‘Buy The Dip’ Versus ‘This Time Is Different’
A monitor displays an S&P 500 chart on the floor of the New York Stock Exchange. (Photographer: Michael Nagle/Bloomberg)

‘Buy The Dip’ Versus ‘This Time Is Different’

BloombergQuintOpinion

Truth is often stranger than fiction, and Dalal Street is slowly coming to terms with that in the last few weeks. In these strange times of the coronavirus, what instead could well be fiction right now is the belief that this moment too shall pass very soon. One hopes this period of worldwide pain and suffering will wane, people get healthier, and with it markets bounce back as they have in the past. But as a wide range of experts on BloombergQuint and elsewhere have emphasised, this is not an ordinary event. The forces at play are more complex when a market correction is accompanied by an economic event, and this one has come with an unprecedented disruption to the basic ways of how we go about living in the modern world.

When folks like Blackrock CEO Larry Fink say that this is something he has not seen in his 44-year career, or when Howards Marks says that the world will be upended by the time this crisis ends, you need to take notice. Try to game out how different this may play out than past downturns. How much of an aberration can this be to the standard global playbook of cyclical recessions and a rapid return to growth? And how different can the Indian scenario be, than much of the world?

A Confirmation Bias

Many people would find it difficult to digest the idea that the film reel yet to play out may not follow any past script. Some may comfort themselves with the adage about how ‘history rhymes, even if it doesn’t repeat’. It’s natural for this to happen. Everyone who is invested has an emotional reason for believing in the likelihood of a potential up-move coming soon because that uptick would add credence to the perceived stability of the financial plan laid out for the rest of one's life.

Having that plan upended is unacceptable, to a mind that prides itself on understanding the financial markets better than the street.

The other reason is the inability of most investors to accept a new normal. As Charles Ellis summarises in The Loser’s Game, ‘the more important the old concept of reality is to a person – the more tenaciously he will hold on to the old concept and the more insistently he will assimilate, ignore or reject new evidence that conflicts with his old and familiar concept of the world.’ It is simply difficult to admit that what is happening is beyond your predictive abilities.

An Altered Growth Trajectory

Let the psychological aspects rest here for now. Let’s try and logically assess what could make this time different. Any stock market correction is the first-order effect of risk aversion. The second-order effect is the longer-term readjustment in the valuation multiples that the market would be willing to pay to a potential lower earnings growth or de-growth story.

As the market assesses what lower price-to-earnings multiple it is willing to pay for a lower earnings value, a few variables come into play – the pace, magnitude, and duration of the overall earnings de-growth, and (for investors who don’t buy indices but stocks) the contributors to that de-growth, and their prospects. The investor has to assess which of a portfolio’s components could suffer permanent earnings damage, which can bounce back, and which ones will eventually get rewarded with an upward rerating of valuation multiples. Making this assessment well is likely to be the hard part of an investor’s job this time. More on that in just a bit.

First, the indices. The near-35 percent Nifty decline from its peak to last week’s close took its forward P/E ratio in the range of 11-12x. This is already lower than the multiples in some of the recent semi-crisis periods, notably the oil price crash in 2015-16, or the peak of the European debt trouble in 2010-2012. The 2008-09 global financial crisis, which is the parallel that some Wall Street titans have drawn to the current crisis, had seen the multiples sink much lower... to below 9x.

Last week’s low of 1.3x trailing price-to-book multiple for the banking index is still higher than the March 2009 lows of 0.94x.

That gives ground to those who say that we may still have some room to fall on a valuation basis. Meanwhile, there are others who say that the market has corrected more than what it should have. Let’s put the latter into context. For an event that most pundits say they haven’t seen something like before, the Indian markets dropped 35 percent peak-to-trough, compared to a fall of 67 percent in the 2008-09 crisis or a 57 percent fall in dollar terms after the tech bubble burst two decades back. Also, bottoms in the four prior 40-plus percent declines of the last 30 years took 10-27 months to play out. We are just two months into the present decline, so on duration too, we may have more to go. That said, on that last point, the new normal has been sharp falls and sharper pullbacks. At the time this was written, a few Asian markets are already back in a bull market, having risen more than 20 percent from the recent lows.

Before Winning, Comes Surviving

On to the harder task of finding the right components for the portfolio. So far, the average multiples for the top 100 companies have still not corrected too much. Does this indicate that those that continue to be valued highly, are seen as those that remain strong franchises?

You will find individual investors and mutual fund managers spending time looking for the drivers of the next move. Folklore has it that the leaders of a new bull market are always different from the previous market. One step before that would be identifying which businesses will continue to stand firm once the dust around Covid-19 settles. Would those that are dependent on the hyper-networked world we’ve known wither away in a New World Order where people may shy away from being in crowded places? How would the business prospects and valuations multiples of airlines, multiplexes, malls shape up? Anybody’s guess. Will coronavirus digitise mechanical businesses the way demonitisation did in the financial formalisation of businesses in India?

How will these changes alter the valuations of businesses that depend on online ordering but the physical delivery of goods or services?

In the absence of a crystal ball, short-term investing in current times is likely to produce abnormal returns, both positive and negative. Aiming to time a bounce or fall correctly, and with it to be in just the correct sectors or businesses, is likely to remain a mirage for most.

One last point. The government spending announced so far has been directed at the weakest sections of society, and not businesses. This disruption is likely to leave lasting scars on business operations and the consumer’s wallet, which may add further stress to a few financial sector entities. All of this is bad news for an economy that was anyways struggling for growth. So while stocks may recover some lost ground as a reversion to mean, how much will they deviate from underlying growth, and go along with other markets as and when all start moving higher? These are all questions that even the best may struggle to answer.

Niraj Shah is Markets Editor at BloombergQuint.

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