Why small investors never make money in the stock market

Dear Reader,

Take a look at the following chart. What does it tell you?


The above chart clearly shows that as the expectations of corporate performance have fallen, the amount of money coming into the equity mutual funds, the best representation of the small investor investing money in the stock market, has gone up. Stock prices are ultimately a reflection of the future expected earnings of companies.

What does this tell us? As analysts Saurabh Mukherjea, Gaurav Mehta, Prashant Mittal and Sumit Shekhar of Ambit write in a recent research note titled Exit The Fantasy, Enter The Reality: “The last time corporate India had such a poor performance in terms of revenue and profit growth was during the 2008 financial crisis, the year that had seen the Sensex drop by more than half of its peak.” 

So how has the stock market continued to do well (if we ignore the recent fall) despite the poor performance of Indian companies. The answer lies in the fact that small investors have been pouring in money into equity mutual funds, which in turn have been investing that money in the stock market.

In the last five months between April and August 2015, equity mutual funds have invested Rs 39,205 crore into the stock market. Between March and July 2015, investors have poured in Rs 45,127 crore into equity mutual funds. The foreign institutional investors, who have been driving the stock market for the last few years, have been net sellers and have sold stocks worth Rs 8,950 crore between April and August 2015.

As the Ambit analysts point out: “Today, however, in spite of such an abysmal performance, Indian equities have remained afloat, helped by retail investor optimism. In contrast, over the past six months, FII equity flows into India have dried up.”

In simple English what this tells us is that the small investors usually start investing in stocks around the time stock prices start to peak, with the expected corporate earnings falling. In fact there is research that backs this up.

As John Plenary writes in Capitalism—Money, Morals and Markets: “There is now academic evidence from Robin Greenwood and Andrei Shleifer at Harvard University that when markets are close to their peak, investors are most bullish because they tend to extrapolate recent rises in prices into the future when they form their expectations. In short, they expect the highest future returns when markets are close to a cyclical peak.”

This is precisely what seems to have happened with the small investors in India who started entering the stock market in hoards through equity mutual funds since mid-2014.

A similar trend was seen during the five month period of November 2007 and March 2008, when Rs 32,109 crore of fresh money came into equity mutual funds. During this time, the FIIs were net sellers to the tune of Rs 11,704 crore. In fact, the contrast comes out best during January 2008, when FIIs were net sellers to the tune of Rs 13,036 crore. At the same time equity mutual funds saw inflows of Rs 12,717 crore, and in turn they invested Rs 7,703 crore into the stock market. The BSE Sensex peaked on 8 January 2008, at 20,873.33 points. So, most money came into stocks when the Sensex was peaking. It started to fall after that and by 17 March 2008, the Sensex had fallen to 14,809.49 points.

A similar sort of trend is playing out now as well. In August 2015, the FIIs have net sold stocks worth Rs 16,877 crore. During the same period, the equity mutual funds invested Rs 10,017 crore in the stock market. The data for fresh inflows into equity mutual funds during August 2015 is not available as of now.

What all these numbers tell us very clearly is that the small investor ends up investing in the stock market through the mutual fund route around the time when the stock market is peaking. And this explains why the small investor rarely makes money in the stock market.

If the market continues to fall in the days to come, as it is expected to at this point of time, the mutual fund equity investor who has invested over the last one year, will be in for a rocky time.

Data contribution by Kishor Kadam.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek) 

The column was originally published on Firstpost on September 1, 2015

Home Prices, And Not Buyers, Are Unrealistic

India-Real-Estate-MarketVivek Kaul

Columnist Gautam Mukherjee wrote an article on real estate published on this website on August 3, 2015. In this column Mukherjee had this to say about prospective buyers looking to buy a home to live-in: “These worthies [i.e. the prospective buyers], expecting a crash in prices as the crisis deepens, are gleefully seeking ever more unrealistic bargains before committing themselves. To them, the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

I really wonder why prospective buyers have been called “worthies” here. And what is wrong about hoping to find a home to live in at a price which one can afford? Further, are the prospective buyers really seeking “unrealistic bargains” or are home prices at unrealistic levels? From all the data that is available it seems to be the latter.

Data put out by real estate research and rating firm Liases Foras tells us that the weighted average price of a flat in a city like Mumbai was Rs 1.3 crore as of March 2015. In the National Capital Region it is Rs 74 lakh. In Bangalore the price is Rs 86 lakh. And so is the situation almost all over the country.
I would like to ask Mr Mukherjee, among the people who he calls “worthies”, how many make the kind of money that is needed to be able to afford these homes? Let’s do some back calculation and see.

