What to expect from your investments this year

“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

― Warren Buffett

With that witty quote from the great man as the opening, let me go on to break-up where we expect asset classes to end up this year based on predominantly long term as well as some short term trends. Please note that this will be a slightly long read.

For most investors 2017 has been the year of equities. The major large-cap indices have been up close to 27% for the year. Several indices such as Infra/ Realty/ Small & Midcap have rallied even more. While we may all speculate as to what has been causing the rally (there is plenty of talk around GST/ Demonetization/ Reforms/ Bank Re-Cap/ Political Stability/ etc.) the data below will be quite revealing-

Year	FII Inflows Net	DII Inflows Net
2016-17	68685	37124
2017-18	12642	90834

*FII- Foreign Institutional Investors, DII- Domestic Institutional Investors

Source: BSE India

What we are witnessing is large-scale in-flows in to the equity markets from within the country. This is unprecedented and has left most experts stumped. The probable reasons for this could be-

1.      Recency Bias- Equities have delivered decent returns over the last few years (especially since 2014) thus emboldening investors.

2.      TINA (There Is No Alternative) Factor- Interest rates are low, Real Estate is in the doldrums after Demonetization and RERA and gold has simply gone nowhere for the last 3-4 years.

These domestic in-flows are a momentum by themselves and could spur the markets even higher. We generally see that these kind of momentum plays last till a major bad news event. We generally believe that this domestic momentum should play out till the 2019 General Elections at a more subdued pace than we have been used to over the past year.  

Donald Trump’s new tax policies will mean a lot of money (FII) will go back in to the American markets. This means there will be less money available for other markets (including India). This also suggests a slow-down in the pace of growth of the markets over the past year.

"In the short run, the market is a voting machine but in the long run it is a weighing machine"

 

-          Benjamin Graham

Broad market earnings have not kept up with the movement of the markets themselves. Therefore by traditional measure such as PE the markets are over-valued. This should correct. Keeping in mind the momentum in in-flows and also that markets are over-valued we expect that the markets may not correct substantially at this point. We also expect that returns will be lower than what we’ve experienced in the recent years. It will be safer to play large-caps and sectors that have been performing not-so-well recently (like IT or Pharma) to other sectors or strategies at this point of time.

The debt markets have been extremely volatile over the past year. Most debt portfolios would have delivered very low returns (average around 5.5%) over the past calendar year because of mark-to-market losses in the underlying. Inflation has been inching up. With a general election due in less than 18 months (where we expect the Govt to be more populist and accommodating) and also crude oil prices rising we expect interest rates could go up. This will have a negative impact on your debt portfolios. We have been lucky in that we have been collecting a lot of money in liquid over the past year. Liquid funds have been the best performing of the debt categories (and this has happened purely by accident!). We will have to be very careful in how we play the debt markets in the coming few months. We expect we will have to average out our short term positions over the next year. But yields will be better.

From a home-loan perspective there could be small drop from these rates currently. But, it is likely to remain there and thereabouts for the year. If inflation spikes we could see an upward revision in interest rates affecting your loans.

Real estate should continue to be subdued. There is a lot of regulatory back-log (in terms of RERA/ Land Registration etc) that will continue to adversely affect prices. It could be a decent time to pick-up a property from a safety perspective (as in prices might not come down substantially from these levels). We however don’t expect real estate as a broad asset class to do too well over the next few years. Buyers will have to be patient with their purchases. Of course with Real Estate a lot of the investment value and risk perspective has to be looked at from the particular property under consideration.

We expect the Indian rupee to depreciate over the year. We expect that it will touch close to 70 to the USD. This is on account of a strengthening dollar (Trump’s Tax Plan) and also higher inflation in India. NRI’s and ESOP holders (of US or other foreign shares) should keep this in mind while making investment decisions.

We expect that gold will do slightly better than it has done for the past few years domestically. Internationally we don’t expect too much movement in the price of Gold. This is because we expect that general international investor confidence to be high after the tax cuts.

We expect that oil will continue to move up and push close to $70-75 per barrel. Once it crosses $70 India’s current account deficit will be under pressure pushing up inflation and possibly interest rates.

Finally we will discuss a little about the rise of Bit Coin and crypto currencies in general.

