When FIIs are chicken, should you be investing in stocks? The answer is 'Yes, but...'

If the Sensex can fall 10 percent in a month, it can gain the same in a month too

R Jagannathan January 21, 2016 11:22:47 IST
When FIIs are chicken, should you be investing in stocks? The answer is 'Yes, but...'

It takes a lot of courage and gumption to fish in a troubled stock market today. Valuations are looking good, but looking down the cliff scares the daylights out of the ordinary investor. Thanks to negative global cues – from a potential Chinese economic meltdown to crashing commodity prices – the Sensex has been on a one-way trip to gloom. It has lost 20 percent from last March’s peak, and an 8 percent fall happened just in January, with yesterday’s (20 January’s) 418-point Sensex drop only emphasising the potential for further downsides.

When FIIs are chicken should you be investing in stocks The answer is Yes but


So here’s the reality – both the positives and negatives.

Have the markets bottomed out? Possibly not. This means buying now may only give you more portfolio losses and sleepless nights.

Is the underlying economy any better? In India, this is probably true, but we can’t say the same thing about the rest of the world, including the US, China, Japan, and Europe. Since it is global fear that is driving markets down, India will not be immune.

Will foreign investors see that India is doing better than before, and thus invest here? This should normally be the case, but the truth is foreign institutional investors (FIIs) are also characterised by herd behaviour. When there is a downtrend, their instinct is to protect their investment values by doing the same. For the foreign fund manager, the name of the game is to not underperform the market; they prefer to come in or go out with the thundering herd, so that they cannot be blamed if their fund only fares as badly as the rest. They will advise us to think contrarian when the pink press interviews them, but they seldom follow their own advice. This is obvious from the fact that $1.2 billion has flowed out of India in January so far. The FIIs are chicken, like everybody else.

The biggest risk today is that our policy-makers will get carried away by the one-eyed-in-the-land-of-the-blind syndrome. The seven-percent-plus growth being projected for India this year and the next is a bit delusional. India may be “the fastest growing big economy in the world” right now, but this does not mean much given that this rate has been arrived at through a new methodology.

And let’s not forget, our growth has been near the top for four years now, but we have remained a $2 trillion economy for as long. If the fastest growing economy can’t get above the $2 trillion mark. This is because the growth has been domestic, and our exchange rate has declined from around 45 to the US dollar to 68 today. All the growth has been swallowed up by a decline in the value of the rupee.

If we were to compute our GDP on the basis of the old methodology, we would probably be closer to 6 percent today – nothing to cheer lustily about. The biggest disservice our national statisticians did was to discontinue the old way of calculating GDP even before the new one had stabilised and its variance with the old one made clearer. We are cheering higher GDP growth with no comparable base index. This is the real danger we face: if we prematurely conclude that everything is great, we will crash even further.

However, there is also the brighter side.

If commodity prices are down, India as a net importer of oil gains huge fiscal space. It has allowed the government to fill its coffers by raising oil taxes, thus covering up for losses in revenue growth elsewhere. In relative terms, the Indian government’s finances look better than what they were three or four years ago.

The war against inflation will be easier to prosecute when commodity prices are lower. Add the possibility of a monsoon rebound this year after two failures, and we are possibly looking at a genuine economic bounce in 2016-17. Add further the likelihood of corporate balance-sheets recovering some of their mojo, and we certainly have no reason for too much gloom. If we assume that our real GDP growth in 2015-16 was 6 percent when calculated under the old methodology, we can reasonably expect to hit 6.5-7 percent in 2016-17.

To reach a real seven-percent-plus rate on a sustainable basis, we have to keep chipping away at reforms – even if they are largely in the non-legislative category. This makes the budget more important than it normally is. After two lacklustre budgets, one can hope that Arun Jaitley will not disappoint us once again. Sheer reversal-to-the-mean logic suggests that he can’t drop this lolly.

The domestic financial institutions are in buy mode. When the FIIs were selling, they were buying, having bought nearly half-a-billion dollars worth of equity in January so far. With the Employees Provident Fund and the National Pension Scheme anyway investing in equity, a useful counter-weight is gradually being built to the FIIs. Their funds are still puny, but with every passing year, domestic money will be more important to drive stocks than foreign money. At some point, both engines will be firing.

Even the FIIs cannot keep running away. Every time they do so, the rupee crashes, and this magnifies their losses further. On Wednesday, for example, the rupee went below 68 to the US dollar, and any further crash makes it more difficult for FIIs to avoid losses in dollar terms. In other words, sooner or later, FII selling hurts them more than us. A lower rupee, while being a negative for inflation, helps our software exporters earn more; our exports of merchandise – down disastrously in 2015-16- will get a leg up. So corporate balance-sheets will improve overall.

In terms of valuations, India’s stock market is less than two-thirds of GDP. The time to really worry about over-valuation is when this ratio reaches 1:1 – that is market capitalisation equals GDP.

Coming back to the markets, there are only two ways of judging whether you should buy or stay clear as stock prices collapse. One is the greed-or-fear rule; and the other is the asset allocation rule.

The big winners in stocks are usually those investors who get greedy when the market is fearful (as it is now), and those who get worried when the market is overly bullish (as in March last year, when the underlying economy was far from healthy). So it is a good time to start buying now, but with one caveat: don’t presume that the market does not have further to fall. You have to close your eyes and let it fall, much like a bungee jumper knows that the fast fall will surely be followed by a fast rise.

The second, and more important, consideration is asset allocation: do not invest anything in equity if you cannot afford to lose half your investment. The allocation between equity and debt will vary for each individual, depending on life-cycle and other factors, but each individual has to be clear that equity is risk money – it can clean you out, and also deliver in spades.

The best option thus would be to invest steadily from now on, not putting all your investment eggs in the equity basket in one shot, but doing so steadily. The truth is no one can be sure when the market will bottom out.

But one thing is also clear: the markets tend to correct quickly, whether upwards or downwards. Most markets today are over-researched, and so where the smart money flows, the dumber money now follows more quickly than before. This means once the direction is clear, there is a deluge of buying or selling, and market corrections happen rather fast.

If the Sensex can fall 10 percent in a month, it can gain the same in a month too.

A mathematical truism is also relevant here: a 10 percent fall is not the same as a 10 percent gain. If you have invested Rs 100 in stocks, a 10 percent fall means you lose Rs 10. But at Rs 90, you can make a 10 percent gain with just a Rs 9 increase. Keep that in mind while investing when the market is declining and falling.

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