The weighted average price of a flat in Mumbai is Rs 1.3 crore. A bank would finance 80% of this. This means that the bank would give a home loan of up to Rs 1.04 crore. The remaining Rs 26 lakh the prospective buyer would have to arrange as a down-payment. This assuming that the builder does not ask for any payment to be made in black. I know that this is an unrealistic assumption, but just humour me for a bit.

The State Bank of India currently charges an interest of 10% on home loans above Rs 1 crore. For a twenty year loan the EMI works out to Rs 96,502. Typically, while lending banks ensure that up to 40% of the salary goes towards the EMI. Hence, to get a loan of around Rs 1.04 crore and to be able to pay an EMI of Rs 96,502, the salary of the borrower has to be around Rs 2.41 lakh per month(Rs 96,502 divided by 40%) or around Rs 29 lakh per year (Rs 2.41 lakh multiplied by 12).

Even in Mumbai how many people make that kind of money? The Maharashtra State Economic Survey for the year 2014-2015 points out that the average per capita income in Mumbai during 2013-2014 stood at Rs 1.88 lakh. So it’s not the “prospective buyers” who are being unrealistic, it’s the prices that builders want to be paid for the homes that they have built, which are unrealistic.

Given this, it is not surprising that, as the latest Economic Survey points out: “At present urban housing shortage is 18.8 million units [i.e. homes].”

As mentioned earlier Mukherjee writes: “To them [prospective buyers], the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

What is wrong with this thinking? As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Another big source of generation of black money is the real estate sector which has witnessed an unprecedented boom in the past ten years or so. In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.” In Mumbai, they put the ratio of black money to total value at between 10-30%. The Ambit analysts were quoting from data put out by National Institute of Public Finance and Policy in July 2014.

I guess Mukherjee may not want to believe this. So here is something out of a report on black money published by the business lobby FICCI in February 2015. As the report points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.” FICCI is a business lobby and not an association of buyers looking to buy homes to live-in. Given these things Mukherjee’s sarcasm towards prospective buyers who cannot afford homes at their current prices, was really uncalled for.

In the example considered above the weighted average price of a flat in Mumbai is Rs 1.3 crore. If the builder asks 20% of this in black (and I am being fairly conservative here), the prospective buyer has to arrange for Rs 26 lakh.

This leaves Rs 1.04 crore, which becomes the price of the flat on which the bank will give a home loan. Now remember, the bank gives a home loan of up to only 80% of the price of the flat. Hence, the bank will give a loan of up to only Rs 83.2 lakh. The remaining Rs 20.8 lakh would have to be paid by the buyer as a down-payment. This means that the buyer needs savings of at least Rs 46.8 lakh(Rs 26 lakh paid in black plus Rs 20.8 lakh to be paid as a down-payment) to buy a flat. How many people have savings of this kind?

And Mumbai has low levels of black money required to buy a home in comparison to other cities. So, if prospective buyers see builders as profiteers who are bloated on black money, there is absolutely nothing wrong with that. Further, many builders have just taken money from buyers and disappeared. There are many others who have endlessly delayed projects. Hence, if other buyers look at them in a negative light, you can’t blame them for it.
Mukherjee further asks: “But what is the government, specifically the RBI and Finance Ministry doing about the high interest rates, the recapitalisation of banks, and renegotiation of all the stressed loans to builders/ industry, which are about to become irretrievable NPAs?.”

He also suggests: “Also, in the interim, the assumption is that the construction industry will receive new lines of credit/ rescheduled debts from the banks and lending institutions to finish their half-built projects.”

The tone is that the government and the banks should come to the rescue of the real estate companies which are in a mess. There are multiple points that need to be made here. First and foremost why can’t builders cut home prices and sell the massive number of unsold homes that they are sitting on.

Second, why should banks lend more to a borrower who is unable to repay his past debt? It is important to understand the main purpose of a bank, which is to ensure that the money deposited by individuals with it, remains safe and earns some return in the process. What Mukherjee is suggesting is that banks throw good money after bad. Why? Just because a few builders are going to go bust?

Also, it is worth asking where did all the money that the builders raise for building projects go? They took money from prospective buyers. They took money from banks. Where did all this money go? Guess Mukherjee can give us an answer for that.

Further, the builders have made potloads of money between 2002 and 2013, when the bull run in real estate drove home-prices to the current unrealistic level. So how is it fair that prices were allowed to rise, but now when the prices are falling (or should be falling), they should not be allowed to fall?

