Sensex Crash: Why It’s Time To Junk Some Of The Traditional Market Wisdom

The last 12 months have yielded practically zero returns on the stock market, with both the Sensex and the Nifty ruling flat around 26,000 and 7,900 between last December and now. This speaks poorly about an economy growing at over 7 per cent, when another economy growing at less than half our rate reports an annual gain of 13 per cent, and its indices are about to hit new records. We are talking about the US Dow hitting the high notes under a prospective Donald Trump presidency.

Even over the longer term, the Bombay Stock Exchange Sensex gained just over 20 per cent from its peak in January 2008, which means stocks have been giving even lower returns than the humble savings bank rate of 4 per cent. You would have gained more by just leaving your money in your savings account, without even bothering with a fixed deposit.

This long period of non-performance should ordinarily lead to a domestic stock market bounce sooner or later, but there are lessons to be learnt from this period. The main one is that traditional investment wisdom needs to be tweaked for investors to benefit. This applies as much to other forms of investment – fixed deposits, debt funds and real estate – as to stocks.

The conventional wisdom on investing includes the following: your asset allocation (between stocks, debt, etc) must vary with your age; don’t try to time the market; don’t put all your eggs in one basket; equity is risk, debt is less risk; fundamentals matter more than momentum; novice investors must use mutual funds rather than try to stock-pick themselves; a real estate investment will seldom go wrong, as land will always be in short supply, and so on.

There is no need to rubbish this conventional wisdom, but if you really want to be a canny investor, you need to understand when these maxims hold and when they don’t.

Let’s go over them one by one.

#1 Your asset allocation must vary with your age.

The assumption here is that as you grow older, you need your investments to generate income, and so more of your money must go into debt or fixed deposits. This is true up to a point, but the chances are, you would lose too many opportunities this way. If you were in the US, post-2008, you would have missed the entire stock boom resulting from zero-cost money, and your bank deposits and debt investments would have earned you zilch.

In India, as inflation stayed high during most of the UPA regime, even bank fixed deposits would have earned you zero or negative returns after adjusting for inflation. It is only now, post-2014, that your fixed investments are earning positive real returns.

The guiding principle for asset allocation should not just be your age, but your ability to take risk. If, at 65, you have enough surpluses in safe avenues, you will restrict your gains by investing in debt instead of equity, especially when rates are falling. You may have less risk-bearing ability when you are 25, and have a family to support, than at 65, when the kids have left the home, and you have a great corpus from PF and pensions. You can afford more risk in this case.

#2 Don’t time your investments.

This means you should not worry if the market is booming or crashing; just keep investing steadily through SIPs (systematic investment plans) so that your costs average out, and your returns look better over the longer term. This is certainly a good technique for passive investors, but higher returns depend on timing the market. You do not need to be a stock market expert to know when the sentiment is bullish and when it is bearish; any pink newspaper will tell you that. In general, it is a good idea to start SIPs in a bearish market, and end them in a bullish market. To be sure, you can’t time the market in terms of predicting the peaks or troughs, but you do need to time it better by identifying relative periods of boom or bust. Almost anyone can figure out if the sentiment is bullish or bearish. Broadly speaking, it may be better to be bullish in a bearish market and vice versa.

#3 Don’t put all your eggs in one basket.

Again, this is good advice for those who don’t want nasty shocks from a sectoral or share-specific crash. But another bit of advice goes like this: put all your eggs in one basket, and watch the basket. The risks may be higher, but the rewards too may be so. Mutual funds cannot put all their eggs (except sectoral funds) in one basket, but individuals can. Concentrated bets are the best way to higher returns, so long as you understand that this can also result in larger losses if your bets go wrong. If you can bear the risks, putting all (or a significant chunk) of your eggs in a high-flying basket is good for your financial health.

#4 Equity is risk, debt less so.

This is true, but when interest rates are volatile, debt funds can give negative returns. This is because listed debt (bonds, debt mutual funds, etc) carry interest-rate risks (even government bonds), and when rates rise, your returns will fall as the underlying bonds must fall in price to match market yields. Only bank fixed deposits carry zero-rate risk, and if you must avoid risk, these are still the best avenues for balancing equity risk.

#5 Fundamentals matter more than market momentum.

No quarrel with this statement, but fundamentals do not always matter. Reason: the price of a stock depends on the number of people willing to buy it, and not only on whether it is a high-profit generator. Similarly, valuations in the market as a whole depend on a rise in liquidity, and not just on fundamentals. The Indian markets have under-performed not due to a poorly performing economy but underwhelming liquidity, with FIIs pulling out funds for investment in US bonds.

Put another way, it is liquidity that determines large gains from a stock portfolio and not just fundamentals. If liquidity remains low, the markets will not gain. The Dow went places after 2008 because the US Fed was pumping zero-cost money like there was no tomorrow. The index’s rise had little to do with the fundamentals of the US economy.

#6 Mutual funds are better than individual stock-picking.

Sure, if you are a passive investor uninterested in knowing how the markets work or doing some simple homework, this is still the best way to invest. But the world over, many mutual funds fail to beat the indices. This is because fund managers track indices and tend to bet on stocks that constitute their benchmark indices. This ensures that all fund managers invest in the same stocks, and these stocks become costlier to acquire, paring gains. The buying interest in underlying stocks tends to make the index rise, and fund managers end up with average performance relative to the index. A better way would thus be to invest directly in index funds, where fees for fund managers tend to be low.

On the other hand, the market tends to be more liquid for small investors. They can buy without impacting the market price too much. You can always buy 1,000 shares of Infosys without impacting the price, but if mutual funds buy one million shares of Infosys, their costs for acquiring the same will be higher; and if they try selling the same, their realisations will be lower.

For the intrepid investor who is willing to do some homework, investing at least a part of your funds directly in the market may yield higher returns than investing only through mutual funds. This is not advice to avoid mutual funds, but a truism: if you want to leave the hard work to fund managers, you can sleep easy, but you may also earn less.

#7 Real estate will always be a sure bet.

This may seem true prima facie, for we all know that the supply of land on Planet Earth, in our own cities and countries, is limited. But the reality is different. The price of a property is the cost of the land plus the cost of building materials, including labour. The latter only depreciate, as a building ages. It is only the first part – land – that is supposedly in short supply, but even this short supply is relative. In India, this short supply is artificial, since crooked builders and politicians restrict land supplies through debilitating delays and arbitrary laws to make huge profits themselves by giving building permissions.

Land supplies in most cities can be increased by allowing more builders to go vertical, and by building infrastructure to access cheaper land in the periphery.

So, no, even land prices need not be permanently in the ascendant.

The point is that all investing rules are good as broad guidelines, but to make bigger returns, you need to know when to discard them.

My personal take is that stocks are the way to go in these bearish times.