End of the Buy & Hold Era

Warren Buffett is undoubtedly the top role model for most of the long-term investors. But when one looks at his last few years’ performance, one feels very disheartened. Buffett’s Berkshire Hathaway (BRK) was in headlines in May for announcing a shocking Q1 loss of $49.7 billion!

Since last several years its performance was just matching the Dow Jones, nothing spectacular, and after the pandemic, it is now substantially lagging behind the Dow Jones Index.

BRK v/s Dow Jones –

The blue line shows Berkshire Hathaway (Buffett) and green one shows Dow Jones.
Comparison –

There are two key reasons for Buffett’s recent below average performance –

1. He suffered massive losses as his investments were not well diversified and were concentrated in the wrong industries – airlines and financials, which suffered heavily on the outbreak of Corona pandemic
2. Buffett sold a large proportion in March and April, from where the markets recovered sharply, and this caused BRK to lag behind the market returns. Bad timing.

The chart above shows that market volatility increased since 2018. There were two major corrections in 2018 and 2019 was punctuated with sharp ups and downs, and finally 2020 saw this severe decline.

Will markets continue to see such wild swings?

There are two main developments that can cause the markets swing wildly even in future –

1. Simultaneous existence of equally strong risks and opportunities
2. Disruptions due to technological or some other risks are causing a sudden shift in survival and growth outlook of industries. Abruptly an industry or company may turn from a high growth to a junk status.

A. Simultaneous existence of equally strong risks and opportunities

Market becomes volatile when uncertainty about future rises. And if major risks and major opportunities exist at the same time then market swings wildly guided by events and emotions.

Right now, we are riding a hope rally that Corona cure will come soon and things will be back to normal, and this rally is getting support from improving macro indicators all over the globe. Emotions are positive globally. But things can change, there may be a fresh Corona wave or a delay in economic recovery, or the new swine flue of China can morph into a human pandemic or there may be a China-India war. Then there are several other global risks that can materialize any time.

This combination of positives and negatives causes markets to swing wildly.

B. Disruptions

Disruptions in industries are happening at a rising rate. It may be due to technology or any other risk. For example, the Corona pandemic has suddenly made all crowd related industries very risky like restaurants, airlines, cinema halls, malls, retail etc. Print media and book publishing industries are vanishing as everyone goes digital. Hotels and motels are facing risk from Airbnb and HomeAway. Even colleges are at risk from online education. Using 3D printing, Nike can create a bespoke pair of athletic footwear from scratch in less than an hour! This kind of 3D printing can put many manufacturing industries at risk. Call centres will be replaced by AI. AI can do wonders for healthcare. AI is currently used by healthcare innovators to predict diseases, identify high-risk patient groups, automate diagnostic tests and to increase speed and accuracy of treatment. It can also be used to improve drug formulations, predictive care, and DNA analysis that can positively impact quality of healthcare and affect human lives.

What all these examples imply that changes are taking place at fast place and what was a good investment today may become junk tomorrow.

That makes buy and hold strategy extremely risky. Buffett lost heavily as was over exposed to financial and aviation companies. The right strategy now needs flexible approach to enable one to enter and exit in the right stock at right time. One need not become a trader, but should be ready to exit with changing scenario.

Long Term Risks and Opportunities – a Close Tie

Opportunities for Indian Economy

1. India’s demographic dividend
2. History’s biggest urbanization movement
3. Transformation from informal to formal economy
4. Political stability – ability for policy initiatives, reforms
5. Improving business environment
6. Possibility of some manufacturing from China coming to India. Our labour costs are 1/4^th, though we lack infra, but some companies may compromise on that looking at labour cost advantage and the need to de-risk their supply chain. The success here will depend on speed of reforms.
7. A huge domestic market with rising purchasing power, a big attraction for FDI, and a big safety net in the era of de-globalization

