Good returns are seldom made on investments made in good times. 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.

Besides, the fair value of markets / companies is not stagnant; rather it is increasing at roughly 15% per annum. This rate is broadly the same as the nominal growth rate of GDP since companies in aggregate represent the economy itself.

When markets are moving up, the news flow is generally good and vice versa. Therefore, generally, in rising markets the perceived risk is low whereas the actual risk is higher as valuations are high. On the other hand, in adverse times, when the markets are not doing well and the news flow is not good, the perceived risk is high whereas the actual risk is lower as valuations are attractive.

The net result of all this is, that time and again, a majority of investors end up investing large amounts at high valuations and small amounts at low valuations. Clearly, such an approach to investments is not conducive to generating good returns and if followed, is likely to lead to disappointing results time and again.

Key challenges

It is true that the economy is currently passing through a difficult phase. However, the problems facing the economy are such that should get resolved over time and through some specific steps.

Given the economic headwinds and adverse news-flow almost on a daily basis, it is easy to forget the several strengths of the Indian economy. Though these strengths seldom make headlines, they are intact and should lead to continued economic growth in future as they have in the past.

Global crude prices are correcting rapidly. OPEC and Saudi officials have openly remarked that they are comfortable with Brent crude at $100. Negotiations with Iran on nuclear sanctions are also reportedly progressing. If oil prices stabilise at lower levels, the pressure on fiscal / current account deficits and INR will quickly ease. Lower interest rates will then be a natural outcome and will support a much-needed revival in the capex.

The current problems facing the economy are not insurmountable. The solution lies in a few difficult decisions. As difficult changes typically take place in difficult situations when there are no easier options left, it is hoped that we will not have to wait for long. With few such steps and over time, it should be possible to put the economy back on the rails fairly quickly.

Difficult or bargain markets?

The stock markets are passing through a difficult phase. The values of the listed businesses, as indicated by the Sensex, are down by 20% between 2008 – 2012. This is despite a nearly 60% growth in the GDP (15% CAGR), and therefore, a similar growth in the fair values of businesses over the same time.

Consequently, the one-year forward P/E multiples have come down sharply from over 20x in FY08 to below 13x presently. These are nearly 20% below the long term averages. Further, the P/E of the Sensex based on FY14(e) EPS of 1,475 is nearly 11x, which is close to the lowest multiples that Indian markets have traded at in the past.

Bargains are available only in challenging environments / in markets characterized by weak sentiment and seldom when the going is good / sentiment is strong. That’s why, from an investor’s perspective, a more appropriate way to describe the current markets would be bargain markets and not difficult markets.

It's tomorrow that matters

By the end of June, or shortly thereafter, Greece will either be in euro-zone or it will not be. Over the same timeframe, the 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.

------------------------------------------------------------------------


The author is executive director and chief investment officer at HDFC Asset Management