How to manage stock investments during a CoVid-19 crisis in Indian Markets
Stocks and Sectors in focus
The Dotcom bubble in the late 1990s, the financial crisis in 2008 and now the coronavirus pandemic. A crisis seems to be halting investors in their tracks every decade.
Despite so much history to learn from, very few investors possess the skills to navigate a crisis. And that is not surprising because of the various behavioral factors embedded in us. That being said, financially fighting a crisis is not rocket science, especially when we’ve got you covered. A new crisis means a new opportunity to invest at cheap valuations.
“A crisis is a great time for professional investors and a horrible time for average ones” — Robert Kiyosaki
Kristina M Durante in her paper ‘The Effect of Stress on Consumer Saving and Spending’ analyzed how stressful situations affect the buying habits of consumers. One surprising result was that in stressful situations, consumers lose their sense of control and hence end up spending more on goods than they otherwise would have. For example, a newly recruited employee who is facing the stress of a new work environment will spend more on buying premium clothes thinking that they are a necessity for him to merge with his new workplace. Consumers tend to spend more and hoard goods which are necessary such as groceries, consumer staples, health care products, and medicines.
A similar explanation is given by thy lipstick effect, which is a well-known phenomenon in behavioral economics. This effect states that during economic downturns and recessions, consumers continue to spend on small-ticket luxury items such as premium lipsticks, premium packaged food and premium wines & coffees. They do this to keep their satisfaction levels up during times when they can’t afford to buy cars or travel the world. Let’s now look at sectors that might benefit from the above literature and back it up with data.
FMCG Industry
A direct beneficiary of the above results is the FMCG industry. Consumer goods comprise of packaged food, personal hygiene products and of course, tissue rolls. These items are basic necessities for survival and hence people can not cut back on their spending on these goods. This segment also comprises some luxury goods which during recessions act as substitutes for big-ticket luxury goods.
A simple way to test this hypothesis would be to check the performance of the NIFTY FMCG index with respect to the NIFTY 50 benchmark during the 2008 financial crisis.
The NIFTY FMCG index outperformed by the NIFTY 50 index by 60 percentage points during and post the 2008 financial crisis. The FMCG industry is hence ‘evergreen’ and investors should consider this industry as a safe haven among equities.
Pharmaceutical Industry
Medicines are another basic necessity for survival and hence, the pharmaceutical industry is another safe haven among equities. The current coronavirus crisis adds 2 more dimensions of scope for this industry.
One, a lot of pharma companies are currently spending a lot of time and resources on R&D hence increasing their operational efficiency. As the race to find a vaccine intensifies, several by-products can be discovered in the research process and these unique findings are beneficial in the long run where people are now expected to spend more on personal health care. Second, India is the 6th largest exporter of packaged medicaments behind USA and other European countries. Given that these top 5 countries have been severely affected by the coronavirus crisis, this opens Indian pharma exporters to a much wider consumer base.
A similar analysis as above can be conducted to test the performance of the pharmaceutical industry during crises.
The NIFTY Pharma index comprehensively outperformed NIFTY 50 by more than 63 percentage points. And that too without the 2 extra dimensions of scope that the pharmaceutical sector has now.
Other Industries
No other industry aligns with consumer behavior during crises and a similar analysis as above says the same. People can not afford to spend on houses and cars due to which the Realty, Infrastructure and Auto sectors take a hit. The Auto industry in India was already slowing hence making it an avoidable option for now. The IT industry is heavily dependant on revenue from USA due to which the 2008 crises and also the current pandemic, both being centered around USA, have hurt Indian IT companies. Oil prices historically have always crashed during crises due to subdued demand and this time is no different. The Energy sector hence is not as attractive. Finally, the Banking sector has loan exposures to multiple companies that are currently under lockdown and hence can not operate. This creates uncertainties about these companies defaulting on their loans and such defaults as we saw in the IL&FS crisis can destroy banks.
The Auto industry does come close to the performance of Pharma and FMCG but with the slowdown in auto sales over the past year, it would be advisable to stay away from the auto sector for now.
NOTES:
- All the above data for the 2008 crisis analysis was taken before the crisis started when equity prices were at their peak. But now, we are in the midst of a crisis and prices have already fallen a considerable amount. So, investing now would lead to more returns than indicated above.
- The above results show that passive benchmark index investing is not the way to go during crises. Sectoral investing is seen to be more profitable. Even within sectors, large-cap companies should be preferred because they are the ones who have the cash to ride the crisis wave. Between December 2007 and February 2012, the NIFTY Midcap index was down by 38.47% and NIFTY Smallcap by 41.66% whereas NIFTY 50, which is a large-cap index, was down only by 12.29%.
- Pharmaceutical Industry can be extended to include healthcare and chemical industries as well. Though the chemical and healthcare sectors did not do particularly well during the 2008 crisis, they have increased importance during a pandemic. Their analysis has not been done here because there is no NSE sectoral index for healthcare and chemicals.
Fixed Income Market, Gold, and Forex
As seen above, none of the equity sectors mentioned above gave positive returns between December 2007 and February 2009. That is where diversification across asset classes comes in. Bonds, Gold, and Forex would’ve all generated positive returns in the above-mentioned crises hence becoming the best way to offset equity losses.
10 Year Fixed Interest Government Bonds are currently trading at yields near 6.3% which is a good deal given equities are having a horrendous time. Only government bonds are of interest to us because corporate papers run a higher risk of default during recessionary times. One might ask why not invest everything in bonds as they generate income even during crises. The answer is that bonds underperform the market during recovery from the crisis. So, in order to capitalize on the recovery, equity is essential
Gold is the universal safe haven and makes for a good diversification tool during crises. It is one of the very few commodities which have performed well in 2020.
The US Dollar is a safe haven even above gold. Considering the strength of the American economy and the say USA has in world affairs, USD is the ultimate asset to hold during recessions. Forex investing also comes with huge leverage so the gains shown below are actually only 1/10 (as 10x is considered safe leverage in forex trading) the gains you would actually make with leverage.
We have ignored real estate as an asset class because it is capital intensive and the current lockdown has reduced demand for houses and commercial spaces drastically.
We have identified 5 investments above which have performed well during and after a crisis keeping the current pandemic in mind — FMCG Sector, Pharmaceutical Sector, Gold, Government Bonds, and US Dollar. Another important aspect is Cash. Having cash in hand should be the first priority of all individuals because, in a pandemic, you never know when you might need quick cash for medical or other emergency needs. These 5 investments comprising 4 asset classes (Equity, Commodity, Fixed Income, and Forex) along with cash are sufficient to build a diversified portfolio in order to make the most of a crisis.
Assigning weights to each asset class is subjective but a rough estimate is as follows:
Not to forget, the most important factor to navigate a crisis is patience and lots of it. Churning the above portfolio often and panic selling can wipe out potential gains. Stay patient and trust your portfolio to do the magic.
We at 50x have created a Crisis portfolio to help guide your investments and keep your portfolio in the green. Subscribe to our mailing list and have a look at the portfolio
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