historically proven to stay ahead of news flows and earnings revisions. Isn’t it?

With most of the media (electronic, print and mainly social media) today painting a grim picture about our future, the outlook remains muted. Is whatever that is happening around us concerning? Of course, it is. Will the spread of virus, and the resultant strategies that most nations are adopting to contain it, paralyse our economies for some time? It most certainly could. How should we investors react?

By keeping our head on the shoulders and not giving in to the panic.

Depending on our individual risk appetite and investment profile, we should work on identifying opportunities across market caps. It’s prudent to assume that the next 1 year could be a complete washout for these companies, while doing so.

  • In the large cap space, identify managements who have demonstrated abilities to sustain past cycles and nimble footedness to capitalise on opportunities presented. Identify the price points at which valuations look reasonable in these shortlisted companies, even after factoring lower growth over the next 1 year (price in the worst).
  • In the midcap space, identify those companies which continued reporting earnings growth and threw free cash, even over the last 2 years. That they continued to report profits and cash flows, despite knowing it’s disconnect with their resp. stock prices in a declining stock market environment, hints at actual earnings that the company may have reported. A bad stock market and future outlook disincentivises several promoters from inflating numbers as they realise no material impact on their stock price.

How much should one invest? Buy in a staggered manner, keeping in mind the qualitative indicators I have written about, even if it means you end buying some quantities at prices higher than those prevalent today. A couple of weeks back, I hadn’t imagined seeing the indices at these levels at all. I’m not sure about you? And I have NO clue of where the indices may actually head in the near future.

It’s one of those times when referring to a chart like this makes a lot of sense.

Screen Shot 2020-03-17 at 1.07.44 PM

source: http://www.onemint.com

 

I would love to hear your views on the same.

Happy Investing,

Sudhir

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