What to make of the Markets

As with any other beginner, when I started off in the market, I was a Bull. I saw friends short stocks but never got enthused. Long stocks are good in bull markets but bull markets end and when it did and we went into one of the longest bear markets I have experienced (2000 to 2003), I migrated to a trader. Retrospectively with more data today vs then, this was one hell of a bad move. 

It took me nearly 15 years to migrate back again – back to the camp of the bull and it has been a good time. So good that I find myself looking at things only from a bullish angle. But we have had a decade of astonishing rise – both in the markets as well as in the size of the central banks that have helped the economy remain afloat during the tough conditions.

This post is trying to, as Charlie says, invert the idea and think about whether I could be wrong.

Markets can go through long periods of nothingness – we have seen that in the Indian markets themselves as they rolled around with no real returns other than a few spurts from 1992 to 2000. In fact, even in 2000, if you were not a participant in the Infotech sector, making money was pretty hard.

We have seen the same in the United States, recently between 2000 and 2010 and previously in the 70’s decade. Does investing, Buy and Hold, Value, Momentum really work during those times?

Data is scarce which means that backtesting is tough (at least in the Indian context, data for the US is available but expensive for theoretical understanding). Compared to the 90’s, Information is not scarce as it was during those times, so the easy opportunities that were found by many great investors will not be as easily found today. 

What would trigger such a long term range bound market?  

When a bubble bursts, markets first go into a bear market and depending on how the economy manages to hold up can go into long sideways action. We saw this in the US post the bust of the Dot com, Japan is still yet to come out of the bust it saw in 1980, much of Europe (exceptions being Germany and a couple of others) have never risen above the heights they saw in either 2008 or even 2000. 

The CAC Index of France was able to break above its high of 2000 only this year. The FTSE of the UK is just above its high of 2000. IBEX of Spain is closer to the 2008 lows among others.  Not surprisingly when we talk about International Investing, we focus only on the US and even there much focus is on the Nasdaq for that has generated returns like no other Index has in the past decade and more.

China has been a growth story for the  last few decades but if you were an investor in the Shanghai Index, it’s been a literal no growth Index for more than 15 years now. HangSeng is pretty close to the high it saw in 2000.

India along with the US have been the most expensive markets. Russia was the cheapest. But does an expensive market mean  we are in a bubble? 

The biggest bubble most point out is the Federal Reserve Balance Sheet. 

The Federal Balance sheet first ballooned up post the financial crisis of 2008, remained elevated for nearly a decade before rocketing up when Covid hit. But if you were to look at the chart closely, you shall see that it was not the Fed’s Balance sheet that brought about the 2008 crash or even the 2000 crash (data not available on the Fred website).

What brought about both the bubbles is an extended period of low interest rates. But inflation did not spike either of the time. This time around, while we have no bubble (housing prices have shot up in the US but not to bubble territory) in any public markets. Private markets are in a bubble depending on how you look at the valuations there but there won’t be any panic selling, just panic shutting shops when the firms burn through their capital. 

Are Indian Markets Expensive?

Expensive Markets are always at a high risk of a crash when expectations of future earnings shift down drastically. Here is the monthly chart of Sensex trailing four quarters price to earnings ratio. While we aren’t cheap, we aren’t anywhere close to the high’s as well. Of course, if future expectations of earnings go down for whatever reason, even this may seem expensive.

Gone up too much and hence markets needs to fall

I keep hearing this and in a way, there is an element of truth there. When markets go up too much, too fast, it seldom has been able to stay at the higher end for long with the subsequent correction being easily to the extent of 20% to 30%. We have seen this in the past – the 2003 rally was followed by the crash in 2004 (narrative being the fall of the NDA govt) though by the end of the year, markets were positive for the year. 

The last year the Index had a negative year was 2015, so with 2022 being the seventh year of a bull market, is a deep correction due?

Even internationally save for Japan where Index went closed in positive for 12 year culminating in the peak of 1989, Indices rarely sport seven or more consecutive years of positive close. Currently one of the Index that is positive for the year which is its 11th consecutive year is the S&P MERVAL Index, Argentina’s flagship index. Not sure we would want to mimic their economic performance though.

