A Brief summary of the Micro/Small/Midcap Carnage


(vaedermacher) #423

Sorry, to clarify:

  • We’re discussing macros and how they impact institutional investors like large asset managers. They may or may not be relevant to value investors. Large market moves are largely not driven by value investors but traders, momentum riders and hedge funds, for whom macros are key - and many of those players make money as well, so whether macros matters to your investment strategy is relative - it is not the value investor’s strategy to follow macros closely. My point is limited to illustrating that market moves can be driven by interest rate changes as large institutional players, mostly foreign ones, react to these by reallocating their portfolios - the rates they refer to are the reserve currency rates.

  • My point on looking at US Fed rates is in so far as we are talking large institutional investors and macros - my personal belief is that market volatility is led by foreign capital inflows and outflows, and these players are so huge that they essentially set the tone for all emerging markets - and their decisions are based on US T bills and the Fed, as it is the primary reserve currency and safe haven. Indian G-secs, as you correctly pointed out, are set at a risk premium to OECD rates. I don’t think we can understand market moves completely when only referencing local policy actions as the primary drivers of those moves (especially tyhe currency) are foreign investors - the recent turmoil has been widespread across emerging markets and has its roots in changing policy stance in the US, and I don’t think its any different for India.

  • Not saying risk premiums are fixed, but refuting the point that they contract because the risk free rate goes up - this is analytically incorrect - market risk premium is defined as a fixed spread above the risk free rate. The spread can change, but this is because the perception of risk changes, not because the risk free rate changes - if I need 5% above the risk free rate to invest in security x as a hurdle, then 5% doesn’t decrease if the risk free rate goes up. It can change if I think security x has become riskier or safer. It is clear that if the safer asset becomes more rewarding, I’ll demand at least the same level of premium as before for an unchanged, riskier asset. Please note this is not data analysis, but just drawing theoretical conclusions from portfolio theory. You can differentiate the equation for the DCF cost of equity by the risk free rate Rf, and noting that Rm is an increasing function of Rf, f(Rf), and see the derivative wrt Rf to be 1 + beta*(f’(Rf) - 1). f’(Rf) => 1 by definition (in simplest terms f(Rf) = Rf + S, where S is the positive markup that is derived from the inherent volatility in the asset). So the derivative is positive as a whole, implying increasing coe i.e. increasing discount rate and lower PV of cash flows, and lower equity valuations.

  • CAPM is theory of course, and does not hold in practice in many instances. Thanks for sharing the article, it is an interesting read, but the article is a little disingenuous with its data - the only place in the data there where equity returns rise is in the years 1978-1980 - and these rises are much below the standard long term return on US indices (about 7%) so cannot draw the conclusion that they increased from the baseline. The only other year is 2006, and the return here is again just about at the long term annual trend. On the contrary, decreasing rates have high correlation to higher than average equity returns.

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  • Another major conceptual issues with the analysis in that article imo - Monetary policy today is v different from how it was in the 1970s and 1980s which were a v chaotic period. Today forward communication and managing expectations is the key task of monetary policy, so rate hikes which are well communicated and within the inflation target range of the central bank should not worry markets - it is the unexpected change in long term yield expectations that causes volatility and erosion in other asset classes - modern central banks spend a lot of effort in keeping the long term yield expectations unchanged through clear policy communication - I do not reallocate my long term portfolios if my long term risk free return remains unchanged - this concept did not exist in the 1970s and was developed later. If one looks at the data for the last ten years again the thesis is not supported - actually there is no recent data for equity performance in a period of rapid rate hikes simply because it is yet to happen - the point is not a permanent increase in rates, but that long term expectations of the risk free rate undergo flux, leading to reallocations of long term strategies. The second piece of data provided, that equity moves up when yields are < 4 is also not fully representative of the fact that 10Y US treasuries have only been below this level since the advent of the modern monetary system in the late 2000s i.e. the era of quantitative easing and massive monetary stimulus - which as we all know propped up markets world over. So imo cannot read any correlation in this relationship as the market has been factoring in continuing loose liquidity in the face of gradual, well communicated rate hikes - liquidity makes the rate hike a moot point, allocation is easy when you continuously get inflows.


