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Samir Arora – How Long is the ‘Long-Term’?

Investment Outlook , Published Feb 17, 2019

Samir Arora

Samir Arora

Founder and Fund Manager at Helios Capital Management Pte. Ltd and Advisor to SHINE Strategy*.

Equity returns on an average are generally good, although they do not come evenly.

Overview

In 2019, both FIIs and domestic investors would be buying, with the background of low oil prices, improved earnings and lower interest rates. Foreign inflows will be better with rupee weakness unlikely to pose a problem again in 2019.

It is easy to talk about the future of equity markets and expected returns, if one can use the words “in the long term” somewhere in the prediction. Elroy Dimson, Paul Marsh and Mike Stanton did a seminal study of 101 years of global investment returns a few years ago, analysing the returns in 16 countries, and concluded that the equity risk premium is on an average approximately 5% p.a. across time and countries.

Simplistically, this means that on an average, investors earned 5% p.a. higher returns from their investments in equities relative to their investments in government bills/bonds of the same country “in the long term”.

In 2018, foreign investors were selling stocks and domestic investors were buying it.

If you buy into the argument that equities outperform alternative asset classes in the long term (and in fact, have done so in the past, including for countries that lost the World Wars and for investors who had invested before the wars had even started), 80% of the job is done. Believing in equities leads to the following actionable steps:

  • Not to sell out of the equity asset class after a correction or in a panic that stocks may not recover, since history clearly suggests markets do recover
  • If point to point returns in equity are high, simple arithmetic shows that returns will be higher when one averages at low points in the market

It may be interesting to note that over the past 20 years, Nifty returns have been higher than the returns from investing with Warren Buffett (via Berkshire Hathaway) (and yes in US$ terms). The Nifty is up 12.73% p.a. in USD terms and 15.55% in INR versus Berkshire (BRK/A) up 8.15% during the period Nov 30, 1998 to Nov 30, 2018. (Source: Bloomberg).

For overseas investors, sustained INR depreciation is an additional irritant. However, we’d note that in the past 13 years, there have been three episodes where the the INR steeply bounded southwards within a calendar year.

*SHINE is a mandate run on the Sanctum PMS platform focusing on the theme of financialisation and formalisation in the Indian economy.

During 2008, 2011 and 2013, INR fell 18.9%, 15.9% and 11.5% respectively, against the US$ (and 9.2% to date in 2018). In the balance nine years since 2005, INR cumulatively lost a mere 5.9% against the US$. Incidentally, immediately following 2008, 2011 and 2013, the Indian markets rose 77.9%, 29.9% and 33.5% in the following calendar years.

In 2018, foreign investors were selling stocks and domestic investors were buying it. History again comes to our rescue, noting that FI investors invariably return to our markets, and periods of heavy FII selling are precursors to good years in equities. This is likely to remain the case given the background of low oil prices, improved earnings and lower interest rates.

With earning shocks due to demonetisation and GST out of the way, a new credit and earnings cycle will start soon. With low food prices (due to weak rural demand, low global food prices and excess supply), low oil prices, and technological deflation, headline inflation should remain comfortably low for some time.

forever-appreciating

With earning shocks due to demonetisation and GST out of the way, a new credit and earnings cycle will start soon.

The crisis in the NBFC industry seems to have been largely averted and these companies should limp back to normal by the end of this quarter. The larger issues around governance and regulatory oversight remain and the trajectory of growth is likely to be lower in the near term due to higher cost of capital, and markets rewarding cautious/ disciplined behaviour rather than vanilla high growth.

With the NPA issue having peaked a few quarters ago, the overall stress on the financial sector has reduced significantly and an important market segment (i.e. corporate banks) should also yield better results going forward.

Political uncertainty related to national election outcomes in May has become less important now that BJP losing in May can no longer be off the table, as far as markets are concerned. Recent state election results have ensured that negative news regarding BJP (if any) will not be a complete surprise in May and may even get discounted before the elections. In that case, BJP forming the government may lead to a rally immediately post elections with perhaps a similar fall if the verdict is unsatisfactory or unclear. This kind of move for the markets is not a show-stopper as the investors will not hold back their normal investments for +/- 5-10% fluctuations.

The upshot: always remember that equity markets do go up “in the long term” and tough years in the markets are usually just another “buying opportunity”.

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