It is good to belt up for the coming volatility
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Every market cycle has its own defining moment. That moment changes everything. The dominant trends, popular investment themes, and investment performance all peak around that time, which is usually also at a market peak. Defining moments are normally triggered by an event. But the triggers are more of an excuse; they were anyway waiting to happen.
Budget 2018, for example, was more of an excuse that triggered a directional change in our markets. But investors remained habituated to thinking in a particular way and failed to read the directional change correctly until the markets had moved decisively lower. Investors tend to remain indecisive until the market shows a decisive and irreversible trend. Investors tend to stay with an investment, thinking it had worked, and remain anchored to that. By being anchored, they fail to read an emerging trend until it establishes itself firmly.
Budget 2018 was a defining moment. Post-budget, FIIs that already saw Indian valuations as stretched, decisively moved into a sell mode on Indian equities. And this trend is unlikely to change anytime soon. On the other hand, domestic investors continue to remain anchored to their investment actions and strategies of 2017. There seems to be no hurry to recognize that defining moment.
This unwillingness manifests in different ways. Domestic investors show no hurry to read emerging trends or to identify popular investment themes of the future. Instead, they remain anchored to past investment performance. We continue to put money into investment themes that are clearly fading out. We refuse to allocate any money to emerging trends. Our hope is largely centred around the expansion of price-to-earnings (P-E) ratio rather than on turnarounds. We continue to bet that commodity user industries will benefit despite rising commodity prices. We are putting most of our monies on the companies that did well in 2016 and 2017.
When our investing needs to be dynamic and forward-looking, we remain mechanical and habitual. This can’t be without consequences.
If companies can’t sustain performance and valuations are stretched, investors may face long time-corrections. If a company’s fortunes reverse or changes, we could see a sharp contraction in its valuation. If institutional investors see a reversal of fund flows, they may show haste in their investment actions. They may be forced to sell stocks, even if they believe in those companies.
So, how can investors prepare themselves and achieve future readiness? How can they align themselves with future trends?
Public investors are unlikely to make a sharp shift in their investment stance or strategy. Their asset gathering objectives will not permit that. But individual investors don’t have such operating constraints. They are free to revisit their macro stance, review their investment strategies, revise their near-term return expectations, and make fresh investment choices. They must read the dominant trends of tomorrow and realign their portfolios. Recognising a defining moment, reflecting on the consequences, and reviewing stance will distinguish a proactive investor from a reactive one. It is important to always be tied to proactive investment behaviour.
Where companies sustain business performance and their valuations are stretched, investors may face prolonged phases of time corrections. If, during that phase, the company’s fortunes reverse or change, we could see a sharp contraction in valuations. Most investors do not have the ability to weather such phases. This is especially true of public investors and fund managers. They often face the threat of sudden withdrawal by end-investors. Retail investors can become reactive and trigger a chain of reactions across markets. This often leads to massive redemptions and reversal of fund flows. If institutional investors see a reversal of fund flows, they may be forced to undertake hasty investment actions. They may be forced to sell stocks even if they still believe in the future of those companies. This can potentially lead to significant value destruction. Such trend changes, in turn, tend to affect individual investors who are personally great believers in their stocks. After all, nobody wants to see their stocks lose one-third in value. The conditioning needed for that has not been put in place. Recent anchoring also tends to create the wrong conditioning in us. The defining moment has clearly set us on a course of investment discovery that will test our resolve, conviction and behaviour. The core issue is not our ability to hold out against odds. It is our lack of preparedness.
The only choice now before us is to prepare. And, we need to prepare ourselves quickly for a year of volatility and dramatic change. Importantly, we need to revisit our investment optimism and tone down our expectations. We need to anticipate a potential dip in company valuations, notional drop in portfolios and dramatically altered investment fortunes. Achieving the requisite mental preparedness and agility to overcome sharp market downswings will help us respond to opportunities. We will also be in a state of readiness to act on opportunities that market volatility will offer us. The coming year may throw up several rounds of such opportunities. There will be times when the markets look shaky and unstable. Sell-offs will happen mostly during these phases. Being ready, prepared and willing to turn these phases into opportunities is the most important thing now. The themes of tomorrow are likely to be quite different from what worked in 2017. This year is likely to be a very different investing year and it will take preparation to keep one’s winning streak going.
Shyam Sekhar is founder of ithought, an investment advisory firm.