(vaedermacher) #424

Agreed @phreakv6, looks like RBI is between the devil and deep sea in this case, and has decided financial stability is more important - keeping money markets liquid and getting OMOs done in Oct seems to be top priority. Unfortunately, it also looks like there is significant political pressure to keep optics on rates to prevent a blowup in the money markets and also manage the NPA issue. This does not bode well for inflation - @devaki.tripathy, with oil at $80+ a barrel, higher inflation is on the cards imo whether we like it or not, and several commodity sectors + foreign capital leveraged cos are going to go back into the red - exacerbating the NPA crisis. Imo RBI has kicked the can down the road, and will face a harder choice in a few months if the pressure on the rupee and oil doesn’t abate, as the financial sector issues will only deepen - and if inflation starts picking up rapidly then, it will be v difficult to manage with just monetary policy alone.


(atul1082) #425

While I agree with you, I believe this is the time to identify tomorrow’s leaders who can ride this downward cycle and rebound


(EL) #426

@vaedermacher
Thanks for the long explanationwity data
If investing in stocks is a business, every business has its loss days when you got to restart
I deleted my posts as people keen on winning the argument than trying to see if there is merit in the post will keep finding fault in your analysis and you wonder what’s in it for you, you don’t want to be a prophet seeker, you want to be a profit seeker
People generally are aware to things they have first hand experience. Like if you are ever hit by lighting and survive, you will be careful when there is lighting. The rest of us won’t care. If you have been pickpocketed, youll always be careful with your wallet in a public place. In the book buffetology, the author says interest rate increases is one of the times Warren picks stocks at bargains but unless you have gone through this once or twice it’s easy to not notice it.


(Ashish) #427

Some indicators of what can work in Small Caps


#428

This Malani guy is highly immature if not a half fraud. Be aware that most of his stocks are duds and had risen during the last bull market due to wide spread marketing on the social media. Can’t believe ET is involving him in pontificating about stock selection.


(JOSE ABRAHAM) #429

Some stability shall come to the market only when the FII have done with their selling. Hence fresh buying or addition to portifolio after the dust settles will help ease immediate pain. Seeing the fund outflow, a V-shaped recovery does,nt seem a likely scenario. All stock market veterans are not in favor of timing the market, but if your horizon is not very long, timing the market will save you a lot of immediate pain and also provide you with decent gains if your investing horizon is 2 to 5 years.


(Dinesh Sairam) #430

I don’t want to continue this conversation anymore, since it adds very little marginally. However, let me touch upon what you concluded-- that there is indeed a high correlation between decreasing interest rates and high returns on equities.

Here’s the relevant data I pulled for India (And don’t worry, I didn’t pull rates from ‘outdated monetary policies’. I’ve pulled them from 1998-2018):

Assuming your argument is right, we should see a correlation between these at least higher than 60% or so. But the actual correlation is somewhere around 6%. You can check this out for yourself: Interest Rates and Equity Returns.xlsx (58.8 KB)

If you really want to continue this conversation, let’s please take it to DMs. We’re really just de-railing this thread going back and forth.


(vaedermacher) #432

I was commenting on the data you shared in the linked article, the correlation is pretty clear there. Sure, lets conclude.


(EL) #433

@vaedermacher
Even if Dinesh is not interested there will be some who would be and use it sometime somewhere
I would like to know where you first entertained the idea that changes in interest rate changes the economy and in turn the stock market
Did you come across a book or research paper or you are an economist
Once you know it, you see it everywhere.
Like Warren buffet learned about value investing from Graham and once he applied it and saw it working he actively directed people to study it. And he learnt about fishers method
I am keen to read the books you have read to arrive at this conclusion so I might better my knowledge as well


(Maunil) #434

That’s the day when Buffet says Invest as if the market is going to close tomorrow for 10 years!


