Fund Manager Speaks – Sept 2019

Market Overview – September 2019 Quarter

Global Economy:

The world economy is afflicted by weak sentiment, trade-related disruptions, and rising downside risks to growth. Central banks leaning towards lower rates reflects growing pessimism on the growth front. The calm that characterised global financial markets in the beginning of 2019 has been dispelled since May, with a combination of trade and geo-political tensions and the worsening global growth outlook imparting heightened volatility.

USA:  Dogged by uneasiness over trade frictions and weak global growth, the American economy’s growth inched lower over the summer. The real GDP growth rate for Q3’19 declined to 1.9% (annualised). The US trade war with China is eroding business confidence, which contributed to the second straight quarterly contraction in business investment. However, growth in consumer spending which accounts for 2/3rd of US economic activity was big positive inspite of it slowing down to 2.9% in Q3 vs 4.6% in Q2’19.

Fed Rate: The Fed as expected in their October meeting lowered its benchmark funds rate by 25 bps to a range of 1.5-1.75% and indicated that it may pause rate cuts from here. Mr. Powell, Chairman Fed showed confidence in US economy as strong backed by consumer spending due to lowest unemployment rate in 50 years and indicated future decisions would be data dependent.

China: Chinese economic growth slumped to its lowest level in 27 years as GDP dropped to 6% in Q3’19 vs 6.2% in second quarter mainly on account of slowing investments. Policy makers appear to be allowing the world’s second-largest economy to drift lower as they seek to clean up the financial system and curb excessive credit growth. With a drop off in exports to the U.S. expected to continue as long as tariffs remain, the economy is likely to keep struggling as falling factory prices hit company profits and rising consumer inflation hits spending power.

Indian Economy:

A combination of domestic and global headwinds has depressed economic activity, especially in terms of aggregate demand. The near-term outlook of the Indian economy is fraught with several risks as IIP for September 2019 contracted for 2nd straight month by 4.3% (lowest since almost 8 years), GST collections for October remained below 1 lakh Cr mark at `95380 Cr whereas overall GST collections in April-October 2019 increased by just 3.38% raising concerns w.r.t. fiscal deficit.

Further private consumption, which all along supported economic activity, is now beginning to slow down due to a host of factors. Additionally, bank credit growth has slowed down and overall fund flows to the commercial sector have declined, partly due to risk aversion and partly due to a slowdown in demand. However, the recent measures such as the sharp cut in corporate tax, concessional tax rate of 15% for new manufacturing units, stressed assets funds for the housing sector, infrastructure investment funds, implementation of a fully electronic GST refund system and funds for export guarantee would be helpful to kickstart the capex cycle so that new capacities can come on stream and lead to the strengthening of domestic demand.

RBI Policy: As was widely expected, the RBI cut the repo rate by 25 bps in its October meeting, 5th consecutive cut this year aggregating to 135 bps. Considering weak global demand, crude oil prices as well as food inflation are expected to remain under control and hence, they continue with their accommodative stance.

Corporate Performance:

India Inc’s revenue growth excluding BFSI declined by 5.2% in Q2’20, the lowest in past 14 quarters, on account of muted private consumption demand whereas PBT declined by 17.4%. Lower tax rate boosted PAT growth across sectors.

Aviation, Automobiles, Metals, Oil & Gas, Chemicals and Consumer Durables performed poorly whereas IT, Pharma, Cement, Capital Goods and Media did fairly well.

Although, considering the slowdown in the economy it was anticipated that the September quarter results would be delivered weak, however, majority of our holdings have delivered reasonable performance considering the economy and delivered better results compared with peers which is a sign of the company’s strengths.

Stock Markets:

The sentiment in stock markets is at all-time low and investors are more focused on safeguarding capital and return expectations are low. This has led to broadening of valuation disparity even as indices hit new highs of 40800, a couple of days ago. The median P/E of top 100 companies (out of top 500 companies) by market cap is ~30x their trailing 12-month earnings whereas the same for bottom 100 (out of top 500 companies) is less than 9x.

Hence, since the beginning of 2019, BSE Large-cap has risen by 9.5% whereas BSE Mid-cap fell by 3.7% and BSE Small-cap went down by 8.8%.

Care PMS Strategy:

What gives us confidence of recovery in our portfolio companies?

If you look at history of equities, good businesses always navigate the stock market correction phase and emerge winner. Most of the investor community follow where returns are being made and hence, are investing in large-caps for the sake of safety (the same was true during Mid and Small-Caps rally 2015-2017 where no one was interested in investing in Large-caps).

While there are concerns whether the Small/Mid-cap companies would ever gather interest?  However, one needs to be mindful that there are very limited opportunities to invest in good quality companies (irrespective of market cap) which should attract good capital inflows once the sentiment turns.

What if the economy does not return to 7-8% growth trajectory?

Though a part of money that went into Large-cap may not come back to Mid and Small-cap space post MF re-classification, even a small improvement in sentiment/small shift of money from high PE Large-caps can drive prices for fundamentally strong Mid and Small-caps considering low equity base.

Are we only waiting for the sentiment to turn? – No, we are doing whatever we can in terms of portfolio structuring (can be seen from below steps taken).

In continuation of our overall strategy to reduce the overall portfolio risk as mentioned in our last Result Update, you may have noticed few changes in your portfolio like

1) Adding of couple of large pharma and cement companies which have very strong fundamentals and where there is scope for improvement in valuations;

2) Profit booking in some companies which had decent run up in short-term or via buy-backs where offer price was attractive;

3) Reducing weightage in some companies where either the outlook is uncertain or to reduce risk through diversification where the cash was unavailable.

Though it may sound repetitive, we would again like to emphasis the importance of patience in investing as stock moves. Recently Reliance Industries became India’s large company in market cap and has delivered (20% CAGR for 27 years). However, if you look carefully, there were 2 stretches of 8-9 years of no returns.

“Though tempting, trying to time the market is a loser’s game. $10,000 continuously invested in the market over the past 20 years grew to more than $48,000. If you missed just the best 30 days, your investment was reduced to $9,900.” – Christopher Davies

Happy Investing!!