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A Pack of Cards – Ajit Dayal - Views on News from Equitymaster
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  • Aug 17, 2007

    A Pack of Cards – Ajit Dayal

    As children we all played that wonderful game: building a house out of cards. We took the first card, bent it a bit, leaned it against a similarly bent card, put 2 straight cards against them, added one on top and, Viola!, there was the house.

    Then we added more houses alongside each other, connected the roofs with flat cards, and we had a colony.

    The ambitious amongst us built one more floor above the base houses, and soon we had a one-story set of card houses. The dreamers built a second story above the first story, card by card, gently laying the top layers over the flimsy lower layers.

    Then someone would open the window and, Whoosh!, a slight breeze would cause the house of cards to collapse.

    Sometimes the entire structure would collapse, sometimes the lower ground floor would remain defiant and standing with the wreckage on the roof. All that effort, all the careful building......

    The emerging markets (and India) are now acting like that house of cards. A change in the patterns of the wind is shaking the house of cards - with a difference, I confess - but shattering many myths along the way:

    Myth #1: the Brazil Russia India China (BRIC) markets are strong enough to withstand any change in global flows.

    Well, barring China which continues to live in a world of its own, the BRI - and other emerging - markets are feeling a lot of pain.

    The desire to own risky assets (like shares in India) has disappeared this past week. No one has any clue when this risk-taking desire will return.

    Myth #2: India has a strong currency that will always appreciate.

    Most people mistook capital flows from FII buying into India as "real" demand for goods and services.

    Many Asian economies will probably have "stronger" currencies as they export real goods and services to the US consumers.

    However, in the case of India all we exported were share certificates of Indian companies.

    In a risky world, that was okay.

    In a world where people shun risk and wish to keep their money back home (the US Dollar is home to much of the source of global capital), this desire to stay away from risk is not good for Indian stock markets, or the Indian currency.

    Myth #3: P-Notes and strong FII flows and increasing stock prices are signs of how well we are doing as an economy.

    Well, we may be doing well as an economy and I remain very optimistic on India's long term potential, but the link between the speculative flows and the strength of our economy was a silly one.

    P-Notes attracted short term hedge fund sort of money, and was the wrong capital for India.

    The RBI has written various dissent notes on why we should stick to long-term sources of capital but they have lost the arguments to the purists that money is green and you cannot distinguish one source of capital from the other.

    Therefore, all capital is good and all capital must be allowed into India.

    Well, we enjoyed the benefits of this cheap risk-taking money being served up by the bar tenders, and now we are paying the price with a collapsing Index.

    So, in this global house of cards that is near collapse, where will India be and what should we investors do?

    At the outset, let me remind you that I have no idea - and no interest - in trying to predict index levels.

    But, for those who follow charts, this must be as interesting as June, 2006. The Index was then in "unchartered territory" and every chartist was talking about an Index level of 6,000 (the market was then about 8,900). Well, we know what happened: the Index nearly doubled in one year!

    Many say that India is a fundamental great long term story and anything you buy at any price will turn to silver or gold - well, maybe. If you had bought the Index at 6,000 in April 1992 you would have made a return of about 5% per annum over the past 16 years. Not worth it for all that risk of being in stocks and all those sleepless nights worry about global cues! Your return is a function of how long you have to hold that asset.

    If you had bought into the Indian stock markets at the 6,000 level in May 2005, that would have given you a return of over 50% per annum for the past 2 years. A lot more interesting than the 5% per annum for those who bought in April, 1992.

    The markets could fall to 13,000. Or 12,000.

    But don't panic, that is where it was in March 2007.

    So all that has really happened - at a 13,000 Index - is that we had a spike in May and June and surrendered that gain in one week!

    The reality is that there are many factors which influence share prices (company profits is the most powerful factor though) and very few people can really figure out the various connections that determine share prices. Would you have ever imagined that the fact that some poor fellow in USA could not pay his mortgage would cause your treasured Indian share portfolio to lose 10% of its value in one week?

    India is a wonderful, long term investment opportunity but we have our own risks: from poverty, to employment generation, to infrastructure - to name a few.

    Many of these will haunt us.

    Election in CY 2008 or a Left Front googly will hurt us, too.

    Scandals in corporate governance and buying favors from governments by powerful people will come home to roost and we will pay the price for that, too.

    Sometimes investors (whether global or local) get too excited and are willing to pay too much to own Indian stocks. Like they did in April, 1992 when they took the Index up to 6,000 levels.

    Sometimes, these same investors get frightened and walk out the door in a rush. Like they did in May 2004, June 2006, and March 2007.

    The key to investing is having an investment approach that you are comfortable with (trading or long term); understanding the implications of that chosen discipline and staying true to your philosophy. Benchmarking your returns against your friends at a cocktail party or against other fund managers is, in our opinion, trying to compare apples to oranges.

    As investors we will all make mistakes, the key is to make less of them and to learn from the past mistakes.

    This disciplined investment philosophy is available for investors at Quantum Long Term Equity Fund (please read the offer documents before considering an investment). Alternatively, if you don’t wish to rely on a fund manager but wish to own your portfolio, know your companies better and subscribe to Equitymaster research.

    But be sure of one thing: knowledge will prevent you from panicking.

    In times like these when sub-prime and P-Notes are torturing the Indian market, you will recall exactly why you invested in a particular mutual fund or a stock.

    Your emotions will be anchored, and that is half the battle won.

    Ajit’s recent articles on this global crisis:

  • What to make of this global crisis

  • Habits die hard: TBTF

    Ajit Dayal is Director, Quantum Advisors Private Limited. Ajit is the founder of Quantum Asset Management Company Pvt. Ltd. and also Quantum Information Services Pvt. Ltd., which owns Equitymaster & Personalfn.



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    Aug 21, 2017 12:48 PM