Investment Advisory Service

Monday, 14 November 2016

Thoughts on recent volatility


"Condoms aren't completely safe. My friend was wearing one and got hit by a bus". For many years, I couldn't understand the meaning of this quote by Robert Rubin, ex-Secretary of Treasury of United States. It means that while thinking about risk factors- a new and potentially unthinkable lethal risk can emerge from nowhere and take one down. It's the black swan risk or risk of the "unknown unknown".

For the first time, I understood it when Ramalinga Raju of Satyam spoke "Satya" and informed the world about ghost cash in his company and how he had taken everybody for a ride - independent directors included. Coupled with global recession, markets went into a tailspin with this news and a lot of stocks fell down 50-70% in a matter of weeks. There were a lot of companies selling below cash because people stopped believing in cash held by companies.

However, if asked to point with certainty now, the month and year of the Satyam crisis, a lot of us might make a wrong guess. If you are guessing it right now, let me give you the answer : Satyam scandal broke out in January, 2009. So, in  a span of 7 years, market has shrugged off the crisis of confidence in Indian companies and has come out with newer highs. That's just one example- there have been many such global and domestic challenges which surfaced and subsided with time. It point towards another concept that problems get solved as they always have as they always do. So, no matter how grave the issue, it will get solved given enough time.

In the last few days, some major upheavals have happened. The issue of corporate governance at the House of Tatas, election of Mr Trump as the President of US and demonetization of Rs 500 and Rs 1000 notes in India. The black swan or should I say a "fleet of  black swans". 
First lets talk about the Tata Group. There are accusations flying thick and fast from both sides. There are many versions of the same story. We don't know and will never know what's the correct version. So, there's no point spending time reading and thinking about that. However, there is lesson to be learnt. Business comes first always and every time, management comes second always and every time.
The second issue is about Mr. Trump. The world is in a shock. I think people are more shocked about their own assessment going wrong (of Hillary becoming the President) rather than Trump becoming the President. The world's best experts, commentators, political readers, investors, reporters, big data analysts : all have gone wrong and wrong by a wide margin. That reminds me of Niels Bohr quote "Prediction is very difficult especially if it's about the future". We need to remember this and remind ourselves, whenever in doubt.

I don't think it matters a lot as to who is the President of the United States. The only thing that I think matters is "Is there a President ?". As long as the answer is yes, it's alright. As history teaches us again and again, a bad government is better than no government. So, as long as there is a democratically elected president in the world's largest economy, things will work out fine. Some policies will be good, some would not be so good but things will be okay on a wholesome basis.
The third and the most important issue is the demonetization of the existing high currency notes in India. The first effect is that people now are cashless and clueless. Over time, people will have cash in their pockets to spend so that's not a big problem. The second more important thing is that people are clueless. A large part of Indian economy is informal cash economy. Some of the businesses have a mix of A business (formal accounted business) and B business (informal unaccounted business). A large number of businesses are completely in B. There is no trail of money in the whole value chain. Those businesses will be the hardest hit. They don't have much clue whatsoever to dispose off the cash that they already have and also as to when and how will they resume their businesses. As of now, everyone and everything seems shocked and frozen. It may take time for cash and people to come back.
We don't know how much time it might take ? It might be a few months or a few quarters or even more. Nobody knows. By the time the dust settles, a lot of businesses might get massively hit and lot of businesses might shine.
What do we investors need to do ? One thing we need to do is to focus on the businesses we own and see if the recent events have reduced the strengths of those businesses. The cash flows would surely become volatile given the external factors but if the businesses are inherently strong, the cash flows would come back even if with a delay.

And if businesses are strong and managements are good and we have not bought stocks with debt, we just need to remind ourselves to :
(i)  hold on to our nerves

         (ii) hold on to our stocks