Aug 1, 2016
Summary
The Gambler’s Fallacy has implications for Indian equities and bonds. India is a clear consensus favourite today. We look at valuations and the best strategy forward.
The Gambler’s Fallacy…
In the summer of 1913, crowds at a roulette table in Monte Carlo witnessed an incredible event. The ball had landed on black 15 times in a row. Many players decided this could not possibly continue and wagered millions of francs on red. The ball continued to land on black. Even more people flocked to the table to bet on red. It had to change eventually. But it kept landing on black again and again. It was not until the twenty sixth spin that the ball finally landed on red. By that time, players that had bet on red had large losses.
The example above is called the gambler’s fallacy. The gambler’s fallacy posits that things must eventually revert to the mean. In some cases, however, extremes intensify.
Today, the market is behaving like black. Every dip is bought. Sell-offs last for a few hours at best. India is a recognised safe haven. Money sits on the side-lines hoping for a sell-off. Sell-offs have come, but of the minor variety.
Probability theory assumes a series of independent events. However, in financial markets, events are completely inter-related and what happened last week has an important bearing on what will happen this week.
Feedback loops are in place for equities, debt and currency. In large part, we would characterise what we are seeing as rational behaviour in the context of an irrational liquidity driven world.
Equities
A Brief Review on Housing Finance …
Housing Finance has been our most favoured theme since April 2016, when Sanctum Wealth Management was launched. Some said the sector was done. Others said it looked boring. Well, you could have bought the top stock in this sector and made 45 – 50% in 3 months. You could have bought upcoming stars and made 50%.
Liquidity & Growth Driving the Market
As discussed, India is being recognised as a safe haven, one of the best markets for long term investors and capital is flowing into the markets.
FDI, FII & FPI Flows
FDI is up 53% in the past two years. Overseas investors infused INR 12,600 crore into equities in July, making it the highest inflow since March 2016 on rising hopes of passage of the GST Bill and expectations of better corporate earnings. Foreign portfolio investors (FPIs) also invested INR 6,845 crore in the debt markets, indicating a reversal in sentiment for India’s debt markets. So far this year, FPIs have invested INR 31,778 crore in equities while withdrawing INR 4,723 crore from the debt market. Rotation into Emerging Markets
Rotation into Emerging Markets
Emerging markets are benefitting from an asset re-allocation as investors are moving their money out of Europe into emerging markets. Almost 70 percent of the funds pouring into emerging markets are from exchange traded funds. Institutional investors are calling India among the bright spots in the post-Brexit world.
Fed Hike is Off the Table
The U.S. reported disappointing second quarter GDP growth, which re-affirms our view that the Federal Reserve will refrain from hiking rates this year. While slowing growth is certainly a concern, we do not believe corporate India is dependent on global economic growth; rather, it remains a market share story.
Earnings Season is Off to a Decent Start
Earnings reports so far have done enough to reinforce investor’s expectations. There have been a few disappointments, particularly in the IT majors and banks. By and large, however, enough companies have come through and demonstrated exceptional performance. Earnings surprises have outnumbered disappointments by a small margin. We are moving into the second phase of the earnings reporting period, which historically has not been as good as the first phase. Liquidity is essential for a bull run. There is much liquidity and capital chasing stocks and seeking consistent high growth.
Nifty 50 Earnings Are Off to a Decent Start…
Our Asset Allocation Model Remains in Neutral
Fixed Income
The Attractiveness of India’s Bonds
It is easy to see why foreign investors are finally getting it. India’s bonds offer two things in combination that no other major economy has today. A stable currency and high yields.
Declining Rates
The decline in the 10 year bond to 7.16% is sure to add additional cheer for equity investors, consumers, and debt investors, as banks will face pressure to reduce their lending rates soon.
Yet again, the market is being driven by global liquidity factors, a good monsoon, and expectations of a decline in inflation.
Along with 10-year gilts, yields on short-term instruments such as government’s Treasury Bills (T-Bills) have also dropped.
While the drop in yields is certainly good news for current bond holders, we wonder how long this liquidity driven rally will last.
The Indian bond market is starting to get affected by the vagaries of global capital flows.
While the prospect of a short term contribution via capital appreciation to a bond investor’s portfolio would certainly be welcome, the long term impact of lower yields would be less appetising for bond investors.
Our asset allocation model shows that equities have become marginally less attractive than bonds, but we are stuck essentially in neutral in terms of preference.
Building a forecast based on global flows is a risky exercise. Building a forecast becomes additionally complex when recognising that the call has to be made for a three-year horizon for tax efficiency.
We have always felt Indian bonds were an attractive destination for investors. However, there is a second level analysis that involves recognszing when global investors recognise this. Brexit turned out to be the catalyst that shone Indian debt in a far better light.
It is difficult to chase a move once it is underway and we have missed the recent 30 bps rally in bonds. The way we had looked to rectify the situation is to reduce our exposure in the short end of the curve and recommend dynamic bond funds for duration seeking investors.
This would leave us with a more diversified bond portfolio of accrual funds, dynamic bond funds and preference shares.
The Nifty 50 Is At the Upper End of It’s Range as FI Buying Continues to Prop the Market
Technicals
The week started on a positive note, but there after the Nifty index remained range bound for the rest of the week to finish with a 1.14% gain at 8638.
FII buying continues to drive the market with another INR 4000 cr inflows into equity segment last week. They have also rolled over good amount of index futures long positions into August series suggesting bullish sentiment.
Momentum indicators on weekly chart remain on an upward trajectory. Though they have reached overbought levels, they can remain within overbought zone in a liquidity driven market continuing to moving higher.
Index is trading below resistance zone of 8630-8654 levels. Sustaining above this zone next level for index is seen at 8855 zone and then 9000 level. On the downside 8500 is the immediate support for the market, which also has the highest open interest for puts indicating good support for the market. Below 8500 level, the next support for the market is seen at 8300 odd levels. In the near term, sustaining above 8654 levels, expect momentum to continue towards 8850, with support for the market at 8500 levels.
Outlook
We have coalesced into a narrower market. There are roughly 100 stocks that are the darlings, promising or delivering 20% plus growth. These stocks are the ones investors are rushing into. These companies are delivering and are being bid up.
Second, we are seeing a rising tide, rising incomes above the $2,000 into the $3,000 level coupled with the government’s initiatives – Aadhaar and Jan Dhan Yojna – leading to the direct transfer of funds into consumer bank accounts and the elimination of the middle man.
Third, rates have declined, adding support to high valuations, and creating the further expectation of a decline in mortgage and consumer lending rates, and rising disposable incomes.
The list of positives about India have been discussed in prior commentaries and is long..
Segmentation of the Market
India is now a consensus trade. It is no longer about the attractiveness about the market. The question today remains valuation, growth and flows.
Select pockets of the market are doing well, and there is a stampede to own these stocks. The returns that these stocks have generated and are generating are exceptional.
Valuations
Investors are willing to pay a 40 P/E or 5-6 times book for a stock that is promising growth above 25% for the foreseeable future.
Growth is rarely cheap, especially in a liquidity driven world.
This market rally has not been broad based. As of today, earnings are supporting the market, declining rates are supporting valuations and most importantly, flows are driving a narrow set of stocks higher.
At some point, the speculative fervour to own Indian equities will mellow out. Until that time, it is wise to stay with black.
From a bigger picture perspective, investors had the opportunity to enter this market at various levels over the past year.
This only serves to reinforce what we have often seen in the markets. It is difficult to time the market and win. It is worse if you stay out of the market. Invariably, it is the investor that invests regularly and stays invested that wins the race by a large margin.
Upcoming Earnings
