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Deepak's Memos

Wealth Letter Nov 2020: TINA. Where else can you go?

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[This post is an edited excerpt of the September 2020 letter to our Capitalmind Wealth clients]

The alternative to stocks is…stocks. 

There is no alternative (TINA) is the mantra. No alternative to stock markets, at least abroad. Because they’ve cut their rates down to near zero. In Europe they charge you a fee to maintain a deposit, rather than paying you interest. In this environment the only way to grow your money, or to have it grow for you, is to invest in risky things. And within those risky things, the most visible alternative is stocks. 

As the US election results started to seep in, this became an interesting point. Would stocks fall if this person got elected versus that? The answer was: no. Stocks just cannot fall, it appears. The politicians will not risk, in any easy way, a destruction of the only wealth that they have slowly pushed everyone into: stocks. If the market falls, so does all the retirement capital that people have built for years, because that is mostly invested in stocks. Why? Because nothing else gives a decent return – fixed income is now just “fixed”. There’s hardly any income. The riskiest asset now cannot be allowed to fail. 

So, central banks will print money to ensure stock markets are up. Of course, their official argument is that they want bond markets to be “calm”. This is an excuse. They look at bond markets but they care a lot about the feedback from stock markets. If you disturb the stock market, there will be repercussions on the bond market. Money doesn’t flow “between” the stock and bond markets anymore like they used to; earlier, they’d tell you that if the stock markets fell, investors would buy bonds. Now they use bonds to finance their stock market purchases, which means that when the stock market crashes, so does the bond market. And vice versa. 

Therefore, the idea of all the central banks now is: protect markets, bond or stock. This will still punish a few stocks, but create an extremely high valuation in others. This is not bad for market investors, of course – because it will only push markets higher. But there’s a point where you start to believe that markets have nowhere to go but up. If the entire ecosystem is out to not just protect you, but to ensure that your stock prices go up, then it’s easy to think your portfolio is invincible. 

This drives us to an interesting point because it was an argument like this that we heard before 2008: that housing prices cannot fall, because people’s fortunes are in houses, and the ecosystem conspires to keep housing prices up. What happened next was a dramatic fall in markets, not just in the US but worldwide. That was however the first time central banks discovered they could actually play God, and have done so ever since. 

Printing money should have generated inflation and a drop in currency rates. Inflation is now in asset prices in the financial system (bonds and stocks) but not in the real economy because the low rates have dramatically boosted productivity. And currency exchange rates will remain the same if all countries print money. 

At some point, this global order will change, and it seems now that it will take an event of a magnitude higher than Covid-19 to bring about this change. It makes sense to stay with stocks, even at higher valuations because you have no idea when this bubble will burst. Not even the knowledgeable people do. In 1996, Alan Greenspan, the Chairman of the Fed then, said famously that stock markets were irrationally exuberant. The market continued to go up for 2.5 years more before correcting, and even after the correction, remained above the level at which Greenspan made that statement. No one would know about liquidity as much as Alan Greenspan, and even he called it too early.

Calling it too early is a disadvantage, as we have seen. Both the multicap and Index strategies maintained a little cash, and we intend to have it till around December. There are some reasons for that:

  • The end of the moratorium period was end-August, and thus loans only turn “Non Performing” after end-November (A bad loan is recorded only three months after they stop paying). Already, we have a large borrower – Shapoorji Pallonji – defaulting on loans to initiate negotiations, and banks will have to deal with more such changes. While the stocks seem to indicate that all is well, we believe that the risk is ahead, and indeed for the market itself.
  • The damage of Covid has resulted in rapidly dropping loan growth. This applies to all sectors, but the largest hit seems to be retail and services. Overall loan growth is below 4% – about the lowest in nearly 30 years. Growth in home loans, an area that’s always grown over 15%, is now around 8.5%, the lowest in 10 years. This doesn’t seem to reflect in listed company valuations, so we’re just going to be a little careful.
  • The resolution of Covid – either through a vaccine or through a slowing of cases – has an initial euphoria. However, that brings focus back to the economy, which is still struggling. Given how sentiment turns on a dime nowadays, we expect some volatility.

Note that India isn’t the west. We still have decent fixed income returns. We have an RBI governor who isn’t too bothered about the stock market. We don’t have our life savings in stocks, so a falling market doesn’t have a deep impact on people’s financial savings. This means in India we might still see a correction. 

That emotion aside, we’re still majority invested in stocks. Markets will do what they have to, but in the longer term, they should do well. 

Recently, the momentum strategy has been hurt by the abrupt trend change, but the quantitative nature of the strategy ensures we stick to the rules. The index strategy continues to notch up superb performance and we’re sticking with the original set of instruments – top 100 India and top 100 US stocks. Multicap continues to change according to the times, with a little pruning to reduce capital gains taxes. 

The Scam 1992 webseries (Sony Liv) has been an interesting watch. It talks about Harshad Mehta and the great banking scam of 1992 which resulted in a massive drop in the stock market as well. Because Harshad was taking money from the bond market – effectively borrowing it short term illegally – and putting money into stocks. The dam broke because eventually he had to pay someone back. The same thing today is now about central banks printing money to buy stocks, which is extreme because they have to pay no one back. 

In this environment, it’s difficult to imagine that anything will bring stocks down. Our answer to this is to focus on innovation – much of which, unfortunately, is only listed in the US. Our quasi ownership of startups (through a few plays in the Multicap strategy) is likely to only be helped as investors abroad start to line up to buy into our economy, simply because there’s too much money. Already, flows into MSCI passive indexes seem to be causing a flutter with around $1.5 billion coming in within the first few days of November. And tomorrow, the capital will flow into startups, into disruption and into growth. 

Think about it. Swiggy and Zomato changed a generation, where otherwise you’d expect free delivery. To the point where the restaurants want them for discovery, for promotion and for order fulfillment. Neo banks make otherwise expensive transactions – like forex transfers – much cheaper using dynamic algorithms. Uber and Ola change suburban habits of owning cars or looking for parking with vehicles-on-demand. This change is expensive, because the building of this technology is costly. It needs a few years of “burn”-able cash, and then more for marketing. All that is possible to raise now, simply because your money won’t make anything anywhere else. 

Reliance showed us this, in two of its verticals. Jio, the telecom arm, raised over Rs. 120,000 cr. and Reliance Retail, the retail commerce arm, is progressing with over Rs. 30,000 cr. invested. The flow is coming, and there will be more. It’s best we position portfolios to benefit from this, but to many of you, it may also help to build your careers or businesses for the future. 

We’ve managed a bunch of regulatory changes, handled very narrow market timings, and kept our systems as transparent as we can. There’s a lot more coming, and we hope to make it such that your portfolios will do wonderfully in the coming year! 

Stay safe, and have a great time!

Cheers,

Deepak

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