Valuations and “Guide”
Dear Clients & Prospects,
I would like to share my view on the current market valuations and how shall it “guide” us going forward. But before that, I would like to present some thoughts on how investors are making investment decisions and how can we improve on that.
As we all know that social media has become the go-to place for people seeking information on macro matters. Be it politics (domestic or international), markets, commodities, entertainment, travel, etc. people are relying more and more on social media and other over the phone modes of communication. This is not healthy. And I have my reasons that I am going to enunciate below.
In critical thinking we say that data is not information, information is not knowledge, and knowledge is not wisdom. Let’s dig deeper to understand what converts data into information, information into knowledge and knowledge into wisdom. We will stick to investments and investment behavior aspects for this exercise.
Data:
As many things in life (at least in perception and not reality), for data it is said the more the merrier. You want to have as much data as possible. This is only possible if it becomes cheaper to acquire, both in terms of time and money. As computers become more powerful (in terms of processing huge amounts of data in least time possible and that too with low costs) we will have more and more data. We can think of data as a raw material to make a finished product. This is a good thing only if we know how to use the data. There in comes information.
Information:
Put simply, information is “refined data”. In other words when we arrange the vastly available data in such a way to give it a meaning, we have gathered information. Day end stock prices of all the stocks traded on the exchange can be considered as data or as raw material. Day end index levels of various indices like Sensex, Nifty, BSE 100, BSE Metals, Small Cap Index, etc. can be considered as information. This is more useful as you can make some sense like large caps are doing well or metals are being punished or broader markets are up while large caps are lagging, etc. rather than saying that out of 1500 stocks traded today 400 were up and 1100 were down. Hence, information gives meaning to data which is a good thing and very helpful. But can we act based solely on information? I believe not. There in comes knowledge.
Knowledge:
Our ability to put information in context (perspective) gives us the required clarity to act. This is knowledge. One needs proper skills to put things into perspective. The same set of information can be used differently by different people. This is where the outcomes diverge. In the current environment, most investors are limited to gathering information only. Most of what we read on our smart phones or social media accounts is information disguised as knowledge. Daily I hear investors talking about information without any context. The questions that are answered by data and information are when, where and at the most how. The “why” is never answered. Extrapolation based on information is not knowledge.
Some questions that I like to ask myself and my fellow investors are: –
- Why should one invest?
- What is my actual rate of return (CAGR or XIRR) for last 3, 5 plus years?
- Have I invested at one go or in tranches or systematically?
- Have I withdrawn money during my investment time frame? If yes, where did I invest that money? is my re-investment rate on money that I withdrew better than my previous investment rate?
- What would have happened if I had not withdrawn the money in between?
There are many such questions, but I am sure you get the gist. Answers to these questions gives context to all the information that we have been surrounded with now-a-days. And finally, there is wisdom.
Wisdom:
Wisdom is understanding the long-term consequences of your actions. We do not know the future beyond a certain point. Not only it takes a set of specific skills and knowledge but a lot of experience as well. This is a topic that can be discussed at length, but I genuinely feel that currently it is out of the scope of this article, and I don’t think I am still competent enough to talk about wisdom yet. There is a lot to learn and experience before I can write about the wisdom in investing.
I wanted to give you a primer before I dwell into my analysis of the current market valuation keeping in mind the ongoing earnings season, geopolitics, and the US Fed. The above information/knowledge framework shall help you and me to think and take actions without compulsive reactions.
Market Guide for 2022:
The market “guide” for 2022 can be summarized in a single line from a famous song of the movie Guide – Aaj phir jeene ki tamanna hai, Aaj phir marne ka iraada hai.
There will be times when markets will be extremely jittery and can give up gains of 15 days in 1 day and you feel like “aaj phir marne ka irada hai”. Later this year once the higher inflation and lower earnings are priced in, the markets will stabilize, and you feel like “aaj phir jeene ki tamanna hai”. In other words, it is going to be a roller coaster ride as markets grapple with high input costs which will shrink the margins of companies, higher (quicker) than expected rate hikes by the US Fed and the supply shocks due to ongoing tensions in China and Russia-Ukraine. Companies trading at higher multiples due to high growth in their recent past will correct to trade at their long-term averages. Companies that have not done anything in the recent past and showing signs of earnings recovery will do well. Overall, there will be no broad market rally but a stock specific movement that we will see going forward, at least for some time. 1-2 sectors like financials and infrastructure can deliver but they will be prone to FII selling as well and one needs to keep that in mind.
In conclusion, markets are poised to correct. The timing and quantum are hard to estimate and hence taking a nuanced view towards ones portfolio is a better approach. There are 3 ways to deal with this.
- Be prepared to invest around 20% of your portfolio when the market corrects by 10% from here. You can start deploying after the 5% mark and gradually increase if market keeps correcting. This is of course if you have liquidity. Also, this is the best way (least risky) to manage the portfolio.
- If you don’t have liquidity, you can redeem 20% of your portfolio and sit on cash. Repeat what I have said in point no. 1 once market have corrected.
- This is the most simple and effective way but difficult to manage psychologically. DO NOTHING or for the sake of action you can shift the portfolio to more conservative funds via daily / weekly STP without taking cash calls like point 1 & 2.
There are more factors that point to downside rather than upside in the near term. If we are aware and if we align our expectations accordingly, we will be able to navigate the downside better. The information/knowledge framework should help us make better decisions.
Bull market lifts all the boats, and people quickly forget what happened even 3 years before. 10, 15 years is obviously out of the question for them. This is the time to rely on time and tested principles of investing and be prepared. Remember: “Testing times are ahead of us and not behind”. Predicting with information only will be futile. Preparing ourselves with knowledge will be helpful.
