September 2019: MoneyWorks4me Outlook

Last Updated on March 5, 2020

Review

Nifty Total Return Index (Nifty including dividends) earned ~6.7% Year to date Oct 4,  2019 and ~11.5% 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 very volatile movements in equity. Hon. The finance minister announced bumper reform of lower corporate tax for large companies and for new manufacturing plants. This led to a steep climb in the stock price of potential beneficiaries from the lower tax rates. However, existing slowdown fears, contagion from NBFCs and FII selling brought the stocks lower.

Outlook

As on date, the average upside of our coverage universe is likely to be ~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.

Some pockets of the market like consumer staples, consumer discretionary are trading at stretched valuation. We expect below-average 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.

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.

An investor can consider investing in value and high dividend yield stocks like Infra & Infra-related companies, autos, few PSUs and select NBFCs. 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. 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.

Risks

India

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.

We think the timing of bad events plays a bigger role in how the news is perceived. When the entire financial system entered clean of NPAs, the economy was doing fine, the new government had a lot of promise which gave investors hope for a better tomorrow. Gross NPAs of more than 15L Crore has been provided for without much panic. However, in today’s scenario, a new tax regime, attack on tax evaders and defaulters and growth slowdown have led to negative sentiment. Since liquidity has become scarce from subdued sentiment, more frauds are seeing the daylight as their way of business is coming to a halt. This has made investors fearful and exaggerates even minor and anecdotal events.

Our fear is that negative sentiment can make a mountain out of a molehill. Loss of faith and drop in liquidity (economic transactions) can lead to growth spiraling downwards. We believe that the government and regulators have a big role to play here to instill faith in the system and give citizens hope of better days ahead. The government recognizes the need of the hour and hence coming up with multiple press conferences to assuage fears of economic contagion.

We request our readers to share optimism and stop others from spreading negative news as this usually tends to builds on and spreads like fire in the jungle.

Yes Bank has been encountering a large set of NPAs which might be a result of its aggressive growth in the recent past. The same fear is taking stocks like IndusInd Bank, RBL Bank, and few mid-sized NBFCs lower as these too grew at exponential pace during the same period. The market believes that aggressive growth might have come at the cost of bad asset quality. This is taking these stocks to lower along with Yes Bank. We find that chances of NPA issues leading to insolvency are bleak for Yes Bank. It is a large-sized bank that generates regular cash flows to provide for bad loans and stay afloat. Whether its shareholders will recover their investment is another discussion and not the material has given it was less than 1% in overall stock market value. This pessimism is also influencing stock prices on some of our investments, even if they do not share a similar business model.

PMC Bank, Mumbai-based cooperative bank, has committed fraud by colluding with HDIL, a large real estate player based out in Mumbai. This incident has shaken investors’ confidence as this level of fraud went unnoticed for several years under the regulator’s nose.

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.

Opportunity for long term investors

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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