The outperformers 2020

Is the current ‘polarized’ market, the new normal?

In a liquidity fueled environment, the textbook definition of ‘value’ has long ceased to exist 

|
Published 24 days ago on Sep 30, 2020 Read
Shutterstock

Welcome to the world of Robinhood traders. Eligibility criteria: Unemployed/WFH, smartphone, zero fee trading account, no experience and a free paycheck from the government. Better still, despite being an amateur, you hit bullseye every now and then, because you are constantly pulling the trigger. But, what if you are a ‘wizened sharpshooter’? Well, keep waiting for the elusive precise moment to shoot while chidiya is chugging khet. This has been the ironical absurdity of the markets over the past few months. And, this may be a norm that old-style ‘value’ investors will have to adjust their strategy to.

Globally, FAANG (Facebook, Amazon, Apple, Netflix, Google) has transitioned into FAMGA (Facebook, Apple, Microsoft, Google, Amazon), and in India, more than one-third of the rally since March is on account of the Big Daddy – Reliance Industries. The rest are the usual suspects at the broad Index level. Some sectors like IT, pharmaceuticals and chemicals have made a comeback, too. Thankfully, some trampled mid and small caps have also seen decent gain, while the dark horse has been gold, which hit a new all-time high and deservedly so. 

An existing dichotomy is the striking fall in fixed deposit/money market rates at one end, and sustainable dividend yield on some cash-rich large caps in the vicinity of 5%, at the other! The lower deposit rate suggests demand contraction given lost Q1FY21, and the latter suggests a mindset that can oxymoronically be termed, ‘Safe Greedy’. Income has contracted, investors have more time on their hands than usual and savings are also yielding less. They want more income but do not want to take risk and therefore are being ‘Safe Greedy’ by piling into the same favoured stocks. The more adventurous are venturing into mid and small caps, where even traded value of Rs.10 million-20 million exaggerates price movement, which then ‘attracts’ more speculators.

If we juxtapose the above with ground reality, it makes for a warped picture. Yes, equities are a lead indicator, but investors are now deriving solace from the immediate future. It is likely that FY22 earnings may be similar to FY20. So, we have lost two years but the benchmark Index has covered more than half the ground it lost in March. In fact, the market has been running ahead of earnings for many years, despite earnings disappointment year after year. 

Perhaps, this is attributable to vanishing time value of money. That is, when interest rates are zero, and if you apply DCF to value a company, then earnings a year later or 10 years later have the same (present) value. This is totally absurd, but the current reality. That is why investors have conveniently brushed aside FY21 as a washout and are already focusing on FY22 or even FY23 in some cases.

 

In such an environment, growth is the sole distinguishing factor that determines if you are in ‘the list’. On a top-down basis, analysts have simply categorized companies into three generic buckets, those that would gain from the pandemic, those which would recover in 6-12 months and finally those who might suffer for a few years and survive/eventually perish. In the first category, its primarily FMCG and pharma/chemicals, third category includes aviation, retail and hospitality. All other sectors fall in the second bucket. Within these buckets, there would be individual companies who would do well or not so well depending on their managements and balance sheets. This categorization seems simple but investing is more of a bottom-up art; kamal keechad mein hi ugta hai, jo asmaan mein dikhta hai wo haath nahi lagta.

Widening chasm

Globally, there is one discernable trend that is taking root. It is the age-old divergence between value and growth investing. The divergence is at almost a two-decade high and there are a host of technical, fundamental, statistical and historical reasons. The divergence is glaring whether we look at it on the basis of Price/Book, Price/Earnings or Price/Sales, whether or not we include Telecom, Media or Technology stocks in the universe and whether or not we consider mega caps (size bias). The diversion is extreme even if 10% of the most expensive stocks are taken out of the sample; so that the results are not distorted by just a handful of outliers! (For a detailed analysis, refer: https://www.aqr.com/Insights/Perspectives/Is-Systematic-Value-Investing-Dead)


Amidst the divergence, there is the favoured and the shunned. Globally, FAMGA are Gods and in India, PSUs are Devils. In the market’s opinion, there seems to be no in-between. The above cocktail leaves us with even stranger anomalies. While Coal India is hated on the ESG scorecard, cement companies are darlings. FMCGs are BAAPs (Buy At Any Price), while the medium through which they promote their products, i.e. traditional media companies are perceivably going out of business. Energy and financial PSUs have a governance or capital allocation problem, but all other PSUs are also assumed to have the same problem though they don’t. Dividends are supposed to be the ultimate safety net, but high yield stocks are ignored even while investors are seeking safety.

 

After pontificating about the possible reason for such glaring dichotomies to exist for longer than usual, I attribute it to investor fatigue. The market moves like a pendulum from one extreme to the other, and when any sector is the flavour of the season, investors do tend to pay a rich price. It is then justified because of a ‘great business’, or ‘growth’, or both. It works till the time it does, and then as and when growth starts reverting to mean, investors look for some new sector to flock to. 

This transition is complete when the pendulum swings to the other extreme since ‘cheery’ investors are fatigued holding onto something expensive while seeing the value of their stock chip away gradually year after year in the absence of their lofty expected earnings growth to the point that the same ‘growth’ stock becomes a ‘value’ stock. 

Due to the old baggage that investors carry, they are so focused on topline growth or market-share matrix or Ebidta (seriously?) that they lose sight of the price at which a good business is available. I think if the same investors are given key numbers of the income statements, balance sheets, margin ratios, return ratios, payout ratios and the valuation at which they are available, without giving out the name of the stocks, their eyes might pop out!

Money trail

And, therein lies the opportunity if you have it in you to take such calls. So, you have a consultancy biggie, a regional media giant and a lubricants behemoth. All three having dominant positions in their businesses, all free cash businesses, all cash rich balance sheets, all spectacular return ratios, all great payouts and all yielding approximately 5%. 

What’s wrong? Low growth or (not and) inefficient management. Well, if you want these two ingredients also to be favourable, then you pay 50x, or in their absence, 10-12x. The choice is yours. Investors clearly prefer the former. But as mentioned earlier, there may be signs of fatigue in these ‘cheery’ stocks, that’s when the time for these laggards will come. We seem close than ever since the past five years.

The other thing I would like to devote a paragraph to is gold. Two things have changed significantly in gold in the previous two decades. One, the old argument against gold was that it does not pay anything. Well, even fixed deposits do not pay much anymore. 

Second, the difficulty in owning physical gold has been done away with ETFs. Warren Buffett’s argument against gold is the lack of its utility; that is true also for the money that is being printed without adding much value except artificially inflating assets. Surely, there is global demand for reserve currencies, but that is not unlimited. And with the latest geopolitical developments, a big buyer may be showing lesser interest. 

As for gold, it has long cycles but when it breaks out, it somewhat makes up for lost time. It rose 16x in the decade ending 1981, then gave zero return for 26 years thereafter (so, 16x in 36 years). Finally, its up 3x since 2007. Technically, $1,800/oz was supposed to be a major resistance. After breaking that, it now trades at $1,900 having hit an all-time high of $2,089.

Psychologically, when there is no reference point for something (just like for many start-ups), the price could be just about anything. In gold’s case, the two reference points are its historical price and its marginal cost of production. But, such reference points have lost their significance in today’s scenario. I invested in gold last year. I wish I had invested more (always the case with me). Still, I am waiting to see if its next big leg up has finally arrived.