Dear Investors,
The following chart depicts our returns viz BSE 500 TRI:
Indian equity markets, especially small and mid-cap companies, have been scaling new highs for the past few months. The question on the mind of most of our existing as well as prospective client is whether it is a good time to initiate investment or continue to remain invested in Indian equities. We have covered this topic several times in the past, but we are going to revisit this topic in this month’s note given how hot it is.
Our stance continues to be that it is impossible to time the market. No investor can accurately predict when the market has topped out to exit / stay out of equities or when the market has bottomed out to enter / re-enter the market. So, we believe there is an overwhelming risk of missing out on great investment opportunities if one tries to continuously time the market. This is not to say that one should be oblivious of stock valuations. In fact, we closely track the valuations of each investment in the portfolio and are very objective in exiting positions that have become expensive. Also, we try to be as disciplined as possible about entry valuations and never overpay to invest in hot or trending stocks.
However, what we have never done and will not do is take overall portfolio calls like completely exiting the market depending on market levels and macros. That is market timing, and we reiterate that it is impossible to do it to make meaningful alpha. Our belief is that alpha generation can mainly come from stock selection rather than market timing.
Just to highlight the futility of market timing, below is a chart of NIFTY SMALLCAP250 index (we have selected as it is a correct benchmark for our small cap focused investment strategy). The index, just like small caps in general, has been on a tear since April this year making new highs with time. At what point during this rally, should we have liquidated our portfolios due to concerns of overvaluation or markets making new highs? If we would have done that, it would have turned out looking so wrong in hindsight. As we have shared earlier, how does one know that the current buoyancy we are seeing in the market is not the start of a multiyear bull cycle? The opposite might as well playout that a correction might be just around the corner. The point we want to emphasize is that no one knows, and a rational investor should be aware that he/she does not know. So, we believe the right course of action is to stick to one’s investment framework. We are bottoms up investors and approach any market condition on a stock-by-stock basis. As we speak, we are partially exiting companies/stocks that are expensive on an absolute basis. We are gradually redeploying this capital into names that have a strong growth prospect and are reasonably valued.
With the benefit of hindsight, the only actionable insight from the above chart is that the one year or so leading up to March 2023 was a good time to invest or top up your investment in Indian equities when the valuations were attractive. We did communicate the same to all our clients during this phase advising them not to panic during this market consolidation and in fact taking advantage of it by investing more. Here, we would like to highlight that taking advantage of market correction / consolidation is the only form of market timing that we have seen to always work out consistently during our decade plus investment journey. As your fund manager, we would continue to advise you to take advantage of any market corrections in future.
Market timing is also difficult because there is no proven correlation between macros and performance of equities. The biggest example of this is the Covid-19 pandemic. The one and half year post break out of Covid-19 in March 2020 turned out to be the one of the best phases for equities globally when humanity was facing its worst calamity of the past 50 years. Very few predicted the rally in equities from April 2020 to Dec 2021. Below is a table of quotes from some of the greatest investors and economists (some of them Noble laureates) predicting a severe bear market in March 2020 and the market humbled them all.
Similarly, the chart below highlights the futility of using macros to predict equity performance. GDP growth rate is probably the single most important factor to gauge the health of an economy. However, as seen in the chart below, there is no strong correlation between nominal GDP growth and corporate earnings growth.
Source: Motial Oswal Financial Services
Similarly, the table below shows the impact of wars, which is again a major macro negative, on performance of leading Indian index Nifty 50 immediately after the breakout of war and 1 year after the event. It is clear from the table that there seems to be no negative impact of wars on Indian equity performance 1 year down the line.
It seems that key macro factors like GDP growth and breakout of war do not have any meaningful correlation with equity performance in the long term. So, using macro factors to try to time the market appears quite futile. What has always worked out for investors is remaining patiently invested in equities in the long term. The table below shows the stellar performance that few Indian MFs have delivered for over long periods of time. The unfortunate truth is also that very few investors of these MFs have actually enjoyed these returns because most investors have not remained invested during such long periods of time. Most MF investors would have tried to time their investment in these MFs by exiting during corrections and entering during bull phases thus giving up these outstanding returns in the process.
Source: Bloomberg, Data as on 16th June 2023
To summarize, our advice to any prospective / existing investors worried about the current peak of the market is to have a long-term orientation and initiate or remain invested. We again reiterate that it is impossible to time the market so our approach will be to continue to invest conservatively in high quality businesses at attractive valuation while exiting existing investments that have become expensive.
Please feel to reach out if you have any questions / concerns.
Regards,
Prescient Capital