Market view: S Nagnath DSP Merill Lynch

Why should you know Nagnath’s view on the market? When the whole world was pessimistic about India he predicted huge cash inflows. I may not be too wrong if I say that he predicted the bull run in 2002, not in 2008! He always has a balanced view and gives excellent quotes and views to the media.

This is what he had to say at the India equity show – a show organised by www.myirisplus.com at Worli, Mumbai.

When quizzed about the Golden rule of investing, Nagnath quoted somebody (Anon) and said “The man who has the Gold makes the rules”. Apart from sounding good I guess what it means is the importance of cash flows. If the valuations are good, the market is attractive. However for the market to go up, there has to be somebody who puts in the cash. My personal view is that the money can come in from Unit linked Insurance and mutual fund sales – to compensate and more than compensate the FIIs taking money out of the country.

One thing apart from liquidity predictions and analysis is that many people who predict things may get it wrong. When the US $ started getting weak and there was a need for many Americans to go away from the US $, the cash flow caused the Emerging Markets and commodities to boom. Now if there is a reversal, we need to be ready for the same.

When markets go up, we rationalise. When markets go down, we rationalise.

Then he spoke about “regression to the mean” – if you are expecting say 15% p.a return over a 15 year period and you have had a bull run for 4 years where you got say 100% return, maybe you take some profits and keep it away. Similarly if you have got a -13% p.a. for say 4 years maybe you pump more money into the market. My take is “continue your SIPs, stay away from Unit Linked plans” theory will work well.

What causes this tendency of the market to run far ahead of earnings or lag the market for long periods of time? It is cashflow – created by euphoria or by excessive pessimism.

Nagnath also said it is difficult to take a long term view because of the crisis in the US and European markets. He called it an unprecedented short term market crisis – and similar crisis seems to have hit the western world only in the 1930s.

He took a nice dig at Bank balance sheets – and said that after the sub prime crisis, in a bank balance sheet if you saw on the “left side” there was nothing right and therefore quite obviously when you saw on the “right side” there was nothing left. He said that banks have very poor quality of assets funded by high leverage. We saw this in case of Bear Sterns, and now Lehman brothers is raising money for meeting its capital adequacy needs.

About the future Nagnath felt that the markets in the next 12 months are likely to be tough. He had no clue on whether we are finished with the sub prime crisis, are at the half way mark or in which leg of the journey we are. He felt the markets will be worse before it got better. He also predicted a market rally as and when the oil prices hit US $ 100 on the way down.

Long term money = Equity Money

“Past performance is not an indicator of future performance” — the literature of every mutual fund you own, mentions something to this effect. In fact once, when I was lecturing at a mutual fund house, which was not performing well, one of the managers said, jocularly, “Can we say our past non-performance is not an indicator that in future we will not perform?” And yet, ignoring the past in investing or in any other field is rarely a wise move. What we should understand is that the past is only a proxy for the future.  Wall Street stock investor, Peter Lynch sums this up well; he says“You cannot look in the rear view mirror and drive.“ History is…history! An important lesson from history —  you cannot learn from it!We tend to over-emphasise the recent events of the immediate past, and worry about it. When you look at a fund performance, you will be guided by past history, the true to label portfolio selection, the consistency of performance and so on. However, if you chase performance on the basis of its immediate past, you are likely to be sorry. There is enough literature to show that equities are an excellent long-term instrument, and very volatile in the short term. Equities outperform other asset classes, and vis-à-vis inflation.In the Indian context if you had invested in the index, in say, 1978-79, and reshuffled it regularly (what an index fund would have done if it were available) your portfolio of Rs 100 would today be worth Rs 18,000. This is an excellent rate of return, to hope for. How to calculate stock returns Studies show that stocks have returned about 19.2% per year from 1980 through 2006. This number however does not include the dividends reinvested. In the USA the dividend reinvested was twice the rate of appreciation. Any return should be broken up into: – Inflation – Dividend – Appreciation/capital gain   The buzzword: Long-term or average? Think long-term. Does this mean that stocks have returned 19% per year in most years? Hardly. The volatility of stocks is legendary. Markets returned a figure as high as 266% in 1992 and followed it up with a 46% fall in 1993. Thus the word average return does not make any sense for a volatile asset class like equity. Historically we have never had a four-year bull run! Three good years have been followed by one bad year – that is to say March 2008 has to end at a sensex figure less than that of March 2007. But this is also an outlandish statement. Statistics are to be used very, very carefully, to analyse rather than predict.   Talking about average in equities is like saying: Yesterday the air conditioner was not working, today it is freezing. So, on an average we are comfortable! But what’s clear is that the probability of making losses is almost nil in case a person chooses a balanced fund, managed by a good manager (fund house), does an SIP and stays invested for say 10 years at least. This wide disparity of returns makes holding stocks for long periods of time a better idea than holding them for short periods. So, where do we place our bets? A thumbs down for this bond If you are interested in steadier, more predictable returns, let’s take a look at bonds, which tend to fluctuate less than stocks. As a rule bonds cannot protect you against inflation. Let’s look at RBI bonds. It pays you 5.6% return (after tax) in a country where inflation is around 7%.  That, effectively is a negative return of 1.4%. When your advisor says, on an average you can expect to get 19% return over the next few years, what should you do? Baulk!Predicting is difficult especially if it is about the future (Mark Twain). Surely this 19% return is fine, but the total return on an equity share (therefore a fund) is a function of how much dividends you get, the inflation rate, and capital appreciation that you can expect. If your advisor does not know that, you need to read and equip yourself before meeting him! Investment wishlist a. For long-term money, equities remain the best investment.They will not (perhaps cannot) return what they returned over the past five years. But other asset classes cannot be compared to equities. b. Other asset classes like say debt funds protect your capital and give reasonably good returns. But they are not protected against inflation. c. Well-diversified funds, index funds, unit linked equity funds (which by definition have a long term horizon) should all be in your wish list.Morgan Stanley – the listed mutual fund available at a discount – should be a good choice too. The final word: Manage your emotions (this may be the most important part of investing). Lynch says: The amount of money you make is not a function of your IQ, but a function of the strength that your stomach muscles have! Can you take a churn?    PV Subramanyam The author is a financial domain trainer. He can be reached at pv.subramanyam@irisindia.net