“Markets can remain irrational for longer than you can remain solvent” – John Maynard Keynes
“In the short run, the market is a voting machine but in the long run it is a weighing machine” – Benjamin Graham
Stock Markets are seeing a melt down. Understandably so. There is only one thing clear about this melt down. Novel Corona Virus, Covid-19. Even after nearly three months, what we know is precious little. Lock down helps. Testing like mad helps. Aside of that world has not learnt anything. How did China, Singapore and South Korea, the immediate places where the outbreak has happened, contain the virus? Is there nothing aside of isolation and testing? Why rest of the world is in such a major crisis now? Aside of health issue, we don’t have clarity on many other things too. How is this going to pan out? How are the subaltern sections of the society and daily wage earners going to be affected? Would there be recession and shrinkage in global GDP? If so what is the likely percentage? What is the likely unemployment percentage? How much will be the drop in corporate earnings? Or will there be a down right depression that might span a decade? Where will Sensex find its bottom?
There are only two things clear as on date. President Trump is one sad man whose re-election hangs in balance because of this “Chinese Virus”. And world over trillions of dollars of wealth went into oblivion. Have a look at the Sensex.
In the last five weeks the virus has gone truly global. It has become a global pandemic in stock exchanges, even before WHO announced it as a pandemic. World over stocks have lost nearly 40% in value. Translated, wealth vanished is over twenty five trillion dollars. That’s eight years of Indian GDP at current levels. No asset class is spared. When interest rate goes down, bond market should pick up. Federal reserve brought the interest rate to near zero. Yet, bond market lost steam after initial blip. When share prices go down, debt securities should pick up. It didn’t. Whenever there is a stock market mayhem, gold prices should go up. Instead, prices came down by about 7% during this time. Commodities are another matter. Lead by oil, the commodities are in deep red. Bit coin, a modern day investment is also down. Real estate is in doldrums. No asset class is safe. There is nowhere to hide. There is a seeming stability in the markets for the past two days. (24rd and 25th March). Is the worst over? I think not. Have a look at the graph.
Look at the 2008 graph. Starts with the time, powers that be knew of the impending crisis and started taking corrective actions (There were articles on impending crisis in late 2007), the times when you and I knew about sub prime crisis, the times when Pranab Mukharjee made interventions, and the revenue reduction reports by corporates all the way to close of the accounting year. Have a closer look. stocks have lost sixty five percent. Yes, 65! Along the way there were quite a few roller coaster rides. That’s what is happening today. Worst is not over yet. I don’t want to hazard a guess on what will be the bottom. But I believe, worst is not over yet.
Before I proceed, some disclaimer is in order. I am not an expert in stock market. I am not a big investor either. But I am losing heavily in the immediate and medium term. A good chunk of my professional income is in obtaining unclaimed shares to the legal heirs. It is a success based service wherein we charge a percentage as fees. We have contracts worth Rs.25 Crores to be executed in the in the near term. Fees that we could charge halved. Our expense structure remains where it is. So, I want this to get over as soon as possible. I had no choice but to understand the pricing dynamics to understand and plan my future cash flows. So, not that I am interested, but I have no choice but to binge at it. Fortunately for me, the valuation Guru Professor Aswath Damodaran comes out with a series of blogs that gives reasonably good perspective about US markets. I am using the same framework to understand Indian markets and providing you the basic perspective to have a closer look at what is in store.
This is not the first time, stock prices have melted. And this is also not the last time. This is the last of Index Graphs. This is BSE 500 from the inception. There are multiple number of times index has melted over 20% and twice over 50%, once during Harshad Mehta Scam and the next was during Sub Prime Crisis. Others being 1998, Dot Coma and Brexit. Five or six melt downs in 30 years. Every time, world economy bounced back and recouped what is lost.
There is a difference, though. Virtually, every major melt down earlier, was man made – Greedy financial services companies or political leadership or rowdy companies. So, Governments and Central Banks could, do what they could to contain it. They had trial and error solutions in place. But solution in this case has to come from some laboratory somewhere in the world. And this problem is huge. It is too big. Bigger than anything the world has experienced for a century perhaps. As the Americans say, this is bigger than great depression and 2008 melt down put together. Better analogy is, it is possibly bigger than Bengal famine.
So an economic impact is a given. No point trying to address the stock market melt down or trying an economic revival package. There are other areas that require support. Daily wage earners and subaltern society – bottom 40% of the pyramid – will be affected big time. Every energy should be trageted at that. Getting them rations, money through Jan dhan accounts etc. Quite a few state Governments have started this. Second is the under employed people trough out India. They have EMI, they have a family to run, they are not sure of salary. Government should provide addition credit to maintain salary. This is a priority area. Quite a few MSME loans are going to be NPA. There has to be a better restructuring mechanism so that the sector will still survive when everything else is over. I hope no other economic stimulus except these three.