Risks for Indian Economy

1. NPAs to soar again – There may be a significant spike in NPAs going ahead. The pain may not be visible immediately since the Reserve Bank of India (RBI) has extended regulatory relaxations. But that cushion won’t be around for long. The moratorium period will end soon and companies and individual borrowers will have to resume repayments from September. With no business happening, workforce availability remaining an issue and rampant pay cuts, it is doubtful how many borrowers will have repayment capacity. According to a report by ICRA, about 328 companies have sought moratorium from banks. That tells us about their financial position. There is a considered view in the government that bank non-performing assets (NPAs) could double to 18-20% by the end of the fiscal year, as 20-25% of outstanding loans face a risk of default.
2. Debt bomb – Covid-19 crisis has caused a significant rise in overall debt of almost all countries. India is one of the most indebted emerging Asian economies. Vietnam, India and Cambodia tops—with 189%, 126% and 116% of GDP, respectively—followed by the Philippines (99%), Pakistan (89%), Bangladesh (75%), Malaysia (73%) and Indonesia (69%). The sharp decline in economic activity coupled with the risk of capital outflows—and a sudden increase in borrowing costs—could be particularly unsettling for India, where state-owned banks are saddled with a significant stock of bad loans.
3. Demand decline – There is an abrupt and significant fall in lending by non-banking financial companies close on the heels of a slowdown in bank lending, reduced income growth of households coupled with a fall in savings and higher leverage. Although some improvement in FY21 is expected, these risks are going to persist. As a result, the Indian economy is stuck in a phase of low consumption as well as low investment demand.
4. Demographic dividend at risk – This great advantage may turn into a nightmare if India is not able to find jobs for its millions of workforces. Weaker investment growth has translated into fewer jobs, with unemployment levels reaching a record high of 23.5% in March 2020. The unemployment rate will likely fall, but labour participation rates remain subdued at around 43%, which does not bode well for domestic consumption going forwards.
5. The pandemic will cause an uneven recovery across different sectors. Businesses that depend on the gathering of people, such as retail, hospitality, tourism, cinemas, exhibitions, and construction sites, may see ongoing restrictions and weaker activity.

Global Risks

The World Economic Forum’s ‘Global Risks Report 2020’ notes that for the first time in the report’s 10-year-history all of the top five issues that are likely to impact the world this year are environmental.

The report is sounding alarm that the “top five global risks in terms of likelihood” are — extreme weather conditions, climate action failure, natural disasters, biodiversity loss and human-made natural disasters. In the previous decade, economic and financial crises were some of the most dangerous.

But despite the need to be more ambitious when it comes to climate action, the UN has warned that countries have veered off course when it comes to meeting their commitments under the Paris Agreement on climate change.

Climate change is striking harder and more rapidly than many expected. The last five years are on track to be the warmest on record, natural disasters are becoming more intense and more frequent, and last year witnessed unprecedented extreme weather throughout the world. Alarmingly, global temperatures are on track to increase by at least 3°C towards the end of the century—twice what climate experts have warned is the limit to avoid the most severe economic, social and environmental consequences. The near-term impacts of climate change add up to a planetary emergency that will include loss of life, social and geopolitical tensions and negative economic impacts.

Climate change risks for India

Climate change, caused by emissions from industries and other human activity, is making the world warmer, disrupting rainfall patterns and increasing the frequency of extreme weather events. No country is immune to these forces, but India is particularly vulnerable. Few countries are likely to suffer from climate change to this extent. According to the Global Climate Risk Index released by Germany-based think tank, Germanwatch, India is the 14th most climate change-affected country in the world.

Severe droughts

The most serious climate change risk to the Indian economy and its people is the increased intensity, frequency and geographical coverage of drought. Higher temperatures, increased evapo-transpiration and decreased winter precipitation may bring about more droughts. The possibility of winter drought will increase in certain areas. Climate change is expected to increase the severity of flooding in many Indian river basins, especially those of the Godavari and Mahanadi along the eastern coast.

Migratory rout

It is possible that climate change may force the pace of urbanisation over the next few decades. The ongoing agrarian crisis in rural India could be catalyzed by climate change into a migratory rout, driven by greater monsoon variability, endemic drought, flooding and resource conflict.

Freshwater availability

In most Asian countries freshwater availability is projected to decrease. More than 60% of India’s agriculture is rain-fed, making the country highly dependent on groundwater. Fifty-four percent of India’s groundwater wells have declined over the past seven years, and 21 major cities are expected to run out of groundwater by 2020. Increased variability in precipitation and more extreme weather events caused by climate change can lead to longer periods of droughts and floods, which directly affects availability and dependency on groundwater. There is already a groundwater crisis in India and climate change is going to make it worse.

