December 2018: Volatility is not bad for the patient investor

CY2018 was marked by the divergence in performance between the large and midcaps stocks. The Nifty was up 3.1% for the year, whereas the Nifty Midcap index was down 15.4% and the Nifty Smallcap index was down 29.1%. Even the median performance of the top 25 equity mutual funds by size was down 4.3%, indicating a fairly tough year for equity investing. This was on the back of a strong year in CY2017, when the Nifty was up 30.3%. Equity market by its very nature is expected to have a mix of strong, moderate and difficult years – but, in our best opinion, long term equity market returns should converge to an annualized return of about 11-13%, which would be in-line with the nominal GDP growth rate.

The year was packed with several extraordinary events. Global events were led by the trade war, mainly between US and China, which also spilt over to the rest of the world. Oil prices shot up during the year and corrected towards the end of the year. This led to a steep fall in the Rupee and rise in interest rates in India, creating concerns over the government’s ability to hold up to its fiscal deficit target. All these events coincided with the NBFC crisis in the last quarter of the year. The tough situation precipitated in intense negotiations between the government and the RBI, eventually leading to the RBI governor resigning from his post – a rare event which will leave a black mark in India’s economic history.

Despite all these events, the Nifty volatility was only about 28% in FY2018 (measured based on Nifty High / Low during the year). Overall volatility in the Nifty over the last 5 years has averaged about 27%, compared with a much higher average volatility of 58% in the decade before 2012. With lower inflation and low overall corporate earnings growth, one would expect overall volatility to reduce. On the other hand, one should also note the maturing nature of the Indian stock market participants. FIIs sold nearly Rs 32,000 cr in the equity in CY2018 and historically such FII selling has led to sharp fall in markets. Unlike the past periods, this sale was compensated by Mutual Fund investments of nearly Rs 110,000 cr. Over the last 4 years, inflows from domestic investors through Mutual Funds has been gaining momentum. The Indian stock market’s resilience is due to a good mix of different classes of investors and this is good for equity investors over time. Ideal equity investing is where one can make reasonable equity market returns above fixed income returns, with as little volatility as possible. Reduced volatility levels are good for investors and only time will tell if this trend would continue.

As we look forward, the general elections in a few months is the big uncertainty for investors – though based on stock market performance in election years over the past several years, there does not seem to be any major cause for worry. There is increased concern on fiscal deficit coming under pressure as we near the election period, though the government is confident of holding up to its targets. The good news is that oil prices have come down sharply and interest rates are also on their way down. The public sector bank capitalization process has also started and corporate earnings growth seems to be gaining momentum. The correction in stock prices over the last year has improved the relative attractiveness of stock prices, though there continue to be several pockets of expensive valuations. The next few months should be a good period to build out some core investment holdings, as uncertain periods tends to create volatility which one can use to buy investment grade companies at sensible prices. We look forward to deploying some capital over the next few months.