I am not a macro economic scholar. But it doesn’t take a rocket scientist to say this. Economy will be hit big time. Even the 4% growth may be rolled back. It may even slip into recession. So long as it does not slip into full blown depression, we should feel lucky. They all can wait. Getting through this beast with minimal hurt is the prime priority.We are not alone. Whole world is hurt in all forms including stock market. Have a look at the stock losses around the world till 20th March, 20201.
Then comes the next question, is it the right time to invest. Has the index reached its bottom? In my opinion, it has not. Quite a few stocks are quoting already at ridiculous valuations and are crying for a buy decision. Market, based on the information we have, has every chance of going down. It is next to impossible to catch the bottom. It is not needed at all. But, what I would bear in mind is this is not a standard ‘buy at fall market’. Lot of qualitative parameters come into play due to a simple reason. Nobody has experienced this extra ordinary situation, we are in today. It is just not feasible to fathom what is in store, based on living memory alone. So qualitative parameters are more important. It is here Aswath Damodaran Models would help.
Before getting into qualitative considerations, a look at what is in store for Indian industry is helpful. Based on the information on the virus as on date, it is reasonable to conclude, we are and the world is entering into deep recession, if not depression. Clamp down and exodus of migrant labour is going to put spokes on companies’ ability to come back on track. Supply chain disruption should also be taken into account. It is clear that there is going to be substantial loss of revenue in FY21 for most of the corporates. Reduction in revenue implies reduction in cash flow and implies lack of ability meet debt and other credit obligations. There is going to be more NPA than we have ever seen. Aswath Damodaran’s diagram below captures these factors vividly.
And in India, we have another twist. FII investments. FIIs are removing money at the rate of Rs.4000-5000 Crs every day. Before all these started, their investment in Indian stocks may have been about. $400 Billion. It has probably halved by now due to reduction in market and infavourable exchange rate. They must have removed about $12 Billion as on date, still a long way to go. What if they decide to exit almost fully? I shudder to think of the consequences. Much depends on how well we control this virus spread and how other countries cope with it. We are good as on date and it is reassuring.
First qualitative parameter is, what is your philosophy on this Covid-19 pandemic? Is it going to pass within one month like astrology predictions in social media say? Or do you believe, this is going the way Spanish Flu went? – Infecting half the world population, killing at least 50 million people, depression for a couple of years, euphoria for a short while and great depression. Or do you believe, it would be several quarters before semblance of normalcy returns, if not years? Window for investment depends on that. Till such time markets bound to react to incremental information and behave like voting machines, increasing the index by 1000 points one day and pushing the index by 1500 points next day. Value will eventually emerge. My personal philosophy is that it will take multiple quarters before semblance of normalcy returns and we Homo Sapiens will come out of this too. But, there is no quick fix.
Second is your own financial status. Do you have liquidity to invest more? Do you need the money already invested to see through the crisis? If we need the liquidity we need to encash and if we have surplus liquidity we can invest on shares whose value is low. If you don’t need liquidity and if you don’t have additional liquidity, best is not to do anything. At best we can swap share to the ones that has better value, the ones that were beaten down hard.
Speaking of value, value is a function of free cash flow to the firm. Free cash flow depends on current earnings, earnings growth and future earnings. Understanding the value of a scrip depends of plausible revenue and growth loss due to the crisis. And an estimate of how much of this revenue loss due to crisis will be recouped in coming years is an important parameter. Just to provide some perspective, a seemingly small 10% reduction in revenue in NIFTY companies is phenomenal loss of value. But this can wait. I think, for another couple of quarters at least, markets will be in voting machine mode. They will not be weighing machines and value discovery is not likely to be in the horizon.
So, we have this final question. Where to invest? You can invest on the index, sector or individual shares. But which ones? There are only broad guidelines. I wouldn’t touch travel related industry or companies that deal with personal discretion, say white goods, I would avoid young companies since they burn more cash and they will find it difficult to raise funds, Companies with lot of debts will find it difficult to service debts. Companies with cash will find it easier to survive.
I have collated a spreadsheet with these parameters in mind. Performance of Indices, performance of sectors over a ten year horizon and performance of BSE 500 companies with debt and cash balance (negative of loan is net cash in balance sheet, loss percentage from 52 week high, Free Cash flow etc, apart from standard PE, Market Cap, Price to Book, Dividend details. You can download the file here.
I am working on Indianising Aswath Damodaran’s models for valuation of index and stressed companies. I will also be periodically updating the file that I shared. I can send the files to you if and when ready/updated. Just leave a comment. Simply say ‘Hi’ or ‘Send’. Your mail ID will not be revealed to others.
Happy Investing and Happy Home Confinement. Just be careful.