Equity markets in the month of August showed some increased levels of volatility, although any downside pressure seemed to be met with equal of even stronger forces of buying as days went by. Bond markets although, atleast on the long end, still is relentless on its bull market as the spread between the 2- 10 year Treasuries seem to be getting narrower and narrower since December, 2016.
Notably, many well known investors and economists have started to ring alarm bells on valuations in equity and bond markets including the likes of Howard Marks of Oaktree Capital (video) and Alan Greenspan (video). It may come off as strange why I talk about US or global markets running an Indian equity investment program, but anyone who has looked at data or earnings across the globe will eventually realize that this global bond and equity market rally that we have seen since the past many years has been led by liquidity, multiple expansion etc. So, any regional or country equity market is invariably linked to this global phenomenon in a major way and any downside risk is also bound to be global in nature.
Usually, a flattened or inverted yield curve is a very good indicator of business cycle turning to the contraction side. If we look at the 2-10 year Treasury yield spread (chart), the German Bund spread, the UK Gilt spread or for that matter even the Indian GSec spread (data), they all lie in the range of 0-1% and declining, possibly pointing to an impending recession (either mild or strong) or a more serious era of stagnation as we have witnessed in Japan since 1991. Like in Japan, asset price bull markets may be followed by serious downside corrections. Of course, no one knows what is actually going to happen but it somehow doesn't paint a rosy picture. Interestingly, NASDAQ Composite is only up about ~40% and S&P 500 just ~65% since the dot com bubble (17 years ago).
On the portfolio front, you may see a standard net short position of ~17% but in reality, I have had to adjust the short position of the portfolio to make the portfolio as close as possible to a bet net position of zero. But as they say 'beta is what beta was', I will be monitoring and changing short exposures to hopefully keep the portfolio net beta neutral.
It has become increasingly difficult to understand market behavior if one is a thoughtful investor who bases his valuations on fundamental data. Nearly, only a few percentage points of the price moves in the past two or three years can be attributed to net profit increases. Quality stocks have sought to become more and more expensive to the point that one has to genuinely think if things are getting to weird valuation levels. In Indian equity markets, anything which is worth investing carries a north of 30 earnings multiple label and is inching upwards, pointing to the increased price risk that tags along with it. It has led me to wonder and examine what could justify these valuations, if there is any that I have a blind spot to. Sometimes, I wish investing to be a little simpler than what we currently face.
The recent lay- offs in the IT industry in India and continuation of it, the lack of jobs or increase in unemployment for white collar human labor, and the difficulty for outgoing graduates to find work all seem to point to a common factor: rapid improvements in use of technology to substitute more expensive human labor.
No longer people in India need to visit a bank to conduct most common banking needs like it was 10 years ago. Most banks, atleast the private sector ones, staff fewer and fewer people. Quite obvious as most banking needs are met online. No longer the manufacturing industry is fully manual in nature as more and more processes come under automation. Apart from the acute skill shortage that the IT industry in India faces, companies like Infosys and TCS are on the path to aggressively automate tasks which were done by white collar human labor 5 to 10 prior.
As more and more automated processes, online and digital methods and AI seeps into the Indian economy, it will harder for out-skilled and unskilled workforce to maintain jobs or to find one. The problem just does not end there. With the country producing about 1.5 million graduates each year just in the Engineering domain, there may come a point when the country does not even produce that many jobs to begin with. Added to that, some reports point to 80% of engineering graduates in the country classified as 'unemployable'. The problem is deeper if we consider the entire white collar workforce.
I am not sure that the government recognizes this problem. I think one way to solve this job issue in India would be to make it extremely easy for entrepreneurship to prosper in high level technologies (both digital and non- digital) so that more new found jobs are created, the likes of which we don't even know can exist. The problem has to to be solved from the grassroots level bringing up a generation of innovative thinkers and doers. Clearly, for this, the education system in India has to massively reform from its current state.