The CNX 500 has delivered a respectable 11.3% in operating profit growth, and an equally respectable 10.2% in sales growth. With normal operating leverage one would expect at least 12% earnings growth
By Sunil Sharma
The destruction of sentiment appears to be fairly complete. In each of the slowdowns in 2018, 2016, 2015, there was an underlying hope, a prevailing sense and expectation, that things would get better. Hope has been replaced by consensus pessimism, disappointment and despair.
The CNX 500 has delivered a respectable 11.3% in operating profit growth, and an equally respectable 10.2% in sales growth. With normal operating leverage one would expect at least 12% earnings growth. A high cost structure, and lack of easy availability of credit is killing the bottom line. High taxes are further impeding profitability.
Domestically, too, the playbook for the bulls has narrowed to monetary policy.
One would hope for a minimum 50 basis points (bps) cut or alternative relief via policy measures to support the market. The central bank must address the issue that borrowing rates are too high in India and must be reduced. With borrowing rates averaging 9-14% the past few years, interest rates are just too high. In order for profits to recover, rates need to come down.
The more important question today revolves around forward strategy. The broader market is in a bear phase. Small and mid cap companies have been pummelled for 18 months, but we would still be unable to say that valuations appear compelling. Our bottom up computation puts the larger CNX 500 valuation at 25.6 times trailing earnings. Forward earnings will need to be ratcheted down yet again in the fourth quarter.
Given our view of the macro risks, we believe adding exposure or shifting to defensive strategies—long short strategies, income strategies, capital protected strategies—makes sense in the current environment. At some point, in coming days / weeks, our next signal will be a buy signal on equities. Alongside, we would also like to witness a philosophical shift to pro-growth, pro investment policies at the finance ministry to gain further comfort.
Continue to prefer large caps
From a cap perspective, mid and small continue to get hammered. We remain comfortable with quality large caps. The biggest mistake investors make at these times is to shed quality companies.
Investment behaviour is likely to be far more critical than investment performance in coming days. This is an important time to review asset allocation, ensure alignment with risk appetite, and build a portfolio of non-correlated investment streams that position portfolios for multiple outcomes.
Outlook: Fixed income
In line with our macro views, our key preferences remain high quality AAA bonds, absolute yield strategies, with diversified exposure to low to moderate duration and yield compression. The clamour is also rising for the RBI to cut rates, so duration is likely to continue to perform. In a world with $14 trillion in negative yielding bonds, a top ten economy with a stable currency, low inflation and stable fiscal situation can see a further decline in rates.
Beyond the AAA highest quality paper, it is clear that there is a funding and liquidity crunch, and it remains fairly challenging to get access to capital. Should the slowdown accelerate, lower quality corporate bonds have risk to the downside, and we would avoid lower rated credit duration exposure. Conservative investors should stick to the short end of the curve and play for absolute high quality yield.
(The writer is chief investment officer, Sanctum Wealth Management. Edited extracts from Investment Strategy report)