Surging stocks amid sinking earnings is a paradox encountered by investors amid an economic morass
Dear new investors of 2020, this is one of the strangest of times to start investing. Whether you make a success out of your investment journey or call it quits will depend on what you make of this year!
I said these are the strangest of times to invest. Here’s why.
When your stock market valuations hit a new high — with an early 30s price-earnings ratio — and your GDP growth is at a decadal low — that’s strange.
When you have lending rates at multi-decadal lows and yet there is little growth in loans, that doesn’t seem normal!
When the Nifty bounces back 50% from its March lows but saw its June quarter earnings fall more than half over a year ago, it is odd.
When nobody wants to buy anything, for fear of running down their savings in these tough times, the consumer inflation is at a peak 6.9%. That seems weird.
When there is no certainty of a tomorrow in the COVID-19 times, but brokerages see a meteoric rise in new brokerage accounts ‘to build wealth,’ it is bizarre!
When bank FD rates are stretching to touch 6% and you have a google newsfeed article crying ‘Yield up to 10.53%. This company offers high returns,’ it’s, well, freaky!
Well, I could list another half a dozen strange things but let’s look at why these seem strange.
Greed or fear?
You learnt that markets factor in earnings growth. They may factor in several years of growth if there is visibility and afford it a premium too! But, what if the way forward is unclear? What if the present numbers talk a bleak picture? Shouldn’t the market stop flaunting high valuations?
This is the point. Returns, when they turn irrational, should teach you to fear, to be sceptical. If you’ve been doing the reverse, it is time to introspect!
The RBI may have cut its interest rates to levels that may seem attractive for you to buy a house now.
But, will you buy one now, when there is a risk of job loss or pay cut? It’s the same with companies. When keeping their house afloat is critical, no company is going to borrow to build new plan(t)s! Therefore, rate cuts aren’t really helping the economy. And this is why the growth picture remains unclear!
A single stock — Reliance Industries — pushed up the bellwether index Nifty to lofty levels, buttressed by a string of private equity deals in Jio Platforms. One swallow does not make a summer!
For the rest of the corporate world, there is neither credit nor capital, with smaller companies having to dip into their reserves to keep themselves afloat. It is the rest of the corporate world that the real economy is reflective of. And, that is why your GDP growth is at decadal low.
In your first year of entry into the markets, if small and mid-cap stocks gave you 50-100% returns in just four months, it may be natural for you to think that stock market is an easy way to make money. But, if you are new to this, you may not have known the prolonged pain, the correction in mid and small-cap stocks, through two full years of 2018 and 2019; falling 40-60% and still not back to their 2017 highs. Such a correction decimated companies, pushing them to becoming penny stocks, with no liquidity left to even sell such stocks!
Not just you, but many retail investors are big time into equities now. Cash volumes in the exchanges speak plenty about the heightened participation by the retail segment. And yet, many are not aware that their big brothers — domestic institutions — have been net sellers for the past two months. They are also not aware that many quant-run dynamic equity funds have been reducing their equities over the same period.
Finally, when I receive a query from an elderly gentleman saying he was solicited to ‘lend’ his long-term stocks for a fee to a brokerage and whether it was worthwhile and safe, I knew there was nothing called fear in this market. And, that is not a good thing.
And this is not a story about just equity markets. Take the earlier point on an attractive yield of 10.5% on an NBFC FD when bank FDs were hardly 6%. Investors who have seen this for several years know that such high rates in a low-interest scenario meant ‘risk.’ But, not so if you were a new investor, believing that attractive interest rates simply meant good opportunity to earn money.
Dear class of 2020, you are witnessing an unusual year 2020. If you don’t put the current events in proper historical context, you’ll be writing the wrong playbook for you to follow in future.
To paraphrase what Charlie Munger once told a class of students: you’re not going to get far in your investment journey based on what you see in 2020. You’re going to advance in your wealth journey by what you’re going to learn from 2020!
(The author is co-founder, Primeinvestor.in)