Virus Will Pass, So Will The Opportunity

Global and domestic equity markets have seen significant correction and most major indices are down about 30%. There is panic, negativity and pessimism all around. These sentiments remind me of the golden words of legendary investor Warren Buffett: “Be fearful when others are greedy, be greedy when others are fearful.”
The table here highlights major corrections in Indian capital markets over the last two decades triggered by global factors and the subsequent returns over the next five years. The healthy returns suggest the best investments are made in toughest of times.

It is interesting to note that while markets have corrected by about 30%, the impact of coronavirus on economy/corporate profits will be far less, especially over a year. If the prices have fallen but the business values have not, then can bargains be far behind?

The fall in equities, and even bonds, is mainly due to massive FII selling. This is probably happening because India is clubbed with emerging markets (EMs), whose economies are significantly dependent on exports and/or are net exporters of oil. As India has received allocation from EM funds, it has also seen significant outflows. The unique thing about India is that it actually stands to gain in this environment. This is because exports are a relatively small portion of our economy, and the sharp fall in oil prices is a big positive for India.

The disruption in global supply chain due to the challenges in China has highlighted the risks of over-dependence on a single country. Thus, many global MNCs are likely to consider diversifying their manufacturing operations away from China with a sense of urgency. India is likely to emerge as a key beneficiary. The simple message here is that while the current environment hurts most EMs, India actually stands to gain over the medium term. Hence the deep correction in Indian equities is an opportunity that investors should not miss.

It will be, however, naive to conclude that there will be no impact of Covid-19. The impact on consumption will be felt for some time. Given that India is a services-led economy, there should be impact on wages, especially of the lower income groups. This could result in a slightly more prolonged effect on consumption. But as the weight of these in the Nifty50 is limited, the impact on broader markets should be limited.

Large banks should be not affected much — credit growth was in any case low and peak NPAs and provisioning costs are behind us. Further, capex, utilities, oil refining & marketing, and pharma should feel low impact over a year. IT could feel some impact of travel restrictions, economic slowdown, etc. Though it benefits from a lower rupee and higher offshoring. Thus, most sectors are likely to be minimally impacted at least over time, but their stock prices have also fallen in tandem with other stocks.

The current volatility is a reminder of the real nature of equities — unpredictable, risky, hard to forecast and prone to throwing surprises, especially in the short run. This is also a reminder of a few time-tested rules that investors must follow: 1) Invest only risk capital in equities, that is, the portion of wealth that can be spared for 3-5 years or longer and on which volatility can be tolerated. 2) Never borrow and invest, avoid futures & options (except for hedging). 3) Maintain diversified portfolios of direct stocks or invest in mutual funds.

Ideally, where risk appetite permits, investors should go a step further and use this deep correction to their advantage by increasing exposure to equities/equity funds. It would also be advisable to invest in 2-3 phases over the next few weeks or months.

An interesting learning over last 3-4 cycles across three decades is that leadership in the markets has changed only in downturns. Old economy to IT in 1992, IT to old economy in 2000, infra & others to FMCG, pharma in 2008. Will this correction also result in a leadership change?

Direct investors should, therefore, be careful when buying stocks that are down sharply after years of strong returns because if there is indeed a trend change, then what worked in the past may not, and what did not work till now may finally do.-Times Of India