Market Outlook - October 2020

Dear Friends,

In the epic battle of Mahabharat, virtuous Pandav's survived and prospered, vicious kaurav's lost everything. Leverage, Cost structure, Governance, access to capital, and adaptiveness determines the Virtuosity of a firm. Firms with less leverage, good governance, ability to raise capital, cutting costs with the precision of a surgeon's knife, innovating to adapt in the current situation will not only survive but also prosper. Our economic recovery will be the function of Top-Down factors like fiscal and monetary stimulus as well as bottom-up entrepreneurial efforts.

Active cases are coming down despite the Normalisation of economic activities. Vaccine breakthroughs seem to be on the horizon. Lower Oil, Gold, and Chinese good Import has made India current account surplus. FX reserves are about to exceed FX Debt. Global Firms are opening their purses for direct as well as portfolio investment. Agriculture reforms will materially benefit the large Rural population. Labor reforms and PLI schemes are step in the right direction for becoming a manufacturing hub though a lot more needs to be done on the ground. Sept 20 quarterly results are by and large ahead of street expectations. Margins have expanded across sectors due to deep cost cuts. In sectors like Auto, consumer durables volumes are ahead of expectations. Many attribute it to pent up demand. Demand Pent up or otherwise has recovered due to steps taken in the past. However, it needs to be sustained in the future by further measures.

Monetary policy is accommodative but credit transmission needs to improve further. Policy rates are at lifetime low levels but the cost of borrowing needs to be lowered in below AA rated borrowers. Fiscal stimulus has supported growth at bottom of the pyramid but sectors like Travel, Tourism, Hotel, Retailing, Aviation, Infrastructure, etc require more support. Path of fiscal prudence is important but needs to be achieved by raising non-tax resources like Proceeds from Strategic Divestment and Monetisation of Assets, unlocking capital stuck in Gold lying in Tijori, etc. The ease of doing business has improved but the Rule of Law needs to be improved. Despite good intentions, commercial disputes are getting addressed like a never-ending trial of the 1992 security scam rather than quick, everyone wins the solution of Satyam. Our laws are being made for the lowest common denominator as crooks escape without adequate punishment. This increases the cost of compliance for the rest. Investment can't pick up sustainably unless the Rule of Law is experienced by Investors. Big has become bigger in these challenging times but eventually small and medium firms need to become competitive and prosper.

The stock market has responded enthusiastically to such developments with large-cap indices trading a little below its pre covid highs. Flows and improving fundamentals have pulled the market to current levels. Undoubtedly we are not out of woods. Factors like the ongoing Second wave in the US and Europe, US election results, etc will impact our markets albeit on a temporary basis.

The stock market will be driven by a long-term growth trajectory. Global Capital in an era of abundant liquidity and ultra low-interest rates will chase return. (US Junk bonds are trading at lifetime low yields). For many investors, Growth or Innovation will be a proxy for return.

There is a money-making opportunity for a disciplined stock picker. On one side defensive sectors like FMCG, Pharma, Tech, etc are trading at high valuations. On the other hand, PSUs and PSBs are trading at lifetime low valuations. On one hand Big is becoming bigger but on the other hand, the market is valuing David far more than Goliath. The future is becoming uncertain due to massive disruption but is most exciting for the disruptor. Within a sector, there is a wide range of return as winners get rewarded disproportionately. There is plenty of information and news but It is difficult to determine facts.

At the cost of going wrong, few trends are worth capturing from a money-making point of view

 

- sustainable long-term growth is visible in sectors where India is becoming part of the global supply chain. Sectors like Contract Manufacturing, Chemicals are at a take-off stage like the IT sector at the beginning of the century Albeit with high valuations

- Firms on the wrong side of ESG investment will get derated. Their profits will get low valuation irrespective of growth.

-Challenger / Disruptor will get high valuations despite capital burn. Firms doing disintermediation will get rewarded disproportionately.

-Sector where PSUs dominate like Banking, insurance will provide long term growth opportunities to private firms.

The investor will make money in this market with lots of discipline and a bit of luck. Portfolios having virtuous companies like Pandav's will outperform portfolios with vicious companies like Kaurav's.

In closing, we believe that our partners can deliver value to investors in the current market through the three-pronged strategy. One: they can communicate the past market experience to develop a long-term investment perspective. Secondly, we will have to help the investors ignore WhatsApp and social media rumors in favor of facts and opportunities. Thirdly, we need to convince the investors of the need to maintain and increase SIP / STP at lower market levels. This way, the investor doesn't exit at relatively low returns and allows the market the time to generate a better investing experience in times ahead.

Wishing you all a very happy Diwali and a Prosperous Year ahead.