Going from vibrant to scary

Wish you all a very Happy 2019!

What a year it’s been. 2018 was a challenge for markets, going from vibrant to scary. We saw a market top, major correction in the mid­ and small­caps, and a fall even in some of the largest cap stocks. The IL&FS default in September added fuel to the fire and then, with Trump firing salvos regularly at international trade, the world markets have become more jittery.

Jittery is good, for a long term investor. Because when you have enough fear in the market, stocks fall to levels that make them attractive. But we don’t have enough fear across the board just yet. Even today, as we approach the January earnings season, the Nifty is just a little bit lower than it was a year ago, even if the mid cap indexes are about 20% lower than last year. Even the Nifty next 50 – the stocks numbered 51­100 in terms of market cap – fell over 21% from peak to trough in the last year.

The US markets have corrected, around 20% from the peaks in October. Part of this is on the back of a slowing China after the Trump infused duties, which could easily get worse. The slowdown in China affects companies like Apple, who sell their smartphones in that country. And it affects Indian companies like Tata Motors, which owns Jaguar and Land Rover, whose largest market has been China.

The US Fed has raised interest rates, but even after that, the US 10 year bond has seen yields fall from above 3.2% to about 2.6% ­ a fall that’s not really reflecting a rising rate situation.

But these problems will always remain. A US Government Shutdown sounds like a terrible thing – but it is currently on. Europe’s in a mess. Japan’s hurting. There’s a bunch of crazy things happening in India – from loan waivers for farmers, to a government contemplating bribing voters by putting money directly into bank accounts. Such things happen, and will keep people fearful at times that they do happen.

Like there is now, of Apple going to crash because its sales in China are lower – and so it’s going to a level where it’s P/E ratio is less than 10, not counting the fact that it has $130 billion in cash. Apple’s an innovative company – so it’s quite likely to find the next big thing after phones, which it evolved to from being a niche computer manufacturer in the first place. There’s good reason to believe things will be bad in the near term. But is that good reason to believe things will always remain bad?

Markets are always going to be fearful in times like this – and when markets are fearful, the potential for good investment returns increases.

What’s exciting about 2019? A theme of disruption.

In the 1800s, the prices of spices were very high, because they were considered to make meat preservable. But ice did that task much better, and a guy named Frederick Tudor came along, and started shipping ice from cold countries to warm countries by ship. The prices of spices plummeted because hey, why not just use ice? Tudor made a killing shipping ice to India as well, even building ice houses all over the country. Then he went bust.

Because someone figured out how to make ice from steam. With ice factories, you didn’t have to ship ice.

And then the ice factories went bust. Because of the refrigerator. If you could make ice at home, why order it from a factory?

The important thing was – you would have thought that the guys who got rich selling spices would have seen the disruption and gotten into ice shipping. They didn’t. The ice­shippers should have built the ice factories. They didn’t. Disruption is invisible to the incumbent, sometimes. And they just get beaten up, time and time again.

When was the last time you bought an alarm clock? An FM radio? A pager? A DVD player? used a STD/ISD booth? Or even a torch? It all sounds like whoa, I use my mobile phone for all of this. But just 15 years ago, you didn’t. And I don’t even remember when we made the switch, but it was made. And the alarm clock makers quietly died, like the pager manufacturers and so on.

Today we can see one layer of disruption in power. As solar power gets cheaper and cheaper, the old power plants that use coal are simply inefficient and expensive. They can't compete on price. But they’re the ones that took lots of money to build, and they owe money to banks. If they go bust, the banks are hit. If the banks are hit, they need to be rescued. Should we then keep burning coal, because banks will go bust otherwise?

As solar cells get cheaper and efficient, they can be used to power most house equipment. Natural gas can be used to power fridges and heaters. If houses can be (mostly) self sufficient, what happens to those massive electricity distribution companies that spent all the money laying lines? They also owe the banks a fat sum.

There’s electric cars, that will disrupt everyone that’s making movable engine parts. There’s disruption in content – people don’t need a TV channel subscription anymore, they can simply watch things on­demand, through a fast internet connection, now available even on mobile phones. Uber and Ola disrupted the traditional cab industry. Flipkart and Amazon disrupted retail stores (somewhat), especially the ones focussed on selling electronics. Something new will come and disrupt all of these current business models too.

The disruption doesn’t mean the current companies are no longer needed. It’s that their growth path will be much lower, and that so many of them won’t be needed – so some will die and others will evolve.

It’s both scary and exciting to see disruption happen, if you can. You can’t see most of it, because it’s invisible. But in this process, what you see is that new companies rise, and some older ones die. We expect that in the coming years, disruption continues to be quite high. And yet, good companies will hurt, die, or default. We have to expect pain as well, and we expect some of that this year, while new things arrive.

At Capitalmind Wealth

Capitalmind Wealth has made a few changes – we sold a few stocks completely and reduced weights of a few others. We are still mid­cap heavy, but we took the opportunity to add a consumer stock in our portfolio in the month, and started with a position in a Capital Goods stock. We are now looking towards the budget to take positions in other Capital Goods stories and infrastructure stocks, if the policies are positive.

We’re constantly adding features to the Capitalmind Wealth Progress site (https://progress.capitalmindwealth.com). Please do check it out and get back if you have questions.

We are looking at debt markets carefully. If things go according to our insight, the bond markets should absolutely blossom next year. In that regard, we have been looking at market traded debt instruments offering more than 10% returns annualised, with relatively low risk issuers such as banks or PSU institutions. As the liquidity in these instruments improves, we hope to be able to offer them as part of our debt portfolios in Capitalmind Wealth. More on this soon.

We continue to look for good stocks at attractive valuations and any market correction would be welcome. In general, we expect that economic growth will return but stock markets will keep throwing tantrums. In those tantrums, we hope to build our portfolio further.

Happy New Yearingly!

Deepak Shenoy