Against conventions

Investments tracking economic expansion and mimicking institutional investors have to reckon with higher costs

It takes a crisis for investors to realize the uselessness of conventional theories. A track record of expanding revenues and profit, a sound dividend policy, transparency in operations, prompt disclosures, shunning discrimination against the small shareholders, standing out in comparison with peers, good liquidity and presence of institutional investors are high on the checklist. It is rare to find a stock that has all these qualities. Gain in market share is often at the expense of the margins. A low base can push up profit in a year but becomes difficult to sustain going ahead unless debt is taken to grow organically or through acquisition. Cash accumulation creates unease about the longevity of the niche position in the event of technological disruption going ahead. Instead of imparting a sense of security, deployment of cash becomes a concern. Promoter control offers solace about continuity as well as discomfort over sudden change of direction. If foreign and local fund holdings are tracked to validate the correctness of the investment decision, their contradictory behavior during the recent market turmoil has caused confusion rather than resolve the issue of using these big-ticket investors as the guiding pole. Overseas portfolio investors have exited while mutual funds stayed put in stocks. The question is whose actions should be considered a reliable indicator of the outlook for a company.  Investors mimicking the footsteps of institutional investors have to prepare to churn their portfolios along with these leaders. Trading expenses and taxes can eat into the gains.

History is rife with the futility of policy makers trying to shape the movement of liquidity to maintain the growth momentum and at the same time exercise fiscal rectitude. During the Great Depression of the 1930s, the US limited credit and cut down expenditure. It took a decade for the global economy to recover from the risk-aversion. The controls imposed on the surging fund inflows into the Asian Tigers to tame prices of assets triggered the first currency crisis in 1998 after the formation of the WTO to facilitate seamless trade. In contrast, the dot-com boom and bust at the turn of the century resulted in loose monetary policy by the Federal Reserve, clearing the way for the global financial meltdown in 2008. Ironically, the seeds of the present turmoil in the foreign exchange market can be traced to the US central bank embarking on an opposite path of money-tightening. The more the Fed raises rates, the more is the intensity of the flight of funds back to the US, weakening the emerging economies and disheartening those betting on a strong US economy boosting exports and inward investment. The effort of India to discourage imports of non-essential items by raising tariffs is a classic throwback to a bygone era but has the capacity to make indigenous manufacturers attractive. The contrasting step of easing foreign investors’ access to corporate debt is an out-of-the-box move to meet the resources need of a growing economy and at the same time check the fall of the rupee. What it means is that henceforth the problem-solving playbook will be a mixture of traditional and innovative solutions, throwing into disarray the usual preference for companies with FDI over external debt. 

A sprinting economy is known to light the fire of inflation as supply lags demand. Those taking positions to capitalize on the consumption story have to keep in mind the heavy-handedness of the central bank. The obsession of the Reserve Bank of India with heating prices was taken to a new level by former governor Raghuram Rajan. He kept the lending rate at 8% throughout 2014 even though the new peg to benchmark the policy rates, consumer inflation, composed mainly of food items, halved from 8.1% in the year. The Wholesale Price Index, with predominance of the core and manufacturing sectors, was negative in 2015. The repo rate was 7.5%, when the headline CPI was 5.3%, in March 2015. By the time he left a year later, the headline WPI was 1% and CPI 5.2%. Yet, the base rate remained at 6.25%. In the process, growth slumped from 8.8% in the September 2014 quarter to 7.6% two years later. The downside of tracking the GDP to get ready to invest is confronting stocks preparing to sprint being weighed down by higher operating costs. Recent events have also demolished the strategies of buying at dips and picking stocks with tailwinds. Cheap forward valuations have proved illusionary as promising stocks crash-landed not because of sudden transformation in the marketplace but on unexpected corporate governance issues. Attractive trailing discounting becomes deceptive when the company’s problem is not cyclical but arises from misjudging the market.     

Mohan Sule