Review

Nifty Total Return Index (Nifty including dividends) earned 9.4% Year to date 2019 and ~14% CAGR in last 3 years. Nifty continues its ascend with 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 continuation of reforms from incumbent government. However, that seems to be waning off with concerns of tight liquidity, higher cost of funds and GDP growth slowing down.

Outlook

As on date, average upside of our coverage universe is likely to be ~8% CAGR over 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 uncertainty of 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 situation but we recommend caution on lump-sum purchases.

Last 10 years performance belonged non-cyclical companies that exhibited 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 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 next 3 years even if earnings growth is good. Starting valuation play an important role in long term returns.

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

Risks

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 last 7 years, 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 market correction. We have been recommending a portion of portfolio to be held in Liquid Funds as markets have lower upside. If you haven’t held Liquid funds, ensure you hold stocks with 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 younger population, under-penetration in several sectors, under-investment in infrastructure would provide ample opportunities for the companies to grow.

US-China Trade War: We believe no one has estimates of the impact from the ongoing trade war. Since 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 rise of 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 partially regulated market till we see adequate wealth dispersion across the economies.

Market correction & NBFC contagion: We had written in previous note that equity returns are not dependent on which government comes to power, but it depends on earnings growth of businesses. As we can see after initial rally on favourable exit polls markets have been under pressure. We believe one must check starting valuation before expecting any returns from equity. We have been cautious for last 3 years and it is only now most investors are realizing that valuation matters. The correction can come on back on any event, NBFC contagion these days, but valuation remains an invincible tool to gauge medium term returns from any asset class.

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

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