Why investors are disappointed with Modi

Regaling an 18,000-plus strong audience from the Indian diaspora at the Madison Square Garden in New York, Prime Minister Narendra Modi in his charismatic style said that many people ask him if he lacks a ‘big vision’. His response was that “he is a man from a humble background attempting to do big things for small people’’.

While this may have struck a chord with the common man, it would have caused a fair bit of disappointment for investors. It was expected that Prime Minister Modi’s priorities for the economy in the first few months of taking office would be to ‘unclog the pipes’ before he builds new ones. However, the popular perception then, both among stock market investors and commentators was very different.

Many stock market investors across the world are wondering what happened to the much sought after ‘Modi Trade’. For those not directly involved with stock markets, the ‘Modi Trade’ referred to stocks in the engineering, power, roads and other infrastructure sectors that were seen as big beneficiaries if Narendra Modi were to become the Prime Minister. The expectations were high for ‘big bang’ reforms and mega-projects getting announced. Stocks from these sectors had started rallying in anticipation from mid-February, but seem to have lost their sizzle barely a few weeks after the election results.

Quite unexpectedly, the best performing sector in India, both year-to-date and since the day the election results were declared is the Healthcare sector (see table below). Now Healthcare is hardly the sector that investors in India and across the world would have expected to out-perform. After a rally in the infrastructure-related sectors ahead of the election results, these stocks have largely under-performed the market, proving once again that it is not profitable to play catch up on a consensus trade.

The S&P BSE Public Sector Undertakings (PSU) Index too peaked in the early June and is down about 17% since then (see table below).

Most of the PSU stocks in that index that are trading today at higher than levels when the PSU Index hit its high are from the Energy sector, which have been buoyed by the tailwind of falling global crude prices.

While this might seem a classic case of ‘Buy the Hope, Sell the News’, what we are trying to highlight in this essay, however, is not about which sectors worked or did not. Nor are we trying to predict if and when the ‘big vision’ policies will be announced (most likely when the market least expects it!).

What we are attempting to understand are common behavioural biases that we often fall prey to. In his book, The Black Swan, Nassim Nicholas Taleb introduces the concept of narrative fallacy. He says we are biologically programmed to love stories. The human mind likes to simplify and look for patterns. We prefer compact stories to raw truths. In short, we prefer to find our own ways to avoid an overload of information and draw our quick and easy interpretation.

A quick Google search reveals that over the last few months, in an attempt to provide a simplistic narrative, particularly in the international media, Modi has been compared to global leaders ranging from Thatcher to Reagan to Lee Kuan Yew. Individual attributes of many of these leaders have been compared to Modi while trying to forecast what he might do as Prime Minister.

Daniel Kahneman too in his book Thinking, Fast and Slow says that the human mind does not deal well with non-events.

He says that paradoxically it is easier to construct a coherent story when you know little that is when there are fewer pieces to fit into the puzzle. Some such over-simplified phrases that we heard were that Modi will ‘convert India into China’ or that he will adopt the ‘Gujarat model of development’.

In short, that there will be a slew of mega-project announcements within the first few days of taking office. No wonder then that global investors and commentators living several thousands of miles away from India thought that they had Modi all figured out. The halo-effect makes us match our view of all qualities of an individual to our judgment of just one significant attribute. Many now find that this fast and frugal heuristic to understand Modi was uni-dimensional. And this audience is getting disillusioned when they hear of ‘Clean Ganga Movement’ instead of, say, an ambitious ‘Eight Lane National Highway Programme’.

As investors, we have to be mindful of the fact that we are all prone to these cognitive biases which are inherent to the way our brains process information. We can do our best to consciously attempt to not fall prey to these simplistic narratives. Catchy phrases like the ‘Modi Trade’ sound good on business news channels, but should not form the sole basis of investing.

Sector performance of MSCI India Index in U.S. dollars

All figures in % / Pre-election period – Jan 1, 2014 to May 15, 2014 / Post-election period – May 16, 2014 to Sep 30, 2014 / Source: Bloomberg / Data as on Sep 30, 2014

This article has been contributed by Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management.