Navigating A Financial Storm

It is not that we may not overcome the virus, rather it is the economic catastrophe that we may struggle to overcome, a bear may argue. Several professional forecasters - economists and otherwise - are building a prognosis for a global recession with severe job losses. One can not estimate with certainty the period for which the current pandemic or an ensuing recession may last. One does not know for sure how much earnings corporations stand to lose in the interim. How should an investor navigate this storm, you may wonder. 

At the risk of sounding clichéd, we think that the best way to navigate this financial storm is how you would navigate any other storm. We propose a three-step approach: 

A. Prepare, do not predict 

"He that observeth the wind shall not sow; and he that regardeth the clouds shall not reap ." (Sow when the time comes, whatever wind blows. Reap when the time comes, whatever clouds are in the sky.) 

You do not rush for an umbrella after it rains, but carry it in anticipation. If the markets were to be a tropical island where it would rain any time of the year, then cash would be your proverbial umbrella. We have long held the view that some cash in hand would never hurt an enterprising investor for she does not know when the market may rain some discounts. Investors would, therefore, be better off in being prepared for rains, rather than predicting them. 

B. When caught in a storm, hang on 

An umbrella can help you weather a down-pour. However, when a storm comes, no matter how big your umbrella, it can do little. When caught in the middle of a storm, the best thing to do is to hold on to something solid. If you try and move around in a storm, you could either be swept away by the winds, drowned by the water, or buried by the sand - depending on the type of storm you are facing. Therefore it is best to hold on to something solid and stay still. When it comes to stocks, there is nothing stronger than faith - in a better future. This faith is not blind but based on over 100 years of history of the stock market and an even longer history of the evolution of human species. A history that aptly reminds us that 'this too shall pass'. Thus, amidst the storm of a sharp and rapid price deceleration, the best thing to do is to hang on to faith and stay still. 

Two important caveats here: 

i) Storms are usually devastating, destroying anything weak, unstable. The strength of most structures are put to test and only the strong ones come out unscathed. In the context of the markets, these structures are balance sheets. Therefore, as important as it is to have faith in the future, such faith should be supported by a portfolio of rock-solid businesses. 

ii) Sometimes strong businesses may be weakening internally, and the cracks may not be entirely visible. However, a storm can expose some of those cracks or weaknesses. Rather than wait to repair such cracks, it is better to replace such a business with a better one, even at a loss. On the other hand, the storm can sometimes offer you an opportunity to swap a strong business with an even stronger one (one that you could not earlier acquire due to its prohibitive costs). Such opportunities should also be taken advantage of. Lastly, a passing storm can also open up the opportunity to acquire a decimated business at a bargain. The moot point being that as the storm recedes, all actions must be directed towards preparation for the next storm, rather than trying to salvage that which is destroyed or increasingly vulnerable. 

C. A blue sky awaits as the storm passes by 

Blue days, all of them gone 

Nothin' but blue skies from now on 

History suggests that an investment cycle is 300 days of mild summer, with intermittent rain showers, and 65 days of harsh weather. As much as we would love to live through only mild summers, we know that the rain showers, and harsh weather, are unavoidable. We also know that most rain showers and storms are followed by bright blue skies, giving life to the hope of 'better days ahead'. These blue skies are meant to be cherished by investors as a reward for weathering many storms. They should, however, also serve as a reminder of the occasional rainfall and the infrequent storm that can always linger around the horizon.When it comes to investing, always remember that the best times are sometimes the worst. 

The above describes not just our approach specifically towards the current situation and market condition, but also our investment philosophy in general. 

Coming back to the current market condition, we do not know yet how and when this pandemic will end. We also do not know how much this will impact near term earnings. What we do know with certainty is that the current event is all but a minor bump in a long journey. Business valuations reject their long term earnings potential, and we do not see that potential being reduced meaningfully by this pandemic. Thus, the correction in share prices seems to be far more than the change in the intrinsic values of many good businesses, thereby offering attractive investment opportunities. We will, therefore, be taking advantage of this situation by deploying the cash in our portfolios as well as making them stronger by re-evaluating each of our holdings. We would urge you to also look at increasing your exposure to equities as such opportunities appear far and few in a decade. As for a market bottom, we are uncertain as to which side of the bottom we are currently - approaching a bottom soon or past a bottom already. What we can say with certainty is that the gap between the intrinsic value of a business and its share price has widened sharply over the last three months, making stocks attractive at current prices. A true bottom will only be known in hindsight, over a while, and will most likely look like a missed opportunity. 

We understand that the current market conditions are challenging, and hope that the above has provided some solace. 

The author is the Head– Portfolio Management Services, Tata Asset Management.