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How stock market investors can reap excellent returns

November 16, 2015 09:54 IST

A combination of stagnant or falling share prices and improving balance sheets, backed by gradually improving macroeconomic indicators should make long-term investors happy, says Devangshu Datta.

 
 

Diwali is a convenient time to take stock of portfolios and review investment strategy.

Last Diwali (October 22, 2014), investors were full of hope. There was a widespread faith in the new government's ability to engineer a turnaround.

The Nifty was up 29 per cent year-on-year (y-o-y), and business sentiment was upbeat. This Diwali is more downbeat. The market is down 3.5 per cent y-o-y.

Hopes of reform have receded. The economic recovery is slow. Prime Minister Narendra Modi is no longer regarded as a magician - there has been a reality check in understanding what he can, and cannot, deliver.

Adverse verdicts in the Bihar and Delhi Assembly elections have also shaken the Bharatiya Janata Party's confidence.

There is a good chance that stock prices will not move up in the next 12 months or so. In fact, capital losses are likely. This is not because the economy is doing badly.

Data suggest it is improving, in fits and starts. But, there will be less foreign money flowing into stocks, during most of 2016. This means, valuations could fall, even if earnings growth improves.

Global growth is slated to remain low through 2016. The US is the only major economy growing at a fast clip. Europe and Japan are on the verge of deflation and China is in slowdown.

On the plus side, global weakness means crude oil, coal and gas will remain cheap. On the negative side, it means little chance of export-led recovery.

India might do comparatively better than other developing markets. The International Monetary Fund says gross domestic product (GDP) growth will improve to about 7.5 per cent.

But, foreign portfolio investments and foreign direct investments into emerging markets will slow or reverse. Hence, the stock market might range-trade or fall.

The domestic economy will have to be the major driver for GDP growth in 2016-17, and earnings growth will be based largely on cyclical effects.

Forget about any sort of reform requiring legislative action. Policy changes that don't need legislation could happen.

There are other positives. Cheap energy and low commodity prices imply low inflation and more sustainable government deficits.

The Reserve Bank of India has cut rates through 2015 and could continue to do so if it assesses the glide path of inflation is benign.

Automobile sales numbers have now started picking up. Purchasing managers' indices suggest upticks in both manufacturing and services. 

On the negative side, it's clear that demand is still low. There's overcapacity in key areas such as steel and cement production. Real estate remains in the doldrums. Banks are struggling with huge non-performing assets.

Infrastructure projects are still stalled, though, pace of action could pick up in railways and roads. The power situation has improved, and the latest bailout scheme might lead to some improvement in state distribution companies' finances.

There are some dangers as well in that another poor monsoon could knock out rural demand. If the global situation gets worse, it will also impact India much harder.

Political turmoil looks very likely, given a series of important Assembly elections in 2016 and the sharply divisive campaign style in the recent Bihar elections.

A combination of stagnant or falling share prices and improving balance sheets, backed by gradually improving macroeconomic indicators should make long-term investors happy.

Such a scenario offers value investors a chance to accumulate portfolios at reasonable valuations.

It is one of the situations where a smart and patient individual can outperform institutions. Institutional investors have deeper pockets.

They have access to more information and have the skills and personnel to research in more breadth and depth. However, most institutional investors cannot operate on long timeframes in order to exploit long periods of price corrections.

Pensions funds are among the few institutions that can lay long-term. But, then, India has very few of these.

Most mutual fund managers are judged on returns in every quarter and there is always the fear of big redemptions in bear markets. This creates pressure on fund managers.

In trying to squeeze out fast returns, they can make big errors of judgment. For the individual, the best way to handle a situation like the one outlined above is slow, systematic investment.

Don't put the housekeeping money into equity. Park only savings that need not be touched for several years. Pick index funds or index exchange traded funds if you want even higher safety.

The vast majority of investors seek short-term returns and need to reformat thought processes to cope with extended bearishness. The few who have the patience to wait out the current bear market will eventually reap excellent returns.

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