What would be the first thought that crosses your mind when you hear a veteran fund manager betting his shirt on Nifty falling 30-40% in the next six months! Yes, you heard it right. Last week, a former CEO/CIO of a large AMC confidently told an audience of top bankers and HNIs that Nifty is bound to come to sub-10,000 levels in the next six months and gold is the only safe haven under present circumstances.
I am not sure about how many amongst the audience actually concurred with his view, but the first thought that came to my mind was “how would this old man look without a shirt!"
In a recent visit to the financial capital Mumbai, I also had the opportunity to meet some senior market participants (bankers and investors). None of them sounded enthusiastic about the markets. The consensus appears to be strongly favouring a slow grind over the next 6-9 months.
Incidentally, the reference point for most of the senior participants is 2008 market crash, in the wake of the global financial crisis (GFC). The fear is that rising cost of funds and fast drying liquidity could trigger some major defaults that could trigger a global contagion like what happened after the Lehman collapse in 2008.
Obviously, the senior bankers and fund managers have much wider vision and knowledge base to form their opinion; and therefore are certainly in a better place to foresee what direction the markets are taking. Nonetheless, I am not inclined to agree with their assessment. I strongly, believe that a repeat of 2008 like condition is unlikely, for the following simple reasons:
1. Contrary to popular perception, the abundant liquidity infused in the global financial system post the GFC has not resulted in excess return on assets. In the past 15 years, European equities (Stoxx600) have returned mere 0.7% compound annual growth rate (CAGR); Chinese equities have yielded negative return; Japanese equities continue to be lower than their 1990 level; Brazilian equities have yielded about 3.5% CAGR despite very high inflation; and US and Indian equities have yielded less than 7% CAGR.
In comparison, during 2005-2007 Chinese equities had surged 131% CAGR; European equities prices gained 25% CAGR; US equity prices gained 14% CAGR and Indian equity prices gained 58% CAGR.
Gold, aluminum, copper, crude oil prices (in USD terms) are at 2011 levels, while silver and steel prices are much lower as compared to 2011 levels.
Apparently, there is no bigger bubble to burst this time. There were localised bubbles in sectors like US tech, India internet, Taiwan semiconductor, China real estate, etc. which have been punctured in the past 9 months and the gas is releasing mostly in an orderly fashion so far. It is also important to note that unlike numerous infrastructure builders commanding crazy valuations in 2007-2008 (e.g., JPA, Suzlon, GVK, GMR, Lanco, Reliance Infra, KSK et. al.) and totally dominating market activity, the share of crazily valued new age businesses in the overall market is much less this time.
Another bubble was inflated in cryptocurrencies, which has already burst.
2. The subprime crisis came to light in July 2007 when Bear Sterns announced the implosion of two of its hedge funds due to credit defaults. The market fell 20-25% and rose again to record higher highs in the next 6months. The governments and central bankers were mostly complacent in this period. They kept sitting on fringes waiting for the crisis to blow out in due course.
The global financial markets started to freeze due to threats of sovereign default crisis and sudden surge in energy prices. But it still took months for the governments and central banks to come out with a concrete plan for handling the crisis. The collapse of Countrywide Financials, Fannie Mae and Freddie Mae and Lehman Brothers (September 2008) actually catalyzed the globally coordinated response to the crisis. The markets made a strong bottom in the next six months (March 2009) and have not looked back since then.
While it took more than a year (July 2007 to September 2008) to devise a rescue and revival plan during GFC, the template is now available readily. The template has been tested extensively during the 2020 pandemic induced global lockdown. Despite a worldwide lockdown, no market froze and the panic fall in the markets was corrected in 3-4 months.
Besides, the global markets have handled Brexit; defaults by countries like Argentina, Sri Lanka etc.; China Evergrande crisis; collapse of some large funds and decimation of some cryptocurrencies (and tokens) etc. rather well in the past one decade.
Hence, it is safe to assume that the chances of a global market freeze like 2008 are significantly less.
3. During the 2003-2007 market rally, the subprime credit was a primary supporting factor. This time it is materially different. This time subprime debt is mostly a tertiary factor. The debt is mostly sitting in the books of the financiers who have funded the investors in private equity funds. These private equity funds have invested in the equity of all these fancy startups. An implosion in the astronomical valuations of these startups would be the ultimate lenders with a significant time lag. Thus the grind could be slower and protracted this time.
4. The regulatory changes since GFC have materially strengthened the global financial system. The risk management systems and processes are much superior now as compared to pre GFC period. Besides, the global agreements on information sharing systems have reduced the probability of unexpected global contagion.
5. Leverage in Indian markets is significantly lower as compared to 2008. In 2008, over 55% NSE derivative volume was single stock futures and less than 10% was in Index options. Now 98% of derivative volumes are in Index options and less than 0.5% volume is single stock futures. Besides, cash margins are much higher. Hence, the chances of markets falling 10-15% in a day are much less.
I therefore believe that the probability of markets falling like 2008 due to inflation, slower growth, debt defaults, any other well-known factor or a combination of all these is insignificant. Of course, the markets can crash 30-40% due to some extraordinary ordinary, which is totally unexpected and cannot be foreseen.
In my view, as I said three months ago (see here), we are more likely to witness a “boring” market rather than a “bear” market in India. The indices may get confined in a narrow range and market breadth also narrow down materially. The market activity that got spread out to 1200-1300 stocks in the past couple of years may constrict to 200-250 stocks.
It will be a test of patience as well as endurance of the investors. Not doing much in the next few months would be the best course of action, in my view.
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