Investment Shastra

July 2019: MoneyWorks4me Outlook

July 2019 MoneyWorks4me Outlook
We do not believe every crisis leads to a 2008 kind of crash. Equity is volatile and still generates the highest returns versus other asset classes.
This article covers the following:

  1. Review
  2. Outlook
  3. Risks
  4. Time to worry?

Review

Nifty Total Return Index (Nifty including dividends) earned ~3% Year to date 2019 and ~10% CAGR in the last 3 years. Nifty continues its highs with a handful of stocks making all-time highs while most of the market is at 52-week lows or even 3-year lows. This has led to underperformance for most advisors and MFs. A lot of stocks in Infra space rallied post-election outcome in anticipation of the continuation of reforms from the incumbent government. However, that seems to be waning off with concerns of tight liquidity, higher cost of funds and GDP growth slowing down. The headlines have worsened as media tends to exaggerate negatives in lines with the trend. The rising trend leads to a more optimistic outlook and downtrend trend lead to pessimistic articles.

Outlook

As on date, the average upside of our coverage universe is likely to be ~9.5% CAGR over the next 3 years. Given quality companies are trading at steep price multiples & our coverage mostly has quality companies, expensive valuation is getting reflected in poor upside potential too.

Few advisors are recommending small and mid-cap companies as the uncertainty of the election is behind us. However, we believe that small and mid-cap are not cheap yet to make risk-adjusted returns over an entire cycle. They may rise temporarily however, long term returns won’t be commensurate for the risk one takes investing in small and mid-cap companies today. A SIP product may work in such a situation but we recommend caution on lump-sum purchases.

The last 10 years’ performance belonged to non-cyclical companies that exhibited a linear growth rate. Our expectation is that there will be “reverse to the mean” in stock prices that have run up more than their earnings growth. Stocks with mediocre earning performance may come out with positive surprises as many woes are behind them. We have been investing in sectors and stocks having a reasonable upside and debt-free balance sheet.

Some pockets of the market like consumer staples, consumer discretionary (except Auto), chemicals, financials (except corp banks/nbfc) are trading at stretched valuation. We expect mediocre returns from this basket over the next 3 years even if earnings growth is good. Starting valuation plays an important role in long term returns.

An investor must consider investing in Infra & Infra-related companies through stocks or funds for the medium term. Some of the Auto stocks have seen deep cuts and trading at low valuation multiples versus the last 5 years. We expect a basket of select NBFCs, corporate banks, utilities, Autos, and diversified non-MNC Pharma to earn good returns over the next 3 years. We have included a lot these stocks in either ‘Time to Buy’ or ‘Close to Buy’.

We are also evaluating ‘Credit Risk funds’ as they might have become cheap, due to herd’s negativity, even after considering the risks they carry. If we find any merit, we will share our recommendations and analysis with our subscribers. May be the aggressive risk profile investors would be interested.

Risks

Global

FII selling FIIs have been selling Emerging market stocks due to uncertainty about global growth. We do not believe this is India specific selling as other EMs are also seeing outflows. Fed bank maintains its dovish stance and did a rate cut to avoid economy slowdown. FIIs are redeeming their risky exposures and there is a flight to safety by buying into perceived safe assets like Gold and US Govt bonds.

US-China Trade War: We believe no one has estimates of the impact of the ongoing trade war. Since the Global Financial Crisis (2008) the rich have become richer thanks to global central banks QE and low-interest rates that fuelled stock market rally rather than main street growth in most developed economies. Inequality has increased considerably leading to rising of a populist government in most countries. This makes us believe that most countries will go for domestic trade and employment protection. However, we still believe that market equilibrium will prevail over time. We might be up for a new normal of one notch below free markets to more like a partially regulated market till we see adequate wealth dispersion across the economies.

India

GDP Slowdown Markets are pricing in the reality that GDP growth is subpar and this would lead to poor earnings growth. We believe this was a known event and we have been saying this through our notes that market is assuming much better growth scenario.

The GDP slowdown looks transitionary due to subpar capex growth in the last 7 years, a slowdown in exports, NBFC fuelled consumption growth normalizing rather than collapsing and large government expenditure going into PSU bank recapitalization and into assets with long term benefits but no immediate accrual. While we do not deny that the government has very limited tools to kick-start near term growth.

The reality check is leading to a market correction. We have been recommending a portion of the portfolio to be held in Liquid Funds as markets have a lower upside. If you haven’t held Liquid funds, ensure you hold stocks with a reasonable valuation. The volatility will come and go. Don’t worry about individual stock movements.

Going forward we continue to remain bullish on Indian equities, thanks to the younger population, under-penetration in several sectors, under-investment in infrastructure would provide ample opportunities for the companies to grow. We do not believe that the long term fundamentals of India have changed in the last 2 years to see such pessimism around us.

Market contagion and liquidity crisis In recent meetings, RBI and the government together have announced many relief measures to control the liquidity crisis. They have allowed banks to increase lending to NBFCs to help them sail through the refinancing cycle. While these measures won’t help to bring back growth immediately but it will arrest the worsening of the situation.

We do not believe that the NBFC/liquidity crisis situation is insurmountable. We have seen worst of NPA provisioning (almost 11% of the loan book in NPA). It’s just that buoyant markets masked the pain of the real crisis. We think that economy-wise we are at the rock bottom of performance and things can only get better in the future. The only problem is we don’t know when will this upmove starts.

Time to worry?

We do not believe every crisis leads to a 2008 kind of crash. Equity is volatile and still generates the highest returns versus other asset classes. Nifty today trades at a reasonable to a slightly overvalued zone. We can’t time the upmove but we can choose what to buy. We need to focus that our underlying companies earn 15-18% ROE on a consistent basis and currently trade at 14-17x P/E ratio. These are quite cheap to expect good returns from equities. There will be near term pain as stocks go lower for some time because that’s what they do some of the time.

Nifty Annual Returns

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Ketan Gujarathi

Manager - Equity Research; Based in Pune, a Total of 7 years of work experience ranging from equity analysis, credit rating and banking. MBA in Finance and a Bachelor's degree in Engineering. Passionate about studying companies. Likes reading history & business books. Spends free time with friends and family.

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