Fund Manager Speaks – March 2019

Market Overview – March 2019 Quarter

Global Economy:

The slew of negative economic headlines in the recent past has been capturing global growth uncertainties. The International Monetary Fund has downgraded the growth forecast, the Brexit conundrum is stretching on, the dispute between the United States (US) and China is affecting trade, and the global oil market is as volatile as ever.

However, global economy defies doomsayers in first quarter as over the past few days, the three largest economic blocs in the world – the EU, China and the US, comprising almost half of the global output have published their first quarter estimates and all three have been stronger than expected.

USA: The US economy grew by an annualized 3.2% in the first quarter of 2019 (1st time since 2015 that Q1 GDP topped 3%), easily beating market expectations of 2% and following a 2.2% expansion in the previous three-month period. Personal consumption expenditure, higher exports and increase in government spending were the key drivers for the GDP growth.

Fed Rate: A strengthening economy had prompted members of the FOMC to raise rates nine times since 2015, with four increases coming under Mr. Powell’s leadership but they have adopted a cautious stance this year, first as growth wavered and more recently as inflation has fallen below the committee’s 2% target.

At its meeting held on May 1, 2019 the Federal Reserve held its rate unchanged as Mr. Powell stressed that it would remain patient even as investors looked for a rate cut and President Trump urged one.

China: The Chinese economy grew 6.4% Y-o-Y which is better than expected but matching Q4’18 growth rate which is the weakest in nearly 30 years. With growth of manufacturing sector slowing and additional tariffs imposed on Chinese goods by the US on 10Th May would lead to slow down in GDP growth in coming quarters.

Indian Economy:

India losses the fastest growing economy tag to China as GDP growth falls to 5.8% in Q4.  Low agriculture and mining output along with subdued consumer demand due to NBFC liquidity issues slowed down the economic growth rate. Government believes that the slowdown will continue in Q1 FY20 but the situation should improve from Q2 FY20.

Re-election of the Modi government with an improved mandate ensures political stability and continuity. That said, the economy is faced with numerous challenges and hence, bold steps will be required by the government for economic revival.

RBI Policy: With economic growth slowing down to slowest in the last 3 years in Q4 and inflation continue to being benign, the RBI is likely to cut repo rate by 25 bps (taking the cumulative cuts to 75 bps in 2019) at its meeting to be held on 6th June 2019 which will be the 1st policy meet of the central bank after elections.

Corporate Performance:

Weakness in consumer spending and softening commodity prices have led India Inc to deliver a 6-quarter low revenue growth of 10.7% in January-March period. From profitability perspective, operating margins also narrowed 0.78% Y-o-Y to 16.8% during the period.

The weakness in consumer linked sentiment impacted sectors like FMCG, Automotive, Real Estate sectors, exports focused sectors like Textiles and Pharma also continue to be under pressure whereas margins in Chemical sector were impacted due to crude oil volatility. PSU as well as Private Banks improved their performance due to lower provisioning, IT companies did well whereas Cement, Steel and Capital Goods benefitted from higher utilisation of capacities.

Stock Markets:

For the last nearly 18 months, the BSE small-cap and mid-cap indices have been under pressure due to sharp rise in crude oil prices and uncertainty around the central elections among other issues. Sensex gained 7.2%/7.9% in 2018/YTD-2019 while BSE mid-cap and small-cap lost (13.5%)/(4.9%) and (23.4%)/(2.7%) respectively.

Valuations of mid-cap and small-cap stocks which were frothy and had a premium over large-caps until last years, cooled off significantly due to sharp corrections. As per Bloomberg data, BSE mid-cap is trading at 15.4x one-year forward PE (lower than its 3-year average of 19.7x), BSE small-cap at 13.2x while BSE sensex is trading at 16.1x. The gap in valuations itself is causing many investors to now turn bullish on these segments. Following table shows the trend of net inflows as per AMFI data

With new fresh and affirmative mandate for BJP, FII and DII flows are expected to improve and this gap in valuations is likely to dwindle. We feel there is significant opportunity to generate Alpha in this space. With benign inflation outlook and the recent slowdown in the economy, we expect RBI to be dovish on interest rates. This will enhance liquidity which in turn will help mid-caps and small-caps outperform over the next few years.

Care PMS Strategy:

The prolonged and drastic fall has resulted in risk reward ratio becoming favorable for select mid and small-caps as performance has improved in FY19 whereas stock prices are lower. Hence, we believe we are very favorably placed to encash on the above opportunity as there is dearth of good stocks and not money. Hence, we are hopeful of good recovery in our portfolios in times to come.

For years, stocks in large companies were considered “investing” and stocks in small companies were considered “speculation,” but lately small stocks have become investments and the speculation is done in futures and options – Peter Lynch

Result update of our portfolio companies is attached for your reference

Happy Investing!!


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