Imagine an investor, let’s call him a market timer, who would have been gifted with a divine foresight in 2010 to predict with absolute certainty the real macro events that would unfold over the next decade—the US by the S&P in 2011. Banking and credit crises in various European countries in 2012, the taper tantrum in 2013, Trump’s ascent to the presidency after Brexit in 2016, the trade war between the two largest economies in 2018 and then all crises in 2020. The most serious of all, covid. Also note that there will be major geopolitical events, including regime change in the Middle East (a major source of global oil supply), and political crises in many emerging market economies.
While the timer is aware of all these events occurring during the decade, it is left to him to assess the potential impact of such events on the market. It is most likely that the timer could stay out of the market entirely (meaning a cash call), assuming ‘logically’ that a gradual string of major macro developments would result in very poor returns over a decade. It’s an entirely different matter that after the war, the S&P 500 delivered its second best decadal return between 2010 and 2020!
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The timer confusion stems from the recent discussions I’ve had with several investors. The questions remain the same—the debate over geopolitics, whether one should wait for the markets to cool before investing, whether a Fed rate hike and runaway inflation could derail the nascent growth recovery, and so on. And I’m sure these concerns will resurface every decade or so. Macros if anything are, in our view, a source of risk and it is impossible to make money from such macro events.
To hedge the risks from macro events, one must maintain a balanced portfolio and should not be affected by timing the portfolio for a particular macro event. The latest example is the performance of sectors after Kovid. If you hold a portfolio defensively or sit in cash, you may have missed the major bounce-back rally in the cyclicals thereafter. A similar example is investor sentiment around the IT sector in 2017 when the US tightened visa restrictions. There were doubts that the Indian IT sector would be hampered by digital transformation and cloud adoption. Staying out of the IT sector would have resulted in those concerns losing huge returns from some stocks, especially mid-caps. Similarly, in 2021, when the IPO market was strong, it would seem like the best thing to do is to load the portfolio with consumer tech names, regardless of business fundamentals. There have been similar precedents across sectors over the decades and the message is not to chase the theme, but to stay invested by selecting good stocks through a bottom-up stock selection process. Thus, it is important to build a balanced portfolio of both pro-cyclical and counter-cyclical to ensure that macro risks do not hijack the portfolio.
It’s also important not to overlook broader trends. For example, India’s per capita income is rising and globally many consumer products have seen volatility of around US$3,000 per capita. This can be an important input in stock selection in the consumer and retail sectors but by no means should this trend be extrapolated to taking top-down calls on this sector.
Interestingly, the best performance of Nifty has come during bear markets. Historically, it has been impossible to make money by exiting the market and coming back at a ‘better’ time. The only investor who has given a worse return than taking a cash call is an investor who wants to time the market.
Prateek Pant, Chief Business Officer, WhiteOak Capital Management.