One reason for the inability to sustain a long period of continued growth comes from the fact that markets are mirrors of the economy and an economy that sees strong growth will generally be over heated to the extent that some cool off is required before the next phase can take off. Japan is an example of what can happen when Central Banks don’t pull in the plug when the economy starts to get overextended.

But if we are to look at India’s growth, or the debt of the Corporate Sector or even the Debt of the government, we don’t seem to be at a stage where excess money supply has chased growth making things expensive for everyone. We saw that in the 2003 to 2008 boom. 

Given that Corporate earnings are good, most Twitter Analysts have veered to Macro to forecast doom and gloom. 

Macroeconomics is tough. Professional Economists have got it wrong so many times that Paul Samuelson joked years ago, “Economists have predicted nine of the last five recessions. Even when they get it right, the claims are muddied somewhat by how early many would have given such a call.

Take this opening para from the book, The Economists Hour 

In 2016, Warren Buffett had this to say on Economists

“I don’t pay any attention to what economists say, frankly,” Buffett said two years ago. “Well, think about it. You have all these economists with 160 IQs that spend their life studying it, can you name me one super-wealthy economist that’s ever made money out of securities? No.”

“If you look at the whole history of [economists], they don’t make a lot of money buying and selling stocks, but people who buy and sell stocks listen to them. I have a little trouble with that,” 

But can we dismiss economics as modern day voodoo? As investors, does it really matter a lot?  

I believe it does matter. When we study markets, much of our focus other than the local markets is on the US markets. There has been so much inflow of funds into the US from Mutual funds here that they have exhausted the RBI limit on the max allowed.

But this attraction in itself is very new. Motilal launched their Nasdaq 100 ETF way back in 2011 but only in the last couple of years did the assets under management really take off. 

First, let’s take a look at why Inflation was on the boil in US (even before the Russia Ukraine crisis sent prices of commodities sharply upwards)

Across two presidencies, Congress approved an unprecedented $5.8 trillion in relief spending that included new interventions such as forgivable loans, direct payments and an expanded child tax credit that was deposited into people’s bank accounts monthly. 

The Federal Reserve Balance sheet was 3.8 Trillion USD before Covid crisi hit and the Balance sheet was expanded.

Here is an interesting data point. The Central Banks for most part are behind the curve, they then start aggressively tightening and from being behind they end up being ahead which in multiple cases have resulted in a recession. The way out of recession, to again aggressively go back behind the curve.

From the book,. The Great Crash 1929 by John Kenneth Galbriath

Speculation on a large scale requires a pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich. People must also have faith in the good intentions and even in the benevolence of others, for it is by the agency of others that they will get rich.

In 1929 Professor Dice observed, The Common folks believe in their leaders. We no longer look upon the leaders of the Industry as glorified crooks. Have we not heard their voices on the radio? Are we not familiar with their thoughts, ambitions and ideals as they expressed them to us almost as a man talks to a friend? Such a feeling of trust is essential for a boom. When people are cautious, questioning, misanthropic, suspicious or mean they are immune to speculative enthusiasms.

In late 2007, things in India were going so well that any doubts of a crash were not even considered as possible. Yes, there was some issue with the housing market in the United States but its impact was seen as being limited to the US. Decoupling was a word that CNBC commentators started to use to claim why Indian markets were continuing to rise even as the US markets had started to react.

The last time I remember such enthusiasm was in the Dot Com bubble and for a short period in 2004 when India was supposedly shining. 

Markets have seen a significant rise in the last 18 months. That combined with low interest rates and high inflation seem to suggest that the future will be tougher. Question though is how tough and how steep a fall should we anticipate from here.

The Federal Reserve has started to hike rates. The last couple of days’ fall in the stock markets can be directly linked to the hike. But as Powell seems to suggest, they will not go all out hiking Interest rates to the extent of pushing the economy into a deep recession.

While we have seen deep corrections in the past, its tough if not impossible to predict normal corrections where there is no bubble visible. Even when bubbles had been visible, for example the housing bubble, timing was the key and it’s doubtful to have been able to time ot a T.

My personal view for now continues to be bullish. I see no reason to jump out. Breadth has started to decay but is still well within the historical range. The icing on the cake will be if Oil starts to come down.