In the past, Indian fund managers often took particular pride in telling you that they never worried about the big picture. If you asked them about the rupee or the economy, the stock answer would be — ‘We’re bottom-up investors. We don’t worry about the macros. We focus on buying great businesses which can deliver exceptional growth’.
Don’t ignore macros
But the last three years have demonstrated that any stock market investor who ignores macro factors does so at his own peril.
Consider these instances. Stocks of FMCG companies have been top performers in the last five years. This is not because they are churning out dramatically different products from five years ago, but because they have delivered consistent numbers. A slowing economy has made their modest but predictable growth look good. IT stocks are the top gainers of the past year, putting on 45 per cent. Valuation multiples for tech majors have expanded mainly because they were among the few sectors to gain from a weakening rupee.
Why the change
But why have trends in the economy or the rupee come to matter so much for stock selection? First there is the realisation that profit growth cannot be taken for granted. In the good old days when India was believed to be a secular growth market, most listed firms routinely managed a 15 per cent profit growth.
This was expected to continue in perpetuity. Market gurus had a simple explanation. If the economy grows at 8 per cent and inflation at 7 per cent, this automatically added up to a 15 per cent nominal growth. And if the economy managed 15 per cent, how could listed companies — the best and brightest of Indian industry — fare worse than that?
With most companies expected to expand at healthy rates, the only challenge for stock investors was to identify businesses which could beat the markets. That’s why the bottom-up approach, which entails a deep dive into a company’s business to identify its strengths, was so popular.
But this approach seems quite blinkered today. The Indian economy has proved to be quite prone to cyclical swings and the earnings trajectory for companies has proved volatile too, with profits buffeted by a varying rupee, fluctuating interest rates and regulatory risks.
Thanks to this change, what a stock investor would like the most today is a company which can deliver predictable numbers. Today, if you’re looking to select sectors or stocks for your portfolio, it is macro factors that come first. Is the business a net earner of foreign exchange? How vulnerable is it to rising interest rates? Is demand resilient to a sluggish economy? Whether the company has a superb business model that helps it gain an edge over peers would come much later.
FII factor
Then, there is the FII factor. With domestic investors permanently in sell mode, foreign institutional investors (FIIs) today own a much larger proportion of Indian equities than they ever did before.
Latest shareholding patterns show that foreign investors held about 20 per cent of the outstanding shares in Indian companies, up from 13 per cent five years ago. If one leaves out the promoter holdings, FIIs in fact own about 40 per cent of all the shares available for trading. With such a large FII ownership, Indian markets cannot but be impacted by macro developments not only in India but at the global level.
After all, foreign investors are constantly looking to shuffle their portfolios across economies and asset classes for better returns. And they would inevitably base their decision on the big picture. If India is likely to expand more slowly than China and see a weaker currency, it is China that will receive a larger share of allocations. Automatically, the prospects for the stocks in your portfolio begin to hinge on the size and quantum of those flows.
Then the FII money sloshing around in the global markets is also impacted by factors such as interest rates in the developed economies and actions by the US Fed. If FIIs who hold a third of a company’s shares decide to pull out, its stock prices will tank, no matter if its business model is the best in the world.
All this suggests that if you’re an investor, you have no choice today but to watch the big picture like a hawk. If you want to own the right stocks, be prepared to read reams about India’s economic prospects, China’s export slowdown, the current account deficit and the consequences of a US debt default. Yes, you may feel this is a tall order for a retail investor. Therefore, the next best thing would be to hand over your portfolio to professional fund managers. They can do the worrying for you, as they no longer have a choice about tracking the macros.