By Arun Malhotra
Hiatus! The markets need a breather; they have shown dramatic rise with high intensity since March, 2020. The pause could be either in the form of price correction or the time correction, but some sort of pause is needed. The euphoria that is going on in the small and mid-cap space is bound to end, and if we have to go by history, it always ends in an ugly manner. This time it will not be different and the retail will be at the receiving end. The trigger comes, and it always comes from unknown sources.
Retail participation in the cash market is currently at an all-time high, close to 70%, which is reflecting the retail frenzy and the Robin Hood effect. Stocks, rather unknown stocks, are rising 30-40% in a week, merely based on circulation of messages on Social Media. Some of the companies had their operations shut down during the second wave, while the stocks continue to roar.
We expect a short term correction that should help remove the froth. The quarterly numbers are likely to be weak and may act as a trigger for the fall. The second wave has affected many families directly or indirectly, especially in Tier 2 and Tier 3 cities, which may impact the consumption pattern in the short to medium term. The FII flows have been very volatile and have turned negative off late. Some of the fundamental and macroeconomic factors are weak while the valuations are also a cause of concern too. For example, the rise in commodity prices including steel, energy, chemicals will put inflationary prices on margins across industries and also may put inflationary pressures in the economy. The economic shutdown has also led to increase in inventory levels and slowing demand will lead to companies finding it difficult to pass on the higher costs to the consumers.
The global factors are also not looking great with growth expected to slow down in Europe and other parts of the World. The U.S balance sheet has expanded to historically high levels, and looks unsustainable. The stimulus ushering in tons of liquidity in the financial system has led to rally in equity markets across the globe. This liquidity surge has to end somewhere and cannot continue forever. The central banks have lent a helping hand in fueling the equity markets rally, with lower interest rates and loose monetary policy, in a way acting as catalyst for higher asset prices. We may see the rates tightening cycle to begin in another 6-9 months starting last quarter of the current calendar year. On the local front, the Indian economy is slowly opening up as lockdown restrictions are eased.
The macroeconomic factors as per latest data on 6th July have shown consistent improvement across major indicators. While the GST collections were at 92k Crs for the last month and were lower as expected, the Industrial indicators are rising slowly closer to pre-Covid levels with energy consumption at record high levels while the mobility index is still lower. Around 22% of the population has been inoculated and the active cases have been on the decline. India has so far vaccinated around 340 million people of its population including 64 million people who have been vaccinated with both doses. Increasing vaccination and decreasing active cases will lead to faster restoration of economic activity and revival of growth.
In terms of sectoral approach, we believe that few sectors have been directly affected by the second wave, namely FMCG, Consumer durables, hospitality, tourism, Airlines, and other consumption related sectors that will face headwinds due to the economic lockdown. The supply chain across industries has got affected, with logistics and economic disruptions, and on top of this the psychological fear due to Covid will lead to underinvestment and under consumption on behalf of the consumers, and hence poorer growth and profitability for companies in those sectors.
The IT sector continues to show strong demand and momentum, driven by large deal wins and the thrust on digitization. We like the IT space as the strong demand environment and steady deal wins will ensure revenue visibility, while the availability of skilled manpower, wage inflation and high attrition may lead to pressure on the operating margins. The demand for Cybersecurity and Cloud services is also on the upswing.
Financials, Mortgage lenders and Insurance is another space that we like from an investment perspective for 12-18 months. Asset quality should remain stable for the sector. The other sector that we are bullish on is Capital Goods driven by the revival of the Capex cycle. We have seen an increase in prices of commodities- cement, metals, Energy, renewables and the utilization levels have been continuously on the rise. This should lead to increased capex, helped by the PLI incentives in other sectors like electronics, consumer durables & pharma.
I believe the retail demand will come with a vengeance, which will form the base for further investments and the investment cycle to revive. Another important dimension to look for is the deleveraging, of both corporate balance sheets as well as promoters. Lot of capital has also been freed from resolutions of large Assets under NCLT. Favorable government spending and global demand along with the PLI incentives might accelerate the Capex cycle and hence the preference for Capital goods stocks. The benefits of the structural reforms undertaken like GST, RERA, NCLT, PLI etc. are beginning to show in select pockets and overall, India story should do well going forward with some pause in the short term.
(Arun Malhotra is Founding Partner & Portfolio Manager, CapGrow Capital Advisors. Views expressed are the author’s own.)