Oh, shoots! - The Honest Truth By Ajit Dayal

Oh, shoots!

11 DECEMBER 2015

Generally, the phrase 'oh, shoots!' is used when one forgets something as in "Oh, shoots! I left my wallet at home."

But in economic and stock market parlance, the phrase "oh, shoots!" can have a whole different meaning.
It can be a prayer.
It can be a hope.
It can be the sighting of a miracle.

In March, 2009 - six months after the exposure of the Great Financial Theft which saw the eventual bankruptcy of thousands of individuals and the eventual use of tax payer money to rescue the jobs and lives of millions of people employed in the financial services industry - the global stock markets reacted wildly to the news that the first signs of economic recovery were visible.
The citing of "green shoots" gave that imagery of a few blades of grass piercing through a grey cold winter.
Since anticipating the future is the job of the stock market, share prices globally went into gallop mode.

Not that the green shoots really materialised as rapidly, as widely, or as freely as people expected.

Seven years after the mess caused by excessive leverage in the system and the deceitful acts of the financial firms, the world economy is far from any sort of meadowland imagery.
At best, to take a Walt Whitman title, there may be a few 'Leaves of Grass'.
This, after governments from China, Japan, Europe, and the US have taken on over USD 12 trillion in debt....and are still happy to keep borrowing to spend their way out of an economic slump.
Leverage from the private sector has been replaced by leverage from the public / government sector.

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India: a shooting star?
In the Indian context, the green shoots have a rather interesting connotation.
The real kicker for the Indian stock markets was not March, 2009 but May, 2009.
The first trading day after the then general elections won by UPA-2, the stock markets zoomed by +17.2% and had to be halted 3 times as it hit circuit breakers. The total time that the stock markets actually traded was some 72 seconds.

But all that euphoria over the victory of UPA-2 faded away.
Caught in a range of scandals from Adarsh to spectrum to coal to gas to iron ore, the UPA-2 was seen as inept and corrupt. Prime Minister Manmohan Singh continued to present himself as a man of high integrity but was increasingly seen as incompetent and unable to run a government. High oil prices globally and food inflation eroded wealth and confidence. Proclamations by then Finance Minister Pranab Mukherjee in February 2012 on retrospective taxation of foreign investors did not help. Ben Bernanke's tapering tantrums by May 2013 suggesting that the US Federal Reserve will raise interest were the nail in the coffin for a stock market that was driven largely by hope of earnings. Between 2009 and 2013, inflation was higher than the rate of growth in earnings for companies comprising the BSE-30 Index.

Rising India: The Modi Wave
The fever of another election saw the stock market sprinting between September 2013 (when Narendra Modi was nominated as the BJP's Prime Ministerial candidate) and May, 2014 when the Congress was thankfully wiped out and the BJP was elected (Graph 1).

The BSE-30 Index (green line) moved into overdrive and broke away from the MSCI Emerging Market Index (red line) to catch up with the MSCI All Country World Index (blue line), which is largely influenced by stock price movements in countries/regions like USA, Europe, and Japan.

Graph 1: India moved to take off mode in September, 2013 - now reversing?

But that hopeful run-up in the BSE-30 Index has started reversing.
Promises of acche din encouraged leading bulls to ramp up their earnings estimates for a Resurgent India.

Alas, so far, the only successful outcome of the 'Make in India' effort is the fictitious story of how companies will perform so much better under the Modi regime!
That is not to say, they will not do better in the future: they may do every well.
But companies were supposed to do well by December 2014...so far, nothing.

The Great Luck for India has been the lower oil prices which has saved some USD 60 billion every year in foreign exchange and - by virtue of lower oil subsidies - allowed the government to come close to reaching a budget deficit target of 3.8% of GDP.

While oil may remain low in 2016 and save India again, in comparison to the benefits this year, there may be no "extra" benefit. So, while the government may still be blessed with a lower oil import bill and lower subsidies for oil in the next year, it will need to do something else to boost the economy - and its fiscal situation. The 'base effect' factor will kick in: what was good for us in 2015 compared to the 'old base year' 2014 will look the same in 2016 when compared to the new 'base year' of 2015. No 'rate of change' benefit for 2016 when compared to 2015.

