Its Tomorrow That Matters

Good returns are seldom made on investments made in good times. Rather, good returns are typically made on investments made in adverse times.

There is a fair value for listed companies, just like for companies that are not listed. In good times when the stock markets are doing well, companies typically trade above fair values and in adverse times when markets are not doing well they tend to trade below fair values. In the long run, markets do not sustain at either overvalued or undervalued levels, rather move close to fair values. This is why investments made in adverse times typically yield above average returns and vice versa.

Table A: Performance of investments made in good times

Time	Sensex Level	1 year forward P/E	Main news / reasons	Total Returns after 3 years	Total Returns after 5 years
Jan-00	5205	25	High optimism in technology stocks	-38%	26%
Dec-07	20287	26	Booming global economy, optimistic markets	1%	-15%*

This table summarises the 3 and 5 year returns for the Sensex from times when the environment was challenging, market sentiment was negative and valuations were low, post year 2000.

Table B: Performance of investments made in adverse times

Time	Sensex Level	1 year forward P/E	Main news / reasons	Total Returns after 3 years	Total Returns after 5 years
Oct-01	2989	11	9/11 attack on WTC, global markets collapse	91%	334%
June-04	4795	10	Unexpected defeat of BJP in general elections	61%	99%
Nov-08	9093	11	Sub-prime crisis - Lehman collapse	77%	N.A.

From the above it is clear that markets do not sustain at either overvalued (high P/E) or undervalued (low P/E) levels and revert close to fair levels over time.

Besides, the fair value of markets / companies is not stagnant; rather it is increasing at roughly 15% p.a. This rate is broadly the same as the nominal growth rate of GDP since companies in aggregate represent the economy itself. India’s nominal GDP growth rate (real growth rate plus inflation) has been 14.1% p.a. since 1979. Current GDP growth rates over last 3 years of 16% p.a. (7.9% p.a. real growth and 8.1% p.a. inflation) are similar. It is not surprising therefore, that the Sensex has yielded nearly 15% p.a. returns from inception in 1979 till date .

God and Equities

There is a couplet by Saint Kabir, a much loved and revered saint of 15th century who lived near Varanasi – which many believe is the oldest city in the world to have survived continuously.

This couplet reads as follows:

Dukh Mein Sumiran Sab Kare, Sukh Mein Kare Na Koye

Jo Sukh Mein Sumiran Kare, Toh Dukh Kahe Ko Hoye

It means the following:

[ In anguish everyone prays to Him, in joy does none

To One who prays in happiness, how sorrow can come ]

Stock markets and God do not have much in common. Probably, that’s why, the above does apply to stock markets but in reverse.

An adapted version of the above for stock markets would be as follows:

[ In good times everyone invests, in adverse times does none

To the wise one who invests in bad times, wealth should come ]

The moral of this is that remember God in good times and equities in bad times. If this is done, then chances are one will avoid both - bad times in life and poor returns on investments.

Its tomorrow that matters

By the end of June or shortly thereafter, Greece will either be in Eurozone or it will not be. Over the same timeframe, steps if any that are undertaken by the government to resolve some of the issues facing the economy will also be known. Irrespective of what happens, markets should discount these outcomes fairly quickly.

It is true that the economy is currently battling twin deficits, but that is known to the markets. What will determine markets of tomorrow, are the deficits of tomorrow and expectations thereof, both of which chances are will be better and not worse than today.

Times such as present, when the markets are not doing well should actually be looked upon as a window of opportunity for savers to invest more into equities, so that when the good times come, there are meaningful investments in equities to reap the benefits from. The lower the markets are, the bigger is the opportunity and the longer the markets remain depressed, better is the opportunity for savers. In a lifespan of investing of say 30-40 years, it is unlikely that the markets will provide many such windows. In the last 20 years there have been only 3-4 such windows.

Finally, what has taken several pages, Sir John Templeton conveyed more effectively in one line:

“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

Needless to say, pessimism is all that one sees all around.

An Article by Prashant Jain – HDFC Mutual Fund