John Kenneth Galbraith, who was probably the most read economist in the mass media in the twentieth century, once said: “In America, the only respectable type of socialism is socialism for the rich.” Mukherjee along these lines wants the government to bailout the builders. I am no capitalist but socialism for the rich, is socialism of the worst kind.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on SwarajyaMag on Aug 5, 2015

A few confessions on real estate forecasting

India-Real-Estate-MarketIn the recent past I have written quite a few columns on real estate. In some of these columns I have clearly said that I expect the real estate prices to continue to fall in the time to come.

In response to this point a question that gets often asked is: “Should I buy a home now?” This is a very difficult question to answer, given that it has zero information built into it. It doesn’t tell me where the person asking the question is based out of.  Does he want to a buy a home to live in? Or is he looking to invest? Further, what is the financial situation of the individual? So on and so forth.

I will try and answer this question in today’s column in a fairly general sort of way. If you are looking to invest in real estate this clearly is not the time to invest, given that the prices are falling and the return over the last one year has been extremely subdued. The time to invest in real estate will come once the prices have fallen from the current levels.

How about buying a home to live in? That really depends on your financial position and how stable you are in the current rented accommodation you are living in. If the landlord is likely to let you continue to live, then it is best to wait it out. You will definitely get a better deal in the days to come.

If he is not and you have enough money going around then it is best to buy a home. Obviously, you need to ensure that you aren’t using up all your savings in making the down-payment and stretching your home loan limit to the hilt. While you will end up paying more now than if you were to buy a home somewhere down the line, there will be other happier things to look forward to.

The social pressure that comes with not owning a house will go away. The child (or children) will have a more stable environment to live in. And given these reasons, if you have the money and need a home to live in, it makes sense to go ahead and buy one.

All this comes with a small caveat—if you are thinking of buying a home in the National Capital Territory, be very careful. As Santhosh Kumar, CEO – Operations & International Director, JLL India recently wrote:The National Capital Region (NCR) has some locations that buyers are best advised to avoid. Various issues like delays in delivery, oversupply, speculation and infrastructure deficit have been plaguing these markets, rendering them unsuitable for first-time home purchase.”

Another question that is often asked is: “By when do you think price of real estate will fall dramatically?” This remains a very tricky question to answer because there is no credible price-volume data going around on Indian real estate. (i.e. how many homes were sold and what at price).

The only real estate data that is available at the agglomerated level is supplied by real estate consultants. The trouble is that these consultants make more money when the real estate sector is doing well i.e. prices are on their way up. Given that, even though the data supplied by them is showing excessive inventory of unsold homes and more or less flat prices on an average across the country, the actual situation might be much worse (which means the crash in real estate prices might happen sooner rather than later, but this cannot be said for sure).

Further, the data supplied by real estate consultants is at best limited to metropolitan cities. Given that, there is almost no information about the price-volume trend of real estate beyond the top cities in the country. So how does one predict, when will prices fall dramatically all across the country without much data?
Further, the real estate indices that India are not “real time” enough. The two main indices put out by the National Housing Bank and the Reserve Bank of India, are really not up-to-date.

Then there is the biggest variable of them all: black money. How does one figure out whether the total amount of black money going into real estate has gone up or come down? In this scenario one can make educated guesses from the data that is available and anecdotal evidence that keeps coming in.

An interesting experiment was carried out by a friend of mine recently. He called up several real estate brokers from two different numbers. On the first call he pretended to be a buyer and was told “Sir, daam abhi bhi badh raha hai (the price is still going up).” On the second call he pretended to be a seller and was told “Sir, there are no buyers in the market.” What conclusion can we draw from this? I leave that up to you.

As far as black money is concerned, the situation in National Capital Region, makes for an interesting reading. As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.”

Hence, among the bigger cities, the maximum amount of black money goes into real estate in Delhi and the National Capital Region. And this I feel has been coming down. The real estate rating and research agency Liases Foras estimates that the National Capital Region had an unsold home inventory of 71 months (the real situation might be worse) as on March 31, 2015. This means that if sales continue at the current pace it would need another 71 months to sell the existing number of unsold homes. An inventory of eight to 12 months is considered healthy.

What this huge inventory clearly tells us is that the amount of black money coming into real estate has come down in the National Capital Region and this is good news for genuine buyers who want homes to live in.

Over and above this, the real estate prices have run up way beyond what most Indians can afford. And once you take this into account, prices are bound to fall. This becomes very clear from the point that rental yields are now as low as 2% (again a data point provided by real estate consultants and given that the situation might be worse). Rental yield is essentially annual rent that can be earned from a home divided by its market price. No market can keep working beyond a point without catering to what the customers really want.

All these reasons, lead me to believe that real estate prices will continue to fall in the days to come. Though please don’t ask me when will they crash? Because I really don’t know.

