Review

Nifty Total Return Index (Nifty including dividends) earned ~2.5% Year to date 2019 and ~9% 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. 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. Current GDP numbers look dismal but a lot of it is caused by poor liquidity in the economy. Quite a few stocks are trading at a deep discount especially PSUs due to constant stake sell by the government.

The government has announced few measures to combat a slowdown in select sectors. We believe that these are good measures and can improve sentiment in the economy. While we can’t quantify the impact, we believe that the government’s initiative to arrest slowdown is good enough for consumer sentiment to improve.

Auto sales were down by steep volumes for the second month in a row due to production cuts. These numbers do not indicate actual vehicle sales but just shipment from Auto company to dealers. Auto companies had shipped a lot of inventory to the distributor/dealer level in the previous 2-3 quarters. These are getting adjusted by way of reducing production. The fall in volumes over a shorter period would not affect auto companies’ valuation. We believe long term monthly volumes are likely to be higher than current volumes.

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.

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.

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.

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 are seeing selective opportunities in PSUs that in utilities or capital goods space. We have included a lot of 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. Maybe the aggressive risk profile investors would be interested.

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

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

Market contagion and liquidity crisis

The slowdown caused by a liquidity crisis has forced the government to come to the rescue. Hon. Finance Minister announced some measures to boost liquidity and lower interest rate transmission to borrowers. This could improve sentiment. Upfront PSU recapitalization can also increase the lending ability of some stable public sector banks who can rescue NBFCs.

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. We are of opinion that with better liquidity from RBI liquidity program, lower interest rate loans and government payments (delayed during election time) will put more money in the system. This could normalize the fall in GDP growth.

The reality check of slower growth 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.

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