The
world we live in today has been rocked by many wars; the Indian equity market
has largely under-performed US and other Western markets in the past 2 years.
With multiple mini battles all around, a key question to ask is how the markets have behaved in the immediate term and how they have behaved 3-months and 6-months after the event. In the long term, what impact does this have on the earning potential of companies?
Sensex Behaviour During Geopolitical Events:
Geopolitical Events Often Cause Short-Term Market
Volatility
History
shows that geopolitical shocks typically affect markets for a short period,
while long-term market direction continues to be driven primarily by economic
growth, corporate earnings, and liquidity.
Recent
developments in the Middle East have already caused a spike in oil prices and
temporary weakness in global equities as investors assess supply risks.
However, markets have repeatedly demonstrated the ability to absorb
geopolitical shocks relatively quickly, once the extent of disruption becomes
clearer.
Stock
prices over the long term are always slaves to the earnings – they follow an
uncanny ability to follow earnings trends. One positive I am seeing in India
today is the strong earnings growth, which has started returning to mid-cap and
small-cap stocks.
The Iran Conflict: What Matters and How Does India Get
Impacted?
The
primary channel through which the Iran conflict affects markets is energy
prices. The Strait of Hormuz handles a significant share of global oil
shipments, making it a critical chokepoint. Even in scenarios where oil spikes
temporarily, markets historically normalise once supply chains adjust or
diplomatic de-escalation begins.
There
are some key unknowns:
·
How does Trump react to the approach by Iran of bombing US bases in the
Middle East?
·
Will he call it a win by accepting the death of Khamenei Senior as a
huge achievement as his son Khamenei Junior takes over!
·
Does sanity prevail? Will the US keep it to aerial bombing instead of
sending ground troops?
Well, my guess is just as good or as bad as yours to the questions above. However, the key to any escalation is a ground invasion, where the US has been known to make a mess of a prolonged war, like fighting the Taliban in Afghanistan for 20 years, just to let them come back again! I’ve written previously about this – you can read more here.
I hope enough sense prevails in the US war department to persuade Trump on how difficult a place Iran is to send ground troops.
Just
for comparison – Iran is half the size of India! Just imagine someone trying to
conquer the whole of South India, crossing the Aravalli-Satpura mountains!
Aurangzeb tried doing that and caused the eventual downfall of the Mughal
empire! Sheer land masses are always difficult to conquer and hold.
The US sneezes, and India catches a cold! This is the age-old reality. However, the Indian economy has navigated global shocks relatively well due to a) strong domestic consumption, b) diversified energy sourcing (except where transportation is concerned) and c) increasing domestic investments with government push through regulatory and tax concessions (GST reduction is a point in this direction).
What Matters to Stocks in the Long-term?
Essentially,
very few metrics define how a portfolio performs over the long term –
·
High earnings yield, which indicates that our stocks are earning well,
and a resulting low P/E ratio that shows potential for re-rating,
·
A higher projected earnings growth, which indicates we are holding good
companies
·
And finally, a favourable market condition with good liquidity, low
interest-rate/inflation environment, positive outlook and stable government
We should buy the stocks at a dip. The dip occurs when market conditions are somewhat depressed, i.e., due to global shocks/pandemic/local conditions.
Earnings growth and visibility: This is the key to the
valuation of any company. In India, the earnings growth has picked up, and
P/E’s in many mid/small cap stocks are in single or low double digits.
Earnings Trend of 4-Quarters (YoY Growth) for BSE Midcap 150:
Interest rates, Inflation and liquidity: The interest rates in India are in a downward trend, from a high of 6.5% a year ago, it has now come down to 5.25% and might even go down lower to encourage more credit uptake. Again, the inflation – has reduced from a high of 6.7% in 2022 down to mid-2% range now (CPI), which is quite comforting. With oil price hikes, CPI might climb higher, but in general, the trend has been clear and lower. Food is usually 50% of the CPI inflation, and the prices there have been very stable.
Liquidity issues? Usually, when there is a shock, liquidity evaporates. I think we are seeing the impact of liquidity not being there, leading to the artificially low prices of some of the smaller and mid-cap stocks.
I had written a detailed commentary on how I look at interest rates (discount rates) and liquidity, comparing that to Gravity and Oxygen. This time, it is no different.
Should You Invest in Markets Now?
As I’ve often said, periods of market volatility frequently create some of the best opportunities to invest in high-quality businesses at attractive valuations.
While short-term uncertainty may unsettle markets, it also allows disciplined investors to accumulate strong businesses at prices that offer a greater margin of safety.
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