This is one of those funny situations where one will be partially wrong till one is proven right. All I can say to conclude is: stay tuned!

The column originally appeared on The Daily Reckoning on July 28, 2015

Will home loans be the next big worry for banks?


Vivek Kaul

I am amazed at the strong belief that people have that real estate prices will never fall. Every time I write a column on real estate readers get back to me with newer theories on why I am wrong. A new theory that was put forward(actually it is not so new, just that no one had come back to me with this theory for a while) to me on Twitter was that the government won’t allow real estate prices to fall.

To this another Twitter follower replied by saying that if real estate prices can fall in China(where the government is far bigger and has a lot more control over things than in India) then they can fall in India as well. Guess that is a fair point.

Anyway, this column is really not about why real estate prices will fall (in fact they have already started to fall). That bit I am already convinced about, I just need to keep reiterating it for the benefits of the believers who don’t see it coming.

What I am worried about is what will happen in the aftermath of home prices falling. Banks clearly have a reason to worry. And here is why.

Every month the Reserve Bank of India (RBI) puts out data regarding the sectoral deployment of credit by scheduled commercial banks operating in the country. For a period of one year ending May 29, 2015, the total lending by banks grew by 8.5% to Rs 61,51,600 crore. During the same period, the total amount of home loans given by banks grew by  17.1% to Rs 6,48,400 crore.

Now compare this to what happened during the period of one year ending May 30, 2014. The overall bank lending had grown by 12.7% to Rs 56,684,00 crore. In comparison the total amount of home loan given out by banks had grown at a similar 17% to Rs 5,53,800 crore.

If we go back a year further to May end 2013, the overall growth in bank lending had stood at 15.3% whereas home loans grew by 18.4%. (Actually the period here is a little more than a year, between May 18, 2012 and May 31, 2013).

What this clearly tells us is that even though the overall growth of lending by banks has considerably slowed down, the growth in home loan lending continues at almost the same pace. What conclusion can be draw here? The RBI does not give out the total number of home loans that banks are giving out. Neither does it tell us the average size of a home loan.

Nevertheless, one explanation for home loans continuing to grow can be that the increase in the price of homes has also led to the increase in the average size of home loans.

What happens if we look at the data a little differently? Over the one year period ending May 29, 2015, the total lending of Indian banks grew by Rs 4,83,210 crore. During the same period the total amount of home loans grew by Rs 94,590 crore. Hence, home loans constituted around 19.6% of bank lending during the last one year.

What was the scene a year back? For the one year period ending May 30, 2014, the total lending of Indian banks grew by Rs 6,40,570 crore. Home loans had grown by Rs 80,260 crore during the same period. Hence, home loans constituted 12.5% of the lending during the course of the period.

For the period of one year ending May 31, 2013, home loans constituted around 11% of the overall lending by banks. (As mentioned earlier, the period here was a little more than a year, between May 18, 2012 and May 31, 2013).

Now what does this tell us? With overall bank lending slowing down, banks have increasingly become dependent on home loans. As Deepak Shenoy of Capital Mind puts it: “the demand for housing loans is pretty much the only game in town for the banks.”

Home loans were formed 11% of the total loans given out during the period of one year ending May 2013. This number jumped to 12.5% during the period of one year ending May 2014. And for the period of one year ending May 2015, home loans amounted to 19.6% of the overall portfolio. Things get even more complicated once we look at the divide between priority sector home loans and other home loans. Home loans of up to Rs 25 lakh get categorised as priority sector loans.

For the period of one year ending May 29, 2015, priority sector home loans grew by just 4.9%. On the other hand home loans of value greater than Rs 25 lakh grew by 32.2%. Hence, higher value home loans are growing at a significantly faster rate. For the period of one year ending May 30, 2014, priority sector home loans had grown by a much faster 8.7%. The home loans greater than Rs 25 lakh had grown by around 29.1%.

The problem is that with the real estate bubble starting to loose fizz banks are likely to face the next spate of bad loans from the home loans that they have given out. I might be jumping the gun here a little, but the numbers show an increasing dependence of banks on home loans and that is clearly not a good sign.

As the analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled  Real Estate: The unwind and its side effects: “Over the last decade, the combined real estate portfolios of banks and NBFCs have increased at a CAGR[compounded annual growth rate] of ~20%. A breakup of this growth between value and volume shows that two-thirds of this growth has been driven by increased ticket sizes (due to the continued increase in ticket sizes), and volume growth for the sector has been relatively modest at ~8-9% CAGR over the last 10 years.”

This is going to change in the days to come. As Mukherjea and Shekhar write: “Housing finance companies/banks would be an obvious casualty if real estate prices correct.”