Fear the Forecasters!
Now that the Samvat 2072 exuberance of a better future is forgotten - though made less than a month ago - the dawn of a new calendar year has started the re-run of the soothsayers looking at the outlook for the year 2016.
And the discussion seems to be hovering around the sighting of the fabled green shoots.

So, as we roll into 2016 over the next few days, my only warning to you is not to get caught in fables and myths. Research analysts and fund managers are paid to spin stories. The more animals they bring to the slaughtering house, the fatter is their belly: whether they are vegetarian or non-vegetarian does not matter! The Alpha Males at the financial firms - and the battery of lawyers that protect them - know the simple rule: You Eat What You Kill.

The research analysts and soothsayers have made wrong assumptions in the past (Graph 2) and they may do so again. Forecasting earnings is not an easy science and, when we start imposing hope into the earnings - and expectations of our own bonus - we can soon indulge in witchcraft.

Graph 2: Earnings Estimates are so wildly off - but who cares!

Note how the earnings estimated for CY 2014 and CY 2015 showed this upward zoom when the first polls suggested that Modi would win the elections. That was a surge based on hope. And then as nothing significant happened on the policy front, the blue line for estimated earnings by the end of Calendar Year 2014 had to face reality of poor earnings: Estimated Earnings had to match the Actual Reported earnings. While the CY 2014 line was declining, the red line of expected earnings for CY 2015 also declined. By February / March of 2015, the hope of a great budget again got the research analysts excited. And then reality set in again....nothing significant happened on the policy front plus we had a poor monsoon. The red line for estimated earnings of CY 2015 has been heading downhill - followed by the estimated earnings for CY 2016, the green line.

Meanwhile, the mid-cap and small-cap stocks are holding their ground - for now (Graph 3). As a group, their P/E ratio is nearly 2x that of the Index on the hope that the earnings of these smaller companies can grow faster. That is true: generally speaking when economies recover, the smaller companies can do a lot better. But, in times of tepid economic growth - like now - it is these same, smaller companies that don't do well. And in a crises or a market sell-off, the share prices of these small companies get creamed. Plus they get hit by "illiquidity": the inability to get out of them in low-volume markets characterised by falling share prices. While this illiquidity may not be a problem for a retail investor buying or selling a few hundred shares, it can be a major problem for mutual funds that own tens of thousands of these shares. As the aftermath of the Lehman collapse showed, not only is there price massive destruction, there is also the frustration of waiting for a long time to liquidate the holdings.

Graph 3: S&P BSE 30, Mid-cap and Small-cap Indices since Sep 2005 when the BRIC story was hot - on a trot since September 2013

Invest in equity markets for sure: but invest carefully.
Oil remains low. The world is not growing so, globally, prices are down since there is excess supply. In India, inflation is down. Interest rates have declined. Gold is subdued. Property is bleak.

Are you buying stocks because there is nothing better out there to invest in?
Don't get me wrong: you must own stocks and have that exposure to equity.
But you need to know why you are buying shares - it's not for the earnings.
Eventually, share prices move based on the fundamentals of growth in earnings.
And they get priced accordingly over different cycles (Graph 4).

Graph 4: Getting closer to value: historical PER of India expands as historical EPS is adjusted downwards on disappointing results

As a 'value' investor, one does not buy at the 'top' - and nor can anyone consistently buy at a 'bottom'. But, if prudent, one can enter at good prices and ride the wonderful long-term India story.

Make sure that - while you are busy peering for all those green shoots of economic activity - you don't lose sight of the fact that someone steals your wallet.
That will really be a different kind of 'oh, shoots!' moment and mark a sad ending to your correct decision to invest in shares.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)

Quantum Long Term Equity Fund and Quantum Equity Fund of Funds Quantum Gold Fund
Quantum Liquid Fund
Why you
should own
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% in total in both; Maybe 20% in QLTEF and 60% in QEFOF 20% Keep aside money to meet your expenses for 6 months to 2 years
Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"
Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is Founder of Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site.

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1 Responses to "Oh, shoots!"

manish patel

Dec 11, 2015

To reach at average PER of 17X, how much point drop in nifty will require ? Have allocate fix amount to invest on every drop of 100 point in nifty but would like to know total drop so that i can divide my amount equally and over time.

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