Investor Letters

It’s Volatile Because It’s Better So

Good things happen, because bad things are also allowed to happen. And in the last few months, only bad things seem to have happened


It’s the last month of the financial year. February is usually interesting as a budget month, when things move on the financial end. This time, it was the political and military move that took centre stage, even as markets dipped and recovered in a volatile round of madness.

Markets are going to be volatile, because it’s by design. If you curtail volatility, forcibly, bad things happen. Oh, and people have tried. In Pakistan in 2008, they framed a rule: markets cannot go down. Meaning, every day, stocks prices would be limited to the price of the previous day.

A strange thing happened. There were just no buyers for stocks. People wanted to buy, no doubt, but not at current prices. And without a buyer, there was nothing a seller could do but to place his orders at the lowest possible number – the high of the previous day.

Between September and December 2008, as the world was crashing and burning (the NSE Nifty fell about 40% in this period) the Karachi Index was at exactly the same level, because no one was willing to buy higher, and you were not allowed to sell lower.

When reality dawned, and apparently it took three months then, the authorities decided to remove the price “freeze”. Consequently the stock market dropped another 40% and only then stabilised and returned to go up more than 10x from the lows.

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The point is that good things happen, because bad things are also allowed to happen. And in the last few months, only bad things seem to have happened: IL&FS as a crisis, a debt market standoff, a slowdown in Auto sales, dull economic growth, exit of foreign investors and what not. That’s taken some stocks down 50%, even though the fundamentals didn’t change that much.

Earnings drive longer term stock prices. Growth in earnings is the single biggest answer to volatility, and over time, the volatility evens out and the earnings potential remains. If the market is big enough, and the story is strong enough, and management is aggressive enough, good things will happen – but doubts about all three of these elements will come in the interim, and cause the stock price to slip. As investors, we just have to learn to differentiate between what’s really falling of a cliff versus what’s only seeming like a temporary issue.

The Geopolitical Situation

We’ve had a tense situation with our western neighbour, the same one which tried to fix prices on their stock exchange. The small difference, perhaps, is that they have only a few billion dollars left in their forex reserve kitty, and have sold much of their infrastructure to China. India on the other hand is huge, stable and has only sold it’s ecommerce businesses to China/US, so we’re in better shape.

Sense seems to have prevailed, so we don’t expect disastrous war situations here, but given the nature of the problem of state sponsored terrorism, we expect that in the future – as in, in the next decade – there will be more such events. As much as we fear an outright war, limited actions will not be heavily destructive to the earnings of our companies.

Elections, Regulation and All That

Soon we’ll have general elections and we think the situation after that will be good for businesses as we get a clearer idea of economic commitments of the government and the spending they will do. Given that they’re all likely to give some sort of income guarantees, we believe the impetus will be on the rural economy to improve, and for a lot more infrastructure to be built.

Indian businesses have substantially reduced debt in the last few years. As interest rates subside towards the middle of the year, this leaves them room to add capacity, and to revive the investment cycle. Regulatory changes in terms of NBFC rules, mutual fund deployment and on who can take deposits means businesses that used to operate a certain way in the past will need to change. There will be a change in leadership, and we’re looking forward to an industrial recovery due to these changes as well.

Changes to Progress

We’ve had a major change to the back-end of our technology system to allow for new portfolios. The progress reporting portal, as per our last note, has a couple of issues we will sort out this week – the portfolio page not yet showing gains, and the Tax P&L area not yet fully ready. We apologize for the delay, and it will be sorted shortly.

We’ve also put all the past letters on the Progress site, so you can see all the previous letters when you log in.

Some of you would have noticed sales of shares in your accounts, and then a buy of some of those very shares. This was our algorithms working to keep your tax liability low – as sales of debt funds have resulted in profits, we have booked some losses in the stocks we owned, just to offset the profits. But we buy them back a few days later because we want to maintain the position. This tax-loss harvesting is a process we will do again sometime in March to ensure you don’t have a tax bill.

Coming soon – in a couple weeks – is information on the new portfolios (Indexed portfolios and Momentum) which you can reallocate your capital to, if you so choose. We are also excited about offering a long-term debt portfolio that is designed to generate income (but will not be liquid). More on this later in the month, and do connect with us if you’re curious.

We expect the markets to start to turn in our favour as the current news flow reverses – from a Trump-China truce, to a turn in the economic cycle in India, to a drop in interest rates, to less uncertainty after elections. This should show up in the portfolio performance too, but we believe it will take a good part of 2019 for the impact. Meanwhile, we continue to find good businesses to add to, and will offer more strategies as well.

Marching-on-ingly,

Deepak Shenoy

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