The markets have done exceedingly well, beyond everybody's expectations in the last 18 months post the onset of the pandemic in March 2020
By Arun Malhotra
The markets have done exceedingly well, beyond everybody’s expectations in the last 18 months post the onset of the pandemic in March 2020. Covid 2nd wave was more dangerous, contagious, and more widespread and had affected all kinds of populations. The rapid pace of Vaccination and the “Break the Chain” rule – have led to signs of improvement. The Indian Government is hopeful that at the current rate of more than ten mln /day, it will be able to vaccinate all the adults by the end of March 2022 with at least one dose and by June 2022 with both doses. Meanwhile, two vaccines for Children are approved, and children can receive protection against any potential third wave. The current statistics and improved healthcare infrastructure point to a reduced probability of any third wave. India’s macro has changed from a linear V-shaped recovery in FY22 to a back-end story of 2nd half growth.
India’s onset of economic activity has inched closer to normal levels with most indicators like GST collections, Purchasing Managers Index (PMI) manufacturing and service, E-Way bills, and mobility indicators in positive territory. After disappointing in July and August, monsoon activity picked up in September, with rainfall deficit at 1% as of 30th Sept (end of the season), and overall sowing, closing the season with a minor deficiency of 0.4%. We believe that we are all set for a strong revival- with a vengeance. The revenge buying and shopping will lead to strong consumer demand in the coming months.
The Government is also doing its best to facilitate economic revival through reforms and structural measures that will go a long way in removing the impediments to long-term economic growth. The setting up of NARCL-IDRCL is structurally very positive for the banking sector. The GOI guarantee on security receipts provides immediate liquidity and puts the risk-weighted assets in a separate pool managed by the ARC.
This move will ensure that a lot of capital is available to the banks for growth as 15% of the realizable value will be immediately paid to the banks in cash. The Corporate lenders will be the biggest beneficiary, especially PSUs, SBI, BOB, Union Bank, etc. The private lenders will also benefit from this move. The recent electricity reforms set out by GOI have unleashed positivity in the entire sector. The GOI is talking of the Privatization of distribution of UTs to address the sub-optimal performance, particularly of state distribution companies, and take steps to reduce T&D losses and improve services to customers. The Govt. Spending is likely to accelerate, driven by buoyant, direct tax revenues. Indirect taxes, including GST Collections, show a healthy trend and may surpass the pre-GST levels soon.
The Credit Cycle is on the upswing as 2020-21 marks the end of a multi-year painful credit cycle where NPAs have shot up due to various credit crises led by ILFS, DHFL. Banks also have sufficient liquidity and surplus provisions to offset any Balance sheet concerns due to covid. The upcoming festive season should help improve the aggregate demand as discretionary spending will remain strong.
The markets had a decent run, and the valuations are not cheap. Still, the strong earnings growth driven by structural factors, strong liquidity unleashed by the ventral banks, and mid-market valuations based on normalized earnings will keep the momentum intact. We may see a minor correction, but the long-term trend is still upwards. The conflict between the ground situation and the market direction is causing uncertainty in the investors’ minds. The fast pace of vaccination and the “revenge buying” has strengthened the rate of economic activity back to pre-pandemic levels on the majority of the parameters.
As reflected in the number of registrations, the revival of the real estate sector will propel the economy into a higher orbit. This momentum in real estate has a multiplier impact on various sectors like cement, steel, labor, home finance, etc. The common theme across industries is that the big are getting more significant, and the small are getting smaller (challenged and wiped out). The past 3-4 yrs. have created wide gaps and accelerated the market shift from unorganized to organized players across industries.
The banking sector has been cleaned up, promoters and companies have deleveraged themselves and are now ready for a new capex cycle, structural reforms undertaken in the last few years will trigger economic revival, formalization of the economy has taken place, and a stable currency and a decisive political stable government auger well for the positive sentiment.
We still prefer banking (evergreen sector), IT (has strong tailwinds due to digitization), pharma (prefer domestic pharma companies) while Covid 2 will provide a one-off bump), and real estate. We remain cautious on commodities and chemicals where stock prices capture the next 2-3 years of solid fundamentals and leave little room for margin of safety.
In terms of risks from now on, it is more global. We have identified three risks that could play a spoilsport in the future. The China factor, the rising prices of commodities and energy leading to Inflation and the US macro. As usual, China continues to be opaque on its policy measures as well as internal economic data. While the Evergrande issue in China dominated headlines during the month, our global view maintains that the company is attempting to restructure and meet its obligations, while Chinese regulators remain focused on ring-fencing Evergrande, ensuring that there is no contagion impact on the local markets.
High commodity prices are a real threat to equities, along with disruptions in logistics, shipping, and the supply chain. This will delay the growth as well as impact margins. We believe this short-term disruption is being ignored by the market. The low-interest rates in the U.S, coupled with the loose monetary policy, including the bond tapering by the U.S Fed in the coming months, remains a risk to global equities. The tapering may also reduce the liquidity and may cause some outflows from the equities. We foresee a gradual shift in the U.S Fed stance and expect the monetary unwind to be slow and orderly besides the overall improving course of the global economy and corporate earnings that should mitigate the risk of any equity drawdowns.
We remain opportunistic and positive on equities going forward. The increase in “E” along with higher growth will bring some sanity to the equity valuations. Maybe the high returns witnessed in the past 15 months cannot be and should not be extrapolated. But, the number of deal transactions and higher aggregate demand across a few sectors provide an attractive opportunity. We believe we should remain invested in good quality companies across economic and business cycles unless we expect a significant drawdown followed by massive excesses created. We do not sense such a scenario currently and will remain invested in fundamentally sound quality companies.
(Arun Malhotra, Founder & CIO, CapGrow Capital Advisors LLP. Views expressed are the author’s own.)