Its interesting to see how the market (Sensex) has gyrated in the last 12 months, from about 26000 levels in end September 2014 to >30,000 and back to 26000 again, from 27500 level at the start of the year to >30,000 and now down at 26600. This kind of steep volatility has surprised most of the market participants who were very bullish on the markets for next few years due to the tall expectations from the new government and its new policies/actions.
Well, these kind of steep corrections or volatility has not much to do with the government of the day (though partial effect due to expectations dampener can’t be ruled out). This is predominantly due to the nature of the beast- the market . Benjamin Graham – The father of value investing, guru of Warren Buffet and author of investing bible called “intelligent investor” once said that Market is like a manic depressive person (called Mr. Market) who has extreme bouts of mood variation between ecstasy and depression. Depending upon his moods, Mr. Market will produce the quotes of his business which are either on the higher side or lower side of the intrinsic or real value of his business. This volatility causes market to be imperfect and inefficient in pricing the assets/ stocks sometimes. At these times, the discerning, wise & patient investors don’t follow the herd mentality of the market and exploit its inefficiencies to create long term wealth.
In markets, volatility is governed not only by change in fundamentals of the businesses but also other factors like information, future expectations and speculation. So , while the fundamentals don’t change that fast , the information regarding the businesses, economy etc. , future expectations of the market participants and level of speculations(influenced by liquidity, prevailing sentiments etc.) keep on changing leading to very dynamic changes in the prices of the securities/stocks.
However, when it comes to Indian markets, they are even more volatile than other markets including developed as well as emerging markets . Its significantly more volatile then developed markets like US, UK , Europe etc when it comes to intra-day and inter day volatility(about 30-40% more) and also more volatile then emerging markets like China, Indonesia etc. by about 15-20% . I always wonder about the reasons behind this greater volatility of Indian stock markets and whether it’s an asset or liability for retail investors? Following is my take on possible reasons for greater volatility in Indian markets
- Predominance of FIIs(Foreign investors) in Indian markets – They call the shots as they have deep pockets and control a majority of large cap free floating stocks unlike China , US , UK etc where the local domestic investors have a dominant position . FIIs are the biggest holders of free float stock among all listed Indian companies , holding 40% of the free floating stock(non promoters stock). Many of these FIIs develop cold feet when they get to hear any bad global cues like recent Federal Reserve(US central bank) hiking the fed rates, China devaluing its currency and its stock market entering into a bear market with >20% market correction etc. They catch cold when developed markets or economies and china sneeze , over-react and sell off assets of emerging markets like India leading to excessive volatility
- Indian derivative market(Future and options) turnover is significantly higher than cash market While the turnover of cash segment was 3.3 lac crore INR , it was 43 lac crore for Future & Options segment in September 2015 (13 times bigger). This again leads to more volatility as future and options market is all about price speculation, taking bets on potential rise or fall of the market prices. If the market doesn’t adhere to their speculative direction, the price speculators immediately perform short covering(close their positions) which further worsens the volatility.
- Equity participation of domestic investors – When compared to FIIs , domestic investors in all markets are more long term oriented as they don’t have multiple options of investing in other countries. Hence, they provide the stability in their local markets. Unfortunately, in India the participation of domestic investors is very thin due to lack of equity culture. Indian investors only invest 2% of their entire savings in equities. Most of their savings go into non-financial assets like real estate and gold while only USD 10-12 billion goes into equites. Domestic retail investors only hold 33% of floating stock, while domestic Institutional investors hold only 20% of free float stocks . This is very less compared to domestic investors holding in Developed as well as emerging country markets. Further long term investors like pension and provident funds invest only an insignificant(5% or less) of their funds into stock markets in India, unlike other countries
- Last but not the least is the typical character of domestic investors(institutional and retail) – manic depressive character. That’s what I mean when I say “manic depressive markets in a manic depressive country” . We Indians are typically emotion driven characters who like to evaluate in dual mode (0 or 1) when it comes to the most passionate things of our lives .Good example could be Indian Cricket team. The country adores them when they win tournaments like one day world cup or T20 world cup and puts them into God’s pedestals. The same fans throw rocks at the cricketers’ homes when they get vanquished by Bangladesh few months later. Second good example could be Modi and his government’s performance. The country and the market adored Modi like God when he became the PM in May 2014 and the markets shot up by >25% in 7-8 months of his entry. The same markets, industrialists and investors started losing their patience even before we had completed 1 year of the new government and started hammering the shares down in disappointment. I have lived in US for 2 years in the most turbulent times(2008-2009 recession), when Obama became the president I didn’t witness any euphoric market upsurge when he became the president nor did I notice any steep market correction in the first year of government due to performance disappointment. This extremely fluctuating evaluation of the Indian investors also leads to added volatility. While all over the world, the domestic investors add stability to the markets, the manic depressive character of our domestic investors adds to the volatility of the markets which worsens the situation.
Is extreme volatility of Indian markets an asset or liability for the domestic retail investors?
I definitely think that this volatility is an asset for Indian retail investors. It produces mouth-watering opportunities for picking up my favorite businesses or stocks at reasonable or under-valued prices . The market hammers down the prices of good as well as bad businesses, painting all the businesses with the same brush. In recent times , we saw extreme volatility due to stupid and short term reasons like likelihood of US Fed raising the interest rates, China devaluating its currency , steep correction(>20%) in Chinese markets etc. . None of these reasons were long term and could not fundamentally impact business models and results of strong businesses in India. Yet markets corrected by 10% in last 2 months as if there was no tomorrow. FIIs pulling money out of Indian markets had a big role to play in this sudden correction along with our manic depressive domestic investors who are very quick in losing patience with the Indian government and Indian long term structural story.
Implications for retail investors like us
If you have missed the earlier rally when Modi government came to power, this is the best time to invest in stocks for long term as markets have over-reacted and hammered the quality businesses also. Though the market(Sensex) has gone up by 1300 points(5%)in last 1-2 weeks after the US Fed meeting where the rate hike was deferred and after Reserve bank cut the interest rate by 0.5% , it’s still a great time to invest with 3-5 years horizon in quality businesses
The businesses where I am investing today after recent corrections are primarily from my 2015 and 2014 model portfolio (published on the site). They are mainly in Private Banks space (Yes Bank, Axis Bank), Housing Finance companies ( India Bulls Housing finance, Dewan Housing), Auto sector(Tata Motors and Apollo Tyres) ,Pharma (Aurobindo, Torrent). Besides these businesses, am also investing in global defensives like IT sector (Tech Mahindra and HCL Tech). From Infra and power related sector, I have invested indirectly through ancillaries/ suppliers like REC so that direct risks are minimized. All these businesses have strong business models with excellent moats, competent and transparent managements, strong balance sheets & financials/ returns , available at reasonable or under-valued prices.
I will remind again that successful equity investment is not a rocket science. It doesn’t require a high IQ or professional expertise. All its requires is the right temperament(long term investing), sound and common sense driven framework to select the right businesses & finally discipline/patience to stick with your decisions, regardless of the short term variations of the market.