Nifty Total Return Index (Nifty including dividends) earned ~10% Year to date Oct 31st, 2019 and ~12.3% CAGR in the last 3 years.
Nifty continues to remain steady thanks to a handful of stocks making all-time highs while the rest of the market is at 52-week lows or even 3-year lows. This has led to underperformance for most advisors and MFs.
This month saw some recovery in beaten down stocks. Some commentary about festive sales have improved the sentiment and also some support was lent by FII buying in the last week of the month. Fed cut interest rates which also helped as global markets rebound.
As on date, the average upside of our coverage universe is likely to be less than 10% 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 average upside potential too.
Just a handful of companies are delivering moderate earning growth due to slow economic growth. These companies are enjoying high valuation as more and more investors are chasing them.
Even within them, some of the companies have disappointed in this quarter. We await more results to conclude how was this earning season.
Some pockets of the market like consumer staples, consumer discretionary and now insurance and AMCs are trading at stretched valuation. As consumption acts like defensive, it is natural that consumer stocks were sought over economically sensitive stocks. Temporary problems in NBFCs and smaller private banks led to money chasing insurance and AMC.
We expect below-average returns from these baskets over the next 3 years even if earnings growth is good. Starting valuation plays an important role in long term returns. Barring a few, auto companies may have run ahead of their valuation due to positive sentiments from festive period sales.
We will be reducing exposure to stocks that are not showing signs of improvement in the near term due to economy slowdown or company specific issues. Even if the overall market doesn’t look cheap, we don’t mind buying stocks with low valuation and good future prospects.
We are looking at companies that have good earning triggers over the next 2 years as we are not certain whether broad-based recovery will happen immediately. Incrementally we are deploying funds in companies that have individual stories rather than economy sensitive.
We are investing in companies i) coming out of sector consolidation, or ii) introducing new products, or iii) commissioning new capacities or iv) executing the order in hand. These can help us sail through the current environment and generate above-average returns.
Incrementally consider investing in stocks that show promise of better growth over the medium term from company-specific triggers discussed above. We have included stocks meeting the above criteria in our “Stocks in Buy Zone”.
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. Maybe the aggressive risk profile investors would be interested.
We are still working on it, and not in hurry to board the bus as they won’t be moving up in a hurry.
Few advisors are recommending small and mid-cap companies as they have seen a free fall in stock prices. However, we believe that small and mid-cap are not cheap yet to make risk-adjusted returns over an entire cycle.
The price fall doesn’t indicate anything about valuation. As of now, less than 33% of small and mid-cap companies have reported more than 10% net sales growth.
Even if they rise from here, 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 till we don’t see broad based earnings recovery in mid and small cap companies.
NBFC & Real Estate Contagion
A new wave of negativity has been making rounds in news and social media from defaults coming from a few real estate groups & NBFCs. This is happening due to one bad apple spoiling the whole bunch.
Some aggressive NBFCs and a couple of banks had inferior underwriting practices and below-average risk management since the beginning.
We have been highlighting our negative view of these companies for the past several years by way of marking these companies’ RED. These companies have finally opened the pandora’s box.
The negative news flow doesn’t stop for these counters. However, these financial companies together form less than 5% of the system. Even if they are hit by large NPAs, overall system NPAs will be below 1%. The fears of contagion are overblown on a fundamental basis.
Realty fund announcement
Hon. Finance Minister announced 25,000 Cr fund for providing liquidity to stuck real estate projects. These projects will include all affordable housing and medium size projects.
Our fear was that negative sentiment can make a mountain out of a molehill. We believe that this new initiative by the government will revive sentiment around the financial system as potential NPA from realty will be recovered by NBFC at the same time, lower stress on NBFC will affect banks lesser.
Although many view these issues as moral hazard, meaning using taxpayer’s money to bail out inefficient or unrelated institutions. However, in the current scenario, we believe that loss form this act is much lesser than ill-effects of contagion which can impact the wealth of individuals who will lose their homes, and salaries/wages.
Real Estate is one of the largest parts of one’s wealth (an individual whose property is stuck) and the RE sector is one of the largest employers in the country.
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.
Opportunity for long term investors
Markets may remain subdued until the time earnings growth kick in. But this doesn’t mean stocks won’t rise. Ones that are underpriced and showing growth can rebound faster. We are already seeing many of our stocks either going up or recovering.
Near term uncertainty in structural growth, story spells an opportunity for long term investors. Stocks are beaten down from short term fears albeit temporary.
The country needs to build 10 crores more houses, says a Reserve Bank of India report. Many people live in poor-quality housing, or without housing altogether.
This makes us confident that sooner or later, real estate players and financial companies will get their act together to take advantage of this huge tailwind for the sector.
We do not find any merit in second-guessing what’s going to happen in the next 6months-1year. We leave this field open for speculators, fear mongers, and punters.
We are managing only long term money and predicting near term events is futile. Asset allocation has taken care of several such uncertainties and tinkering asset allocation will only reduce long term returns thereby missing one’s target corpus.
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