Rise in sea level

With India close to the equator, the sub-continent would see much higher rises in sea levels than higher latitudes.

Mumbai has the world’s largest population exposed to coastal flooding, with large parts of the city built on reclaimed land, below the high-tide mark.  Rapid and unplanned urbanization further increases the risks of sea water intrusion.

Sea-level rise and storm surges would lead to saltwater intrusion in the coastal areas, impacting agriculture, degrading groundwater quality, contaminating drinking water, and possibly causing a rise in diarrhea cases and cholera outbreaks, as the cholera bacterium survives longer in saline water.

Kolkata and Mumbai, both densely populated cities, are particularly vulnerable to the impacts of sea-level rise, tropical cyclones, and riverine flooding.

Food security

Recent studies show that wheat yields peaked in India and Bangladesh around 2001 and have not increased since despite increasing fertilizer applications. Observations show that extremely high temperatures in northern India – above 34°C – have had a substantial negative effect on wheat yields, and rising temperatures can only aggravate the situation.

Seasonal water scarcity, rising temperatures, and intrusion of sea water would threaten crop yields, jeopardizing the country’s food security.

Should current trends persist, substantial yield reductions in both rice and wheat can be expected in the near and medium term.   

Energy security

Climate-related impacts on water resources can undermine the two dominant forms of power generation in India – hydropower and thermal power generation – both of which depend on adequate water supplies to function effectively.

To function at full efficiency, thermal power plants need a constant supply of fresh cool water to maintain their cooling systems.

The increasing variability and long-term decreases in river flows can pose a major challenge to hydropower plants and increase the risk of physical damage from landslides, flash floods, glacial lake outbursts, and other climate-related natural disasters.

Decreases in the availability of water and increases in temperature will pose major risk factors to thermal power generation.

Water security

Many parts of India are already experiencing water stress. Even without climate change, satisfying future demand for water will be a major challenge.

Urbanization, population growth, economic development, and increasing demand for water from agriculture and industry are likely to aggravate the situation further.

An increase in variability of monsoon rainfall is expected to increase water shortages in some areas.

Studies have found that the threat to water security is very high over central India, along the mountain ranges of the Western Ghats, and in India’s north-eastern states.

Health

Climate change is expected to have major health impacts in India- increasing malnutrition and related health disorders such as child stunting – with the poor likely to be affected most severely. Child stunting is projected to increase by 35% by 2050 compared to a scenario without climate change.

Malaria and other vector-borne diseases, along with and diarrheal infections which are a major cause of child mortality, are likely to spread into areas where colder temperatures had previously limited transmission.

Heat waves are likely to result in a very substantial rise in mortality and death, and injuries from extreme weather events are likely to increase.

Migration and conflict

South Asia is a hotspot for the migration of people from disaster-affected or degraded areas to other national and international regions.

The Indus and the Ganges-Brahmaputra-Meghna Basins are major trans boundary rivers, and increasing demand for water is already leading to tensions among countries over water sharing.

Climate change impacts on agriculture and livelihoods can increase the number of climate refugees.

Covid Risks

World Economic Forum did a survey of 347 risk analysts on how they rank the likelihood of major risks we face in the aftermath of the pandemic. Economic and geopolitical risks were at top. The greatest risks are as below –

Impact on Markets – The Era of Buy and Hold Strategy is Now Gone

When markets rise on hope and if expectations are finally not realized, then the reaction is always swift and disastrous for investors.

Right now, there is a hope that the pandemic will soon be controlled and then there are great opportunities for economy to drive a long-term growth. But the risks are also equally grave and in case there is delay in economic recovery, or if any of the environmental or geopolitical risks materializes, this rally may abruptly turn into a bear market. In case of environmental risks, the likelihood is very high and sadly, the impacts are also going to be very high.

to conclude, we reiterate the main reasons that may cause wild swings in markets –

1. Simultaneous existence of equally strong risks and opportunities
2. Disruptions due to technological or some other risks are causing a sudden shift in survival and growth outlook of industries. Abruptly an industry or company may turn from a high growth to a junk status.

Change is the law of nature, what worked for past 50 years may not work now or in the future. The buy and hold policy of Buffett can now cause severe damage to your financial health.