How Power of Perseverance works in Investing?

“Successful Investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.” — Warren Buffett

Shall economic activity change your investment decisions?

Indian financial markets are in doldrums and a complete mess. There seems to be no future for the Indian economy. ATLEAST as per what the news media has to say. Let us get to the line of events that have happened in 2018 & 2019, that has led to ripples on financial system and markets.

2018

• IL&FS Scam: IL&FS, an AAA-rated investment NBFCs defaulted on its loan. The reason for the default was the poor governance and business practices observed by these firms. This led to a loss in confidence in other NBFCs or banks irrespective of their credit rating or financial position enjoyed. Bankers/lenders became cautious and tightened their fist. This led to a collapse of financing to select small cap companies.
• Many episodes of fraud came to daylight due to illiquidity. Then came governance slippage in Sun Pharmaceuticals vide whistleblower report. This shook the confidence of investors as it was a large cap company widely held by investors.
• 2018 ended with IT, Pharma and FMCG reaching 52-week highs backed by good growth in sales and profits.

2019

• The year started with huge selling pressure in companies that had their promoter shares pledged for loans. Lenders started selling off shares marked against loans to build up liquidity.
• Then there was a new chapter in Yes Bank (supposedly known as next HDFC Bank) reporting jump in NPA numbers and many of it from not so good quality borrowers. And the bad loans kept rising as every big corporate (RCom, Cox & Kings) defaulted on their interest payments. This House of cards tumbled at once given the unconventional loan structure.
• Fall in liquidity across the board made lenders cautious against even auto dealers and second rung NBFCs which led to auto sector slowdown and consumption slowdown.
• Despite all this news, there are around 50 stocks that are making new highs. Their growth has not been hampered as badly as others.

Business performance over Economy

The point worth noting here is- it’s not about the economy but about the individual businesses. When there is a slowdown or recession, some businesses will go down because of various reasons like an unviable business model, poor corporate governance and a slow economy, the above-mentioned names are a few of the examples. On the other hand, there are few businesses that will be reporting good growth rates, like what’s happening in Chemical, FMCG and consumer durables stocks because their business may not be very much correlated to the economy. So on average, even if the economy is not doing good, there could be a vast divergence in individual business performance. This can lead to non-correlated stock performance as well. Hence we can conclude that even if there is a slowdown, we can find enough money-making opportunities.

Divergence in stock price and fundamentals

Besides, history suggests that there is no exact overlap of performance every year between aggregate stock prices and nominal GDP growth even if in the long term they grow at a similar pace. Look at Figure 1 below. Likewise, stock prices and earnings growth do not move exactly in line because slow growth can often be already factored in by drop in stock price or market may have rallied before earnings growth came in.

One of the reasons for this divergent movement is because in short term markets are also driven by sentiments and fund flows versus just fundamentals.

As highlighted above, the year 1996–97 lodged a negative change in the nominal growth rate of GDP. Still, the market rallied up to 16%. Similarly, from 2014 to 2016, there was no positive change in the nominal GDP growth rate, still, the market rallied more than 12% CAGR.

Continue reading here…