A month back it seemed like there was no end to the Indian market’s woes. The FPIs were pulling money out, crude oil prices were rising through the roof, the Rupee was falling without a bottom, inflation looked like it would keep increasing, there was speculation that the current account deficit and the fiscal deficit could be much larger than forecasted and, that RBI was likely to increase the interest rates. Further, the domestic situation of the IL&FS defaults spilling over to the rest of the financial sector and possibly a liquidity crisis potentially brewing provided further grist for the rumour mills.
Oh, what a difference a month has made!
The FPIs seem to be coming back in, crude oil prices seem to be on the way down, the Rupee seems to be stabilizing, inflation and the twin deficits seem to be under reasonable control and consequently there doesn’t seem to be strong reasons for the RBI to raise interest rates anytime soon. Further, the possible liquidity crisis due to the IL&FS default seem to be already handled reasonably well and seem like so much water under the bridge.
The markets seem to have bottomed out and the valuations seem to be quite juicy. A large number of stocks have fallen 30% to 50% or more and many are available at large discounts to intrinsic value.
A look at the Buffett indicator, i.e. the market cap-to-GDP ratio, seems to suggest that this is probably the rare chance to take a serious look at allocating to equity markets from a long-term investment perspective. In 3 year’s time it is highly likely that we have a stable government, a strong economy and the markets at levels which are likely to evoke nostalgia and envy for the current market levels.
In short, now is a time to be seriously considering a significant allocation to the equity markets.
However, while the outlook from a 3-year perspective looks quite rosy, the job of the scientific investor is not to speculate on that. Rather, the scientific investor focuses on the bottom-up stock picking using his or her favourite investment strategy, i.e. finding SuperNormal Companies at SuperNormal Prices.
Under the current situation, many more SuperNormal Companies are now available at SuperNormal Prices. More choices should potentially provide higher expected alpha since one can exercise more selectivity and choose companies with brighter futures and which are available at much higher discounts to intrinsic values. If one chooses to diversify further, the risk mitigation would also add to the alpha.
Ideally, one can focus on creating a portfolio of companies diversified across multiple sectors. The SuperNormal Portfolio currently seems to have exposure to a number of cash-rich sectors, viz., the IT sector, defence sector, basic materials, speciality NBFCs, utilities, automobiles and publishing, among others.
One should use the Scientific Alpha process which focuses on SuperNormal Companies which enjoy business and financial integrity, efficient capital reinvestments, and are available at SuperNormal Prices, i.e. large discounts to intrinsic values.
Ideally, if an investor is eligible for portfolio management services, they should avail of those. However, if one is not, they could create a crude version of the Scientific Alpha process themselves. Even if they chose to eliminate high debt companies and tried to avoid overpaying for popular but overvalued companies, they would have done a decent job and are likely to be ahead of the markets.