(Hitesh Patel) #435

I think people will have different reasons/theories for market falls. Some of these maybe partly true but doesnt get us anywhere. The key thing to do in these situations is to keep a calm head and behave in a rational manner.

Best thing is to focus on individual companies and try to stress test them in terms of any macro events/news affecting them. If these appear immune to such shocks then one should take the study to next level and do a deep dive in to these companies. Try to focus on management quality, balance sheet, past track record, future prospects etc and then make a list of stocks you would love to buy. If one is not too confident about what to pay one can put up levels to buy these companies and then buy objectively at these levels.

Most of the times this simple exercise tends to get one out of the dumps and gets to strenghthen the portfolio quality.

There’s no time like a correction to rejig the portfolio as the market offers great choices if one can take them.

Its not use trying to be too clever and be too theoretical and do a lot of gyanbaazi. I met a very savvy investor a couple of days back who focussed obsessively only on his portfolio companies and gives u investment logic on his companies in 5 minutes. This is the kind of clarity one needs to invest confidently.

And one needs to believe markets dont fall in a straight line. There would be intermittent rallies even if markets were to go down further. I have no idea where markets are headed but feel there is enough blood on the streets to start nibbling if not to be too aggressive.


(suhagpatel) #436

As you have mentioned Sasket, thought of highlighting L&T technology services (LTTS) here. Sasken and LTTS are working in similar sectors. However, LTTS has better brand, reputed management, geographical spread and some of the best clients from the E&RD space. Company’s RoE and RoCE are also at a higher end. IPO of LTTS was very lackluster but off late it has caught the fancy of the markets. It was able to withstand the recent correction so far but started falling in last two trading days.

Disc: Started investing recently in LTTS.

Regards,
Suhag


(vaedermacher) #437

Hi , I wouldn’t say I think it’s the theory to think about economies , but it is a v useful framework to have in our toolkit. Charlie Munger stressed the need to have multiple mental models to understand facts , and I think this is a useful one to have. My points were limited to correcting the interpretation of the framework , I do not endorse it specifically, context being king. In terms of reading material, it’s a topic I like following, not for value investing, but because I’m interested in public policy - happy to share - Buffet himself has spoken of the interplay of interest rates and dividend yields and taxes, Ray Dalio has a series of articles and videos that explain the basics of the debt based boom bust theory , Raghuram Rajan has several lecture series that elaborate on the links between currency and central bank actions, Urjit Patel had a speech from few months ago that predicted the current dynamics quite well, seeking alpha and zero hedge regularly feature several articles on these topics. No specific books , just following current affairs.


(manivannan.g) #438

Quick recap of previous pre-elections (6months prior elections) and post elections (24months after elections) equity performance. Govt change never made a big dent so far.


(manivannan.g) #439

Already rumours around it.

Govt doesn’t care about these rumours that hit the market very hard in recent times. Media keeps pushing one or the other rumours.

In another angle, are the media spreading rumours intentionally ? I read somewhere before every election, the opposition will try to bring the market down to have the negative sentiment over the ruling govt.


(sincyvarghese) #440

These might be rumours but I think the premium paying public have a right to know what is happening with their premium revenues. I have surrendered one of my policies. I will surrender one this month. If even a significant percentage of all the policy holders understand what is happening to their money with LIC and surrender their policies things could get dirty.


(Balusu Aditya) #441

Folks. Any thoughts on this article about an impending 2000 like crash?


(EL) #442

Wasn’t there something called us-64 or something that went down sometime in '98 - '00


(Shyam) #443

Whenever you see such articles, please look at the history of their recommendation as well. Sometimes, there are people (who might very well be genuine) who cry wolf a bit too many times. Just keep saying it will crash and when it crashes eventually, say “I told you so” and ask people to give their life savings so that you can manage it for them.

Another person who had long believed that a crash is coming is below. If you followed him, you would have missed half the bull run by now.