Fund Manager Speaks – June 2019

Market Overview – June 2019 Quarter

Global Economy:

In all corners of the globe, warning signs are flashing about the state of the economy. The IMF has recently downgraded its forecast for global economic growth for the 4th time in 9 months to 3.2%. 70% of the global economy is expected to experience slowdown this year, the IMF forecasts. The IMF isn’t projecting a recession but its an uncertain and bumpy path ahead. To add fuel to the fire, the US-China trade war is not giving any certainty and keeps on bringing volatility around the globe.

USA: Economic growth fell to 2.1% annual rate in the second quarter, down from 3.1% pace in the first 3 months of 2019. A 5.2% drop in exports amid economic weakness in Europe and elsewhere as well as US trade war with China and other countries contributed to slowdown.

The US Treasury bond yield curve inverted which is often (but not always) followed by recession within a short while. The yield curve inversion happens when short dated interest rates are higher than longer ones. US 10-year yields have fallen sharply from 3.2% to 2.5% in just 5 months.

Fed Rate: For the 1st time in more than a decade, Federal Reserve decided to cut rate by 25 bps, dropping it to a range between 2-2.25%. Mr. Powell, Fed Chairman said that policy makers would continue to monitor incoming data and would act as needed to support the economy and there is an expectation that there is more room for rate cuts.

China: Chinese economic growth slumped to its lowest level in nearly 3 decades as GDP dropped to 6.2% in second quarter. Along with trade war with US, debt mountain arising from massive stimulus package launched during 2008 financial crisis and cutting back of spending by consumers are the major reasons for steady deceleration in economic growth.

Indian Economy:

The GDP growth has fallen to 5.8% in the fourth quarter of 2018-19 and is expected to dip further to 5.6% in first quarter of 2019-20. Private consumption has been the main driver of India’s growth, contributing about 60% to GDP, and its fall post liquidity crises due to NBFC fallouts is dragging economic growth further down. Better monsoon, low crude oil prices and falling interest rates are positives for the Indian economy. Various government schemes for masses including MSP for farmers are expected to better their purchasing power. Further, as per budget announcement based on the economic survey, the government is willing to spend Rs. 150tn in next 5 years on infrastructure and railway development wherein private sector will have to play a major role.

RBI Policy: The MPC of the RBI cut the repo rate by 35 bps to 5.40% during its August 2019 meeting. With economic growth slowing down, inflation expected to remain benign and fall in crude oil price, there is further room for the central bank to prioritise growth and cut interest rates.

Corporate Performance:

Slowdown worsens for corporate Indian during the April to June 2019 quarter with India’s top 1470 listed companies (excluding financials and energy) witnessing a growth of 4.1% Y-o-Y i.e. a 3-year low whereas net profits fell by 10.1% during the same period.

Some of the key sectors like private banks, NBFCs, automobiles, metals, capital goods and oil & gas reported weak performance on most of the parameters whereas industries like FMCG, Retail, IT and Pharmaceuticals did better than expectation. Now, all the eyes are on the upcoming festive season which is expected to boost consumer spending and thus boost demand.

Further, major company’s management forecast has also been cautious to negative considering economic slowdown, giving a hint of weak September quarter results as well.

Our top portfolio companies delivered mixed bag of results with some doing very good whereas the rest impacted due to general slowdown on account of elections as well as industry related issues (though which was as per expectation and already priced in by the market).

Stock Markets:

The sentiment in stock markets is at all-time low and with corporate governance issues coming up in companies across various sectors, investors are more focused on safeguarding capital and return expectations are low. Therefore, companies having good governance with robust business model and strong balance sheet are expected to attract more and more investors.

Below data will help us understand the actual situation in stock markets since 20 months

Within Nifty 50 too, there has been wide variation with top 10 stocks delivering returns of 20% during the above period and the next 35 stocks delivering negative return of 15%.

Care PMS Strategy:

Good monsoon, improving liquidity and reducing interest rates will bring back interest in good companies irrespective of market cap. We believe our companies are placed favorably w.r.t corporate governance (name of none of our portfolio companies have appeared w.r.t fraud/financial mis-management etc.), financial strength (except a couple of companies which have debt due to capital intensive nature of their business, rest are virtually net debt free) and valuations (weighted average PE of our portfolio companies is <10 vs Small-Cap Index PE of close to 30) and hence, should see good recovery whenever the sentiment turns positive.

As our strategy so far was to hold a concentrated pool of Small-Cap stocks, the current situation has hit us harder. However, while we believe that the strategy can be questioned at the moment, but the same strategy has yielded us rich dividends in the past and will perform well as our companies are strong on financial parameters. Also, the recent address by the Finance Minister has come ‘better late than never’ and it gives confidence that the government would take some steps to improve the situation which would in turn help boosting many industries.

Further, to reduce the overall portfolio risk, we have made a couple of changes in our strategy a) to increase number of companies in portfolio to reduce concentration risk and b) increase weightage to 15%-25% of companies having institutional interest. Our endeavor will be to align all our portfolios to the above strategies which may take time considering the fact that though the market has pressed the panic button, we would not want to sell our holdings at current depressed prices.

When the mood around the country is extremely negative (more frustration than pessimism), everything around seems to be negative and any positive is being ignored. So, we would like to end the portfolio update with the following quote which is apt for the current situation:

I’ve found that when the market’s going down and you buy fund’s wisely,

at some point in future, you will be happy – Peter Lynch

Happy Investing!!


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