A recovering market offers enough opportunity to join in. So don’t be in a hurry to get back in
Posted by: Uma Shashikant on Jun 15, 2020, 06.30 AM IST
We can’t miss it. Many businesses have reopened; people are going back to work; trains and buses are plying, remarkably crowded. But rebounding stocks, that is a different story. No one can satisfactorily explain what the stock markets do on a daily basis. We don’t know why the markets are jumping about, but hold on to that streak of optimism that is egging you to act. Not now. Not yet.
The most popular idea in explaining a jump in stock prices is that they corrected too much too soon and now that things are clearer, it may not be as bad as was expected. The markets fell in a panic and now are making up for it. This might be the optimist’s version of why there is always a reason to invest in stocks. We don’t see such remorse and recovery, typically.
When markets move up, they move with great frenzy. The primary driver is liquidity. Much as we love a good stock or a good story, without money to back it, nothing happens. The bullish spiral is such that higher prices attract more money and the power of liquidity pushes prices up. The correction at the top is remorse and regret that optimism pushed prices too much. Puncture the source of funds, and prices fall. Bear markets are different.
When stock prices fall, they crash. Suddenly and sharply. Liquidity leaves the market. For this market that fell severely to come back, not only is liquidity needed, but the possibility that such liquidity will be rewarded with profits. So without a semblance of positive news, much of the early enthusiasm drains off. There is no such thing as a falling market correcting itself because it fell too much.
There must be a clear and sustainable indication that things are turning around. We may not remain shut down and closed as was the case in the last two months. But return to normalcy is not in sight. Most businesses will operate at a fraction of their capacities, if at all.
When it is quite clear that the world is hurtling towards a painful recession, where is the profit growth that the market is supposed to be dynamically discounting to arrive at fair value for the stocks? It is easy to lose sight of the cash flows and the revenue growth, when all one wants to see is the recent past. Wait for the signals to turn green; they are clearly red at this time.
What if this is the bottom that we just cannot miss? What if things won’t get worse? Isn’t this the right time? To all those optimists, a wait until quarterly numbers are published is in order. In a few weeks from now, we will get those numbers for the April-June quarter. We might not have seen such numbers, ever.
The brave hearts who assume that everything is only getting better from here onwards, fail to recognise the real struggles of real businesses. We are not dealing with a few errant traders, bankers or conmen this time. We instead have an unprecedented shutdown of economic activity across the board. Recovery is bound to be slow. It shows as it happens, and we see nothing yet.
The optimists don’t give up. They point to the fact that interest rates have been cut; central bankers have acted; and governments have taken relief measures. But how much of it percolates down to the real economy and turns those wheels is the question to ask.
Low interest rates do not translate into credit growth overnight. Not during times of pessimism as we now see. We would have a period of liquidity that stays undeployed. Lower rates will not attract borrowers, until they are optimistic about economic recovery themselves. A low or even a zero interest rate is necessary but not sufficient to ring in recovery.
What should investors do? What should they look for, even as they hold their breath as if the rising markets will slip off their hands denying them a stellar opportunity to be a part of the next boom?
First, pick out the gainers and check their numbers out. In a weak market where speculators want to quickly turn things about to make some money, stocks with poor track records will also move up. A recovery must be marked by the best of the lot surviving through the crisis and coming up first even as others struggle. A rising tide of uneven winners is weak.
Second, don’t waste your energy on PE multiples and relative valuations. Always remember that the P in the PE is changing every day. What must matter is the E. Without the possibility of earnings growth, no stock can sustain a rise in prices. If there are stocks that are actually doing better than they did the same time last year, get to the investment thesis of that earning growth. What is driving those earnings?How is it growing when all else is down? If you can’t come up with satisfactory explanations, it pays to remain pessimistic.
Third, don’t buy theories about stocks that are always good; that the best are available for cheap prices; that some businesses are resilient; or that some managements are so good that they will do well even in the most adverse conditions. Allow the numbers to do the talking. If the best bank in the system reports that it is seeing a lower rate of credit growth, is provisioning more than before, and is holding too much of liquidity, it is not the time to invest yet.
Fourth, shouldn’t you continue to invest as you always did? Maybe, provided your personal financial position has not weakened. If you are confident about your job and income, and believe you have enough liquidity for any unexpected turn of events, continue to invest. But if you think risks remain, you would not want your savings invested in a risky market and make it worse for yourself. We all love to see ourselves as the mavericks of the marketplace. We want to make the smart moves and rake the money in. These are not the times for those fantasies. A recovering market offers enough opportunity to join in. Don’t be anxious about missing that bus, it is not even moving yet.
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