The 50,000 foot view of the market

It's been a rough month on the markets. We've been expecting rough, and this is just the beginning of rough. But is something seriously wrong with markets? Or is this a temporary phenomenon?

Sometimes it's better to get to a 50,000 foot view. Has anything basic changed? For India, there is one major macro change. Interest rates seem to be going up. RBI might seal that deal later this week, but the bond markets have shown that players are already demanding higher rates: HDFC Bank is paying over 8% in the bond markets for one year deposits. And then, there's the international thing - rates all over the world are going up. US 10 year rates are hovering around 3% and there's an expectation of rising rates there and in Europe.

When rates rise, companies pay more in interest for what they borrow. That will, by definition, reduce profits. But at another level, their customers may choose not to purchase things from them, because they have less money in their pocket. And that reduces revenues, which means even lower profits.

This is a good "phase 1" thought process. But we tend to live longer than a phase 1, which might last a year or so. What happens afterwards?

In phase 2, strong businesses are able to get back to their margins. The economy adjusts to the rates, and after a period of contraction, revenues rise again as customers don't deny themselves for too long, and the cost pressure subsides due to general control in inflation. Even if there is pain, the phase 2 part of the economy will let good businesses go to better earnings, partly from the revival, and partly because their weaker competition has died in the melee.

You can't directly go to phase 2. Phase 1 will have to happen first, and if it's happening, the opportunity is in finding which businesses will make the grade in phase 2. So you have to keep a bit of cash handy.

But let's go a little deeper. How come so many stocks are beaten up? Is there a 100 foot view?

One change has been in recent regulatory measures. Mutual funds have been told to rejig themselves. A fund house can have just one large cap fund, one midcap fund, one small cap fund and so on. And then, they must stay true to their cause - with large cap funds focussing on the top 100 stocks, the midcap funds on the next 150 and so on. The relative shift in liquidity, for many stocks, is massive. Large cap funds have over 280,000 cr. in them, but midcap funds a relatively smaller 110,000 cr. and the small cap variety a tiny 35,000 cr. As money flocks to the larger caps when these funds became more "true" to their philosophy, it flows out of the mid- and small-caps.

Secondly, the regulators have been concerned about stock changes. They have recently attempted to increase margins for stocks in the derivatives segment. (This will apply from July) They also added certain strong moving stocks to an "additional surveillance" mechanism that increases margins and costs for intraday traders. Some of these stocks have had phenomenal earnings growth, and their moves in prices are probably commensurate, but the additional margin requirements has stunted liquidity, and there's a "correction".

Does this matter at all? If stocks fall because there are no intraday traders, or because some mutual funds are rejigging their portfolios, does it mean the businesses are gone? In most cases, no. I say "most" because some businesses are created for the purpose of selling to small retail shareholders by fraudulent means, and they come out the wazoo in every bull run. But in most others, where the underlying business is sound, a temporary liquidity issue in the stock market is not going to change its fundamentals.

Even an HDFC Bank fell 30% when margins were increase in April 2006. By June, no one wanted to buy stocks, and even the good stocks had taken a knock. But today, HDFC bank is more than 10x higher than even the peak it was in April 2006. You can't keep a good stock down.

Why is this even important?

It is not, really. If you're looking at longer term investments, this is a little dip that, at best, provides fodder for conversation. But as fund managers, we're happy that our cash levels have been relatively high, so as the market corrects we can be buyers and take advantage of opportunities where liquidity drives stocks down.

But it's not truly important. If the object of the entire exercise was that you'd have to worry every time the market has a hiccup, then we're not doing our job right. It's our job to worry and find opportunities and ensure that some paper company is sticking to its estimates or move money to debt when times look lousy.

At some point, we are like that pilot who tells you mid-flight that he's got you at 32,000 feet. And doing some X knots, flying south westerly with some oncoming turbulence. Seinfeld's response, in typical fashion, is: "We're in the back, going, fine...just do whatever the hell you gotta do, I don't know. Just end up where it says on the ticket, really".

This has been some gyan, and coming to what money is actually useful for: The Football World Cup in Russia, starts June 14, and I'm so excited because for the first time, I have no idea who any of the players are. Which is fantastic because I'm just going to support the winning team in every match. As long as they're either Brazil or Argentina.

Good luck to all of you football lovers, and remember: tickets are between Rs. 10,000 and Rs. 50,000 per match, so a tour of just Brazil plays (hopefully 7 in total) is probably going to be at least Rs. 5 lakh including travel per head. Probably worthwhile to start to plan for that, and add some more for inflation, in 2022.

Goal scoringly,

Deepak Shenoy