Equity investors suddenly have to deal with two 8th November 2016 storms, Trump victory and Demonetisation. Trump victory has resulted in strong USD that has caused the INR to fall. Read our note on INR Fall on Trump Victory. The fall in INR coupled with the unexpected move to demonetise the Rs.500 and Rs.1000 notes took markets completely by surprise and have resulted in violent reactions. Sensex / Nifty have slumped by about 6% post the 8th November announcement. Some frontline stocks have taken it on the chin, falling more than 10-15%.
On the other hand bond prices have gone up by about 5% post 8th November. Normally the correlation between equity benchmarks and bond prices is not so linear but this time the opposing move in prices is uncanny.
Stock market investors are stunned and actually don’t know what to make of the situation. The implementation has caused hardships but the public is mostly stoic and believes that there was no easy way to weed out black money in the system and big bang move like this will do the trick. India has a glaring disparity in income and this one strike from the top has made the honest and poor feel that justice does prevail.
We at Investorsareidiots also believe that the demonetisation move will bring about a positive change and is good for our economy.
You should buy into this market fall
The Trump victory has taken US equity indices to record highs on expectations that the US economic growth will rise on fiscal boost to the economy. Global markets and economies are highly correlated and if US markets and the economy does well, it will filter down into the rest of the world, India being no exception.
Demonetisation, while temporarily throwing demand out of gear, has not pulled down the latent demand in the economy. Demand will get back to normal once the dust settles and cash gets back into the system. Inflation can stay down and so too can interest rates as banking system liquidity improves. Demonetisation can improve supply side economics as more resources are available for investments, which otherwise went into buying of real estate, gold and luxury products.
The market fall is seen as temporary in nature and provides good opportunity to invest in the right stocks.
Why Have Stocks Fallen?
Then why have stocks taken such a beating? How to look at markets and your investments? Most of these listed companies are not dealing in cash transactions so why are they being decimated?
The reason is that the Rs.500 and Rs.1000 notes which were demonetised comprised about 85% of currency in the circulation. The sudden move to take them out has created a void, the demonetised currency will take time to replace and getting used for trade and commerce.
The cash economy which is estimated to be about 40-50% of our GDP has come to a grinding halt. Our GDP will contract, the extent of contraction, which cannot be completely estimated. Economists are estimating it to a lower GDP from 0.5% to a more shocking 3% for the next two years.
The black money in the system which was not hoarded was also being used for consumption which will come to a standstill. Some small businessman and traders who were trading only in cash and not paying full taxes will fold as their businesses will no longer be viable. Their and their out of work employee’s consumption will reduce drastically.
All this will impact company’s profitability and their growth prospects which is why markets are correcting so much.
What should you do if you are already fully invested in equities?
The foremost thing in an investors mind is protection of their principal. What they want to know is that should one sell their holdings as equity markets are on a freefall? While investors are not panicking but the question most often asked is, will equities tank further and how much will it tank more?
No one can really accurately predict the bottom and markets can fall a lot. So that is why the situation merits some circumspection and introspection.
The sudden fall in equity will make you understand what your risk tolerance is for sure. It is a foolproof measure. If this fall and uncertainty gives you sleepless nights then you have to ask yourself why? Have you invested a very large chunk of your savings in equities? Have you leveraged too much and invested in the markets? Did you not expect the markets to fall this much, ever and now reality is unpalatable? If the reaction is anxiety attacks and panic, it may be because you have overshot your limits and have over-invested in equities.
The learning from this episode is that markets are unpredictable. Economies and politics play a role. There are a hundred moving parts which make markets which nobody can forsee accurately. What the RBI does? What the Fed does, who wins elections in the US? What their policies will be? How will we be impacted? What economic policies are getting changed? How will the consumers behave? What labour laws are getting changed? How much is the inflation? How much is the interest rates? None of this is in our control.
Markets move pretty much at whims and fancies of these levers which are managed by others.
The only sane response to such unprecedented events is philosophical. We can only control our reaction to these bizarre unexpected events. We can choose to remain calm, rational and not panic. Our reaction and some help from experts are the only weapons in our hands and we should use them wisely.
Experts do their best but the reality is that no one has a crystal ball. At best they can analyse the situation and guide you through the turbulence. If the ship you are on capsizes, the lifeguard/ experts have a drill and can help you from not drowning but can’t save you from getting wet.
The one thing which market pundits have always emphasised which will come to fore during such events is the significance of weights in your overall Asset Allocation, primarily in debt and equity.
Discipline about weights in your portfolio is the holy grail of investing in markets.
As per your risk profiling, if the weights on equity and debt are correct in your portfolio then this market fall will not worry you that much. This time around ,the fall in equity may have been somewhat compensated by gains in debt. But always individual weights in stocks will control losses in your overall portfolio.
Markets can lull you into a sense of security for weeks and months and years about your understanding of the direction of markets and stocks and in one lethal swoop all your knowledge will go out the window. Humility is a virtue in this business like no other.
Eventually markets will calm down, stocks will stabilise and growth will come back on track. Strong stable companies will be able to withstand this slowdown; they may have to rework their business models and may even come out stronger as they may be able to capture the market share of the disorganised sector. Experts will guide you to reorganise and realign your portfolio as the effect of events and outlook become a bit clear.
Right now, savers in fixed deposits would be well advised to lock in rates for a longer tenure. Debt mutual fund investors can expect super normal gains for sometime at least.
There is also speculation that after such a huge demonetisation stick, the government may come up with some carrots to support markets like big infrastucture spends, cut in tax slabs etc.
To conclude ,the biggest takeaway of the aftermath of demonetisation is to stick to the right asset allocation and make sure within an asset, weights are correct in your portfolio. That is the best way to insulate from sudden shocks in the system. Otherwise there is enough data to support any narrative – bullish, bearish, ambivalent.. Confirmation bias is a very dangerous thing and stock market investors fall prey to it very often.
Markets will taking each incoming data and news will iterate and the only certainty is that markets will be volatile.