Let me take you back to March 2020. A virus that threatens to bring the world to an end is knocking on the door. No one has any clue what will happen next. There is a selloff in the stock markets. And then, the US Federal Reserve and Reserve Bank of India cut interest rates sharply. As if on cue, the stock markets take off, implying all is going to be fine. In case there’s any confusion, let me clarify. Lower interest rates are not an antidote for the virus. Yet, we know what transpired immediately post the rate cut.
Now, if you were a cautious risk averse investor in March 2020, you would have probably built up large cash positions, or perhaps moved money to gold. If you were an investor with some appetite for risk, perhaps, you did not exit the stock markets completely, but still ensured you had funds at your disposal to take care of your family if the worst were to come true. However, if you were a perma bull (an investor perennially bullish on stock markets), you went all in, putting all the money you had, and more, to work.
The point I want to make is this. The three kinds of investors I mentioned above, did what was perfect for their needs. They all get a big pat on the back. However, there’s one thing that stands out, or rather, which needs to be called out. The perma bull who went all in, played a gamble. If the immediate post rate cut call had gone wrong (i.e. the virus had caused far more damage for far longer), wealth of untold proportions would have probably been destroyed. But we know the gamble worked, and money was made. On a lighter note, what’s even worse is that today we suffer such perma bulls who give all sorts of stories but are yet to answer this simple question–how did they come to the conclusion that a fed rate cut will kill the virus?! They gambled. And won. Period. Admit it! There’s nothing wrong in taking such an optimistic view.
Why is this story important today? Well, lots that was to go wrong in the 2023 did not. Smaller banks in the US were to go bust by the dozens, commercial real estate market was to collapse, inflation was to be sticky, and as a result, interest rates were to remain high. Finally, all this was to lead to a sharp recession in the US. All these were high probability events. But as we know today, none of this transpired. On the contrary, a change in Fed commentary in November 2023, implying Fed rate cuts are coming, triggered one of the sharpest surges in stock prices across markets, including in India. The local state election results were again a ‘surprise’, pushing prices higher (a lot of the push came from surging flows from foreign institutional investors, which could have been the result of the November move).
All this while, the Indian stock markets presented a dichotomy. Racy small-cap and mid-cap stocks in general traded at very high valuations. Interestingly, new terms were invented to justify them, like, market cap to order book! On the flip side, many large blue chip stocks traded at multi-year low valuations. The perma bulls wanted the racy stuff, and it worked like a charm. Right till the end of the year.
The gamble by perma bulls that the only play in town is small- caps and mid-caps, no matter the valuation, worked. Big time. Kudos to them.
The question now is whether the absence of bad news will persist, allowing the perma bulls to stretch their gains even further? One is tempted to answer this question. But then one is wise to know that it is impossible to answer. Just look at how wrong predictions (not mine!) turned out in 2023!
But I offer you this. Sooner or later, irrationality will end. And when that happens, you need to be sure you are playing this game in line with your appetite for risk. That way, no matter what happens, you will have the appetite to absorb it–good or not so good.
Happy gambling, er, investing for 2024!
Rahul Goel is the former CEO of Equitymaster.
Disclaimer: you should always consult your personal investment adviser or wealth manager before making any decisions.
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Published: 04 Jan 2024, 10:57 PM IST