“I could calculate the motions of the heavenly bodies, but not the madness of the people.”  

-         Sir Isaac Newton

This quote is attributed to Newton after he lost a lot of money in the South Sea Bubble. We have no doubt that crypto currencies are a bubble. How long this is going to last is anyone’s guess. We generally prefer to buy investments once they’re beaten down (when the risk premium is low!) to when the prices are inflated (when the risk premiums are high!). We would recommend that lay speculators avoid crypto currencies in general and leave it to the hands of experts.   

Weekend Reading- The Man who Drowned

There is a story of a man who wanted to cross a river that had a depth of “four feet on average.” Feeling fairly confident about it he set about on his journey only to drown somewhere near the centre.

Beware of the ‘averages’!

In his brilliant little book- “How to Lie with Statistics”, Darell Huff introduces us to this particular concept and how the human mind gets lulled in to understanding the term ‘average’.

Think about it like this. Suppose you were building data on incomes of all your neighbours. If we took an average then it is possible that with some accuracy we could tell you what each person was earning. But what if one of your neighbours was Mukesh Ambani? Wouldn’t the average income number be way off the mark?

Finding exceptions in your Data Set

A sense of confirmation bias (covered earlier) and an inability to conceptualize a black swan (like having Mukesh Ambani as your neighbour) can create problems for us like the man who drowned. It is therefore imperative for us to:

1. Understand the sample set of data that we are reading and 

2. Actively look for exceptions to the rule.

How does this play out in your finances?

“Equity markets have returned 15% on average over the long-term.”

“Real-estate will beat inflation on average.”

“My salary will increase at 10% per year since that has been the past average.”

Can you see exceptions to all those cases? What can cause them? Are you at the crest or trough of your sample space? Each of these can have wide-leading ramifications to the way you ‘plan’.

Confirmation Bias

A doctor wanted to demonstrate the ill-effects of alcohol to a group of alcoholics. So he took a glass of whisky and placed a worm in it. After some time the worm dies. He turns to his audience and asks what they learnt from the experiment. Pat came the reply from one of the alcoholics- "It means if you drink alcohol you won't have any worms in your stomach." The above is an example of 'selective listening' or what we call 'confirmation bias'. We fit reality in to our beliefs and not vice-versa.

Philosophers and scientists have long-struggled with the confirmation bias. We have all come across the famous quote- "the eyes only see what the mind wants to." This sort of behaviour happens to all of us and is an example of a heuristic (short- cut) employed by the brain in order to take quick decisions. Take the case of the gambler who's on a losing streak. The evidence is clear that things are not going well for him and yet he will continue as he sees the streak of losses as a test of his 'belief' in his own skill.

One of the first steps to counter the bias is of course to be aware of it. When you want to buy that new car your mind will automatically start telling you about how fantastic the new car looks and what great mileage it gives and how your social-status improves and/or how you need to live life in the moment etc. When you want to buy a new stock you will see that the reports are great and the share price is high (or low!) and that the economy is about to take off due to GST etc. Similarly if you are going to buy a new property then your mind will tell you that real estate is beaten down (so a great time to buy!) or I need to have another house or this area will boom etc.
PS: note you will have opposite sentiments if you are looking to sell your car(look how old it has become), sell your stock (it has run too high) or sell your property (I needed a bigger house).

The second step is to actively seek dis-confirming evidence. Ask your self 'why I shouldn't do it?'. Why I shouldn't buy that car? (Not, 'why shouldn't I buy that car', small but important difference). Maybe my present car will run another few years? Maybe financially it isn't a very smart proposition? Maybe if I spent some money on the present car I could improve it's mileage etc? Maybe I could use the money better elsewhere? It's only when you look at both sides objectively will you be able to make a more informed decision.

I'll end this with a poem from Shannon L. Adler that further illustrates the concept-

Read it with sorrow and you will feel hate.
Read it with anger and you will feel vengeful.
Read it with paranoia and you will feel confusion.
Read it with empathy and you will feel compassion.
Read it with love and you will feel flattery.
Read it with hope and you will feel positive.
Read it with humor and you will feel joy.
Read it without bias and you will feel peace.
Do not read it at all and you will not feel a thing.