Strange Markets and Strange Economy

Just as the GDP number came in at a new low of just 6.1% nominal growth and 4.5% real growth, the market hit a new high. It’s surprising how markets seem to just be so optimistic when everything else looks horrible. People aren’t spending, but they are investing?

In some perverse way, that’s the consequence of “quantitative easing” - not just in the west, but in India as well. The RBI has been printing more money, quietly, and there’s an excess Rs. 300,000 cr. in the system right now with banks - which are quickly parking the money back with RBI. Why? Because they don’t want to lend it out even if there are opportunities - there’s a lot of fear of defaults, and a fear of more NPAs.

This kind of fear means they will only give money to the most creditworthy of borrowers, who are now able to borrow short-term at less than 6% a year. Many of those borrowers don’t even want the money, but we need to understand that bankers will only give you an umbrella when it’s not raining.

With credit not exactly flowing, markets start to go up because money ends up in investments. The rich don’t need to up their spending, so they don’t spend. The excess money goes into investments. But the less rich, or small businesses, don’t get any loans, so they cut their spending, and don’t even ask about investing. In such a situation, more investments come by, but spending falls. Which explains why markets are buoyant when things look horrible for all sorts of businesses.

How long will this last? We have no idea. Something has to give, of course. At some point, investment flows will reduce. And at some point, people will start to spend again.

The Dead Salmon Experiment

There was an experiment conducted on whether Salmon (the fish) responded to human imagery. So a fish was hooked up to an MRI machine, and shown pictures of human activity, and the MRI machine tracked what the salmon was thinking. And apparently there were some activity notes in the salmon’s brain.

The salmon, though, was “not alive at the time”, said the researcher. They had used a frozen fish for this experiment.

This sounds like a joke, but it wasn’t. The idea of the experiment was to ensure that any tests that detected activity could have been a “false positive” - i.e. showing a result where there wasn’t any. If you decided that certain red areas in an MRI meant a brain reaction, then you would be stupid (because the subject was a dead fish). But if you did the tests later with a live human being, you should adjust the results for the dead salmon red areas, because the result could be entirely by accident.

In the investing world, we have too many false positives. Bank X is going to raise capital

Why? Because it said so. Hasn’t it been accused of lying earlier? Yes, but this time’s different. Who exactly is putting the capital in? Someone big. We don’t really know. Could be a dead salmon. So, adjusted for dead salmons, are they raising capital?

There’s also the problem that the older we get, the more cynical we get. Everything starts to look like a dead salmon, because we have seen such things turn out to be dead salmons sometime in the past. This is why the success of the 147th search engine (google) surprised everyone who had seen the previous 146 die horrible deaths.

So you shouldn’t just adjust for dead salmons, you need to adjust for over-presumptuous observers who call everything dead salmons.

One reason that the simplest investing strategies work is that they don’t try to second guess everything all the time. Index investing, for its part, has been simple - just buy the top stocks and wait. If something’s not a top stock anymore, exit. That’s also why our index portfolio is doing as well or better than other strategies.

Strange happenings and Changes

The situation at Karvy is now known to all, but if you haven’t heard much, please check out our podcast (click here) and our article on it (click here). If you have an account with Karvy, you will need to take action.

There are more defaults coming in. Recently, bonds backed by Zee and DishTV shares have been downgraded to “Default”, even when Zee promoters have sold their holdings and promised to repay shareholders. DHFL went into actual bankruptcy with the RBI taking over and putting it the bankruptcy courts. A few others too are swinging in and out, with Reliance Capital now struggling and Jet Airways nearly done and dusted. The impact of some of these will come in the next quarterly results, and will cause some consternation. We believe a few debt funds will be impacted (and are looking to ensure ours have minimal impact).

The PMS regulations changes are coming soon - we don’t know when. Till then please feel free to continue as you wish, either adding capital or staying put. We will get back with more information as rule changes come about. Please connect with Akanksha for any clarifications.

It’s going to be a rough set of months ahead. We do see the risk to some of our portfolios, and will adjust accordingly. But we should be ready for some sort of shakedown, which is likely to be an opportunity to buy more. The next year will be better, we believe, with the lower tax rate taking effect and perhaps helping cut prices to spur consumption as well. A good budget will go a long way, but the economy will recover because it has gone into a slump, and perhaps markets will follow it both down and up.

Watching closely, Deepak