Disclosure: The idea for writing this column came after reading Capital Mind’s research report titled Bank NPAs Show Alarming Signs, Add to Woes of the Sector

The column originally appeared on The Daily Reckoning on July 24, 2015

How black money hurts the entire idea of a happy family

Yesterday I spent an hour talking to a friend who wants to buy a two BHK apartment for Rs 55 lakh in Mira Road, a distant western suburb of Mumbai. I was trying to explain to him that Rs 55 lakh is too much money to spend for living in Mira Road. Also, given that I know the financial position he is in, I knew if he went ahead and bought the apartment, he would really be stretching himself.

His logic is very simple: “I need something of my own. The rent I am paying is essentially getting wasted.” I tried telling him that he was paying rent to live in a decent locality from where he could reach most parts of Mumbai in under an hour, on a good day. The same wouldn’t be true after he moves to Mira Road, with his family. He currently pays a rent of around Rs 16,000 for a one BHK apartment, somewhere in the Central suburbs.

But his need to ‘own’ a house is so strong that he did not see it that way. So, for an hour we kept going round and round and he kept coming to the same thing of the rent being ‘wasted’. I guess he basically wanted me to tell him that he is making the right decision, which I wouldn’t. And so we kept talking.

As is the case with these things, social pressure to buy a home must have been at play as well—parents and relatives, whose experience is of a bygone era, wanting to see their kids settled and putting pressure on them to do things, which they think are right.

First they want you to get married. Then they want you to buy a few Life Insurance Corporation of India policies, because they have always done that. Then they want you to buy a house. Then they want you to produce kids. These wants never come to an end. And so the story goes.

The trouble is that all of this is not possible at once given how things stand these days. And one reason for this revolves around the huge amount of black money that keeps finding its way into Indian real estate. Black money is essentially money which has been earned and on which taxes have not been paid.

With a massive amount of black money finding its way into real estate, the prices of homes have gone way beyond what most people can afford. When you can’t afford a home to live in, the decision to have children also becomes a tricky one. A child needs some stability in life. If you are living on rent, you will have to keep changing your home every few years. And once a child starts going to school, this becomes very difficult.

Other than going to school there are other activities with which a child is involved as well. So, marriage, home, children, school and other activities are all closely linked. And the massive amount of black money in the Indian financial system is essentially threatening this very important “link,” which is a very important part of leading a happy family life.

Further, black money also leads to higher interest rate on loans. How is that? As I said earlier in the column, black money is essentially money which has been earned, legally or illegally, and on which taxes have not been paid. Lower taxes mean that the government has to borrow more in order to meet its expenditure.
When the government borrows more, it leads to crowding out, and leaves lesser money for the private sector to borrow. This leads to the private sector having to pay a higher rate of interest when they have to borrow. The private sector also includes banks. Hence, banks borrow at a higher rate of interest, they lend at an even higher rate of interest.

This hurts the honest tax payers as they end up paying higher EMIs. This is another way in which black money ends up hurting those who need homes to live in.

There is a third way in which black money hurts which a lot of people find out only while  buying a home. During the course of buying a home a certain amount of payment has to be made in black.

As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Whilst official figures are not available that quantify the size of the black money percolating through the real estate sector, research suggests that more than 30% of India’s real estate sector is funded by black. Our channel checks suggest that individuals who are involved in real estate transactions for their personal needs in Mumbai are routinely asked for black money payments ranging from 10% to 30% of the transaction value.”

The proportion of black money can be even higher in other cities. As Mukherjea and Shekhar point out citing a July 2014 report of the National Institute of Public Finance and Policy: “In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.”

And how does this impact genuine buyers? Let’s say an individual buys a property with a market price of Rs 50 lakh. The deal is 80:20, where 20% of the market price is to be handed over in cash to the seller. Hence, Rs 10 lakh (20% of Rs 50 lakh) gets handed over to the seller in cash.

Then the individual goes to the bank for a loan. The bank gives a loan against the remaining Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh that has been handed over in cash), which is deemed to be the official value of the home. Further, the bank also follows an 80:20 ratio i.e. it gives a loan of Rs 32 lakh (80% of Rs 40 lakh) against the value of Rs 40 lakh. The remaining Rs 8 lakh the individual has to offer as a downpayment. It is his contribution to buying the home.

Many people realise this basic point only during the process of buying a home. Some of them get stuck because they have already handed over the cash they had to fulfil the black portion of the deal. And then they have a hard time trying to raise money for the downpayment.

To conclude, black money makes things difficult for people wanting to buy a home to live in at multiple levels and stops them from living a happy life.

The column originally appeared on The Daily Reckoning on July 22, 2015