Fund Manager Speaks- December 2018

Market Overview – December 2018 Quarter

Global Economy:

Global growth was likely steady in December quarter, although 2019 begins with economic clouds on the horizon. The global economy is estimated to have grown by 3.1% in the fourth quarter, unchanged from Q3’s figure.

Looking at the economic performance of G7 economies, the U.S. likely led the pack thanks to healthy employment growth, elevated consumer confidence and solid wage growth. In addition, Japan should have gained momentum following a third quarter hampered by natural disasters. In contrast, the Eurozone and the UK likely expanded at a meager pace. The Eurozone’s composite PMI sank to a multi-year low in December, amid social unrest in France and weak momentum in powerhouse Germany.

USA: The US economy slowed down slightly vs Q3 with a growth of 2.8%. However, the outlook for next year is uncertain due to partial government shutdown which is getting prolonged plus other economic headwinds i.e. likely impact US-China trade war. Hence, the USA GDP growth is expected to slow to 2.3% in 2019 from 3% in 2018.

Fed Rate: Federal Reserve Chairman, Mr. Jerome Powell in Jan 2019 informed that Fed is likely to lower its forecast from two interest rate hikes in FY19 amid volatile financial markets and a slowing US and global economy.

China: The Chinese growth fell to 6.4% for the quarter and ending the year with a growth of 6.6%, slowest pace in 28 years on the back of spillovers from financial deleveraging and downbeat economic sentiment due to the trade spat with the United States.

Indian Economy:

Indian economy is in much better shape than many other economies despite headwinds with fiscal deficit of around 3.3%, inflation being largely under control and economy growing at brisk pace post the slowdown due to GST and demonetisation. Further, the government though its interim budget has shared the vision for India’s growth and development for years to come.

In a major policy shift, the 6-member MPC committee, headed by new RBI governor Mr. Shaktikanta Das lowered the repo rate by 25 basis points to 6.25% (first rate cut in 17 months). The MPC also changed the policy stance to ‘neutral’ from ‘calibrated tightening’.

Corporate Performance:

The performance of 2167 companies in Q3 FY19 over the last year (Q3 FY18) reveals an improvement, with net sales registering 16.6% growth on the back of GST and demonetization which gradually subsided whereas net profits by only 0.8% during the quarter i.e. NP margins witnessed contraction of 90 bps Y-o-Y as rising RM and Power & Fuel costs on the back rising commodity prices put pressure on margins.

Sectors such as IT (especially large ones), Pharma, FMCG, Private Banking, Paper did well. Textiles and Mining & Minerals were a bit of mixed results whereas telecom, Auto, Cement, Real Estate, Finance and Power reported stress during Q3 FY19. Overall the growth was led by select large companies and not all.

Stock Markets:

Though the index performance for the quarter has been stable, Mid-cap and Small-cap segments have witnessed a lot of pain in the months of Jan and Feb 2019 with a fall of more than 10% in both Mid-cap as well as Small-cap Index; in 2019 alone. The pain is now spreading even in large caps with 54% of the large cap companies falling by more than 20%, but the index heavy weights are hiding the ground reality.

The continuing pain in small mid cap stock since last 2018 budget, seems to be overdone considering their long-term average valuations. After initial negative news like levy of LTCG, Mutual Fund asset reclassification, Trade war, crude oil volatility, auditor resignations etc.; and the recent episodes of IL&FS and DHFL crises have raised big doubts on corporate governance leading to confidence crises in the market resulting in money moving out from Mid-cap/Small-cap companies.

Care PMS strategy:

Inspite of the current attractive valuations of a lot of good companies in the Mid-Cap/Small-Cap segment, the recovery in terms of price (inspite of decent set of results) is missing as investors are cautious due to the uncertainty over the outcome of general elections along with the recent unfortunate Pulwama incident, which is prompting them to adopt ‘Wait and Watch’ strategy.

We feel that the most important factor that is gaining importance and impacting most of the stocks is the issue relating to corporate governance. Impact of this factor is observed on stocks of many companies, the very recent examples are Zee group and Vedanta. Therefore, corporate governance is becoming prime stock selection criteria leaving behind factors like growth, ROCE etc. This has considerably reduced population of investible stocks.

We believe that there is a dearth of good stocks but not money. People are now more conscious than ever before as less returns or no returns are affordable than loss of capital. The next boom should be restricted to stocks with good corporate governance and will have a spread irrespective of market cap.

The major trigger for the market can be reduction of interest rates. After peak out of the interest rate cycle, the rate reversal cycle has begun. Another 25 bps reduction is expected in forthcoming RBI policy in April as inflation is expected to remain on the lower side of the expected range.

The prolonged & drastic fall, in a way, has considerably reduced risk and generated many opportunities also. The steps with reference to re-shufflement in the portfolios are on and wherever funds are being added; we are concentrating on increasing weights where the performance of the company is good and the chances of recovery are brighter and few new ideas.  But beyond that we are adopting ‘hold with patience’ approach and we should see good recovery in our portfolios in times to come.

We see the way forward as very clear because the prolonged correction has cleared all the fog and the dust from the road. It’s a time to invest as everybody is fearful, nervous & frustrated.

 ” When the public is most frightened, only the strong are left;

that’s when the market is in the best possible hands.

Victor Niederhoffer

Happy Investing!!


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