Market Outlook & Investment Strategy – September 2019

‘Gloom & Doom’ or ‘Dawn after Dusk’?

Recently, I met one of my old friends in the social gathering and found him to be very worried about his existing MF investments & running SIPs. He started by asking – whether he should withdraw his entire MF investments and stop all the running SIP?

Although I was hearing him patiently, I felt the excitement within me. Certainly, it was not because of any jealousy but his behavior was an indicator that we are in the capitulation phase (panic!!) of the market cycle. As he represents the common investor community, this behavior corroborates our view that we are very close to the bottom of the market cycle.

I used the famous quote of Investment Guru Warren Buffett – “The stock market is a device for transferring money from the impatient to the patient.” I suggested him to remain patient as the current volatility might play out for some more time, as growth concerns globally continue to worry markets. However, looking at the historical data, you can always find that investments made during these times are very very rewarding.

Note: Investment is assumed to be made at the end of FY (March-end)
Source: NSE, MOSPI, DreamLadder Capital Research

Therefore, we should continue investing in a disciplined way in line with our risk appetite. In the current market scenario, staggered investments through SIP or STP along with some tactical lump-sum exposure to good funds from beaten-down mid-cap and small-cap categories might remain the best strategy to invest in equity as an asset class.

The US-China trade war continues to jolt global equities

Global equities ended in negative terrain during the month of August 2019 primarily on the back of US-China trade disputes and recession fear. In the UK, Brexit fear added to the overall pain. The trade war has impacted the global trade volumes and the Trump administration’s latest announcement to impose additional tariffs (10% on the remaining $300 bn of Imports) on China is likely to only exacerbate the weakness. On August 23, trade tension intensified further with China announcing an additional tariff on $75 bn of imported products from the US and re-imposing tariffs on auto and auto parts imported from the US from December 15.

Source: AMC Presentations, DreamLadder Capital Research

Global equity markets saw broad-based selling on the back of rising global worries – the MSCI Developed Markets fell 2.2% while the MSCI Emerging Markets Index fell 5.1%. Nonetheless, India outperformed its global peers by ending marginally negative (-0.4% MoM).

India’s GDP impacted by low-income growth, investment, & lower consumer confidence

The sharp deterioration in GDP growth (5%) during Q1FY20 (April-June), the lowest quarterly growth since March 2013 has come on the back of weaker consumer demand and slowing private investments. Private consumption spending at 3.1%, slumped to an 18-quarter low, from 7.2% in the previous quarter. Similarly, gross fixed capital formation (GFCF), a proxy for investment activity, grew only 4%, much lower than 11% witnessed during 2018.

We can see the rising share of consumption as a % of GDP during the past few years (Exhibit 2), where households might have continued to consume at a higher pace despite lower income growth. However, weakening consumer sentiments (Exhibit 3) and a sharp fall in the household saving rate has made households less confident about consuming.

Source: CMIE, KIE, AMC Presentations
Source: CMIE, KIE, AMC Presentations

Global bond yields continued to fall

There are several countries like Germany, Japan, Switzerland, Netherland & France, etc. having a negative 10-year government yield. German 10-year bund yield fell below the ECB’s deposit rate while Japan’s 10-year bond yield is trading well below its long term average, triggering fears of a future recession in these economies. Even the US yield curve witnessed an inversion after a decade, leading to recession fear. Its yield spreads have turned negative or flat (10Y – 3M: negative 50bps; 10Y – 2Y: Zero).

Source: AMC Presentations, DreamLadder Capital Research

As per the Morgan Staley report, out of $55 tn of total global debt outstanding (as on August 31, 2019), $16.8 tn is in negative yield zone. As a result, Emerging Market (EM) borrowers are loading up with record amounts of euro-denominated debt. There is ample liquidity conditions world over and any country which can deliver good economic growth and has a positive carry should be able to attract disproportionate capital.

Source: Bloomberg, AMC Presentations, DreamLadder Capital Research

Equity Market Performance

Divergence in returns for Nifty 50, Nifty Mid Cap and Nifty Small Cap indices has continued since the peak of Jan 2018. Large-cap represented by NIfty 50 has delivered +5.6% return since Jan-18, while the other two indices saw negative returns at -25.9% and -40.7%, respectively. On the sectoral front, cyclical sectors have continued to underperform during the previous 3 months, similar to their underperformance since Jan-18.

Indian equities have not shown any sign of recovery as tepid earnings season and weak macro data prints continued to dampen the spirits. The NIFTY, NSE Mid Cap and NSE Small Cap indices fell 0.9%, 1.7%, and 1.4%, respectively, during the month of August 2019. During the same period, IT index (+2.6%) outperformed the market due to tailwinds from a sharp depreciation of INR. While Consumer Durables (+4.8%; prolonged summer resulting in stronger demand for AC/Refrigerators) and Healthcare (+1.3%; aided by strong US sales) outperformed the market due to its defensive traits in a volatile environment, Metals witnessed a sharp decline due to the US-China Trade War.

Note: Data as on 30 August 2019
Source: Bloomberg, BSE, DreamLadder Capital Research

a) FIIs continued to sell for a second consecutive month

FIIs selling increased to $2.2 bn in August 2019 as compared to an outflow of $1.9 bn during July 2019, reducing the YTD inflows to $7.2 bn in CY19 (8 months). On the other hand, DIIs remained net buyers to the tune of $2.9 bn in August 2019 ($2.9 bn during July 19 as well) taking the YTD net inflows to $4.8 bn in CY19 (8 months). Domestic MFs were also the net buyers with net inflows of $5.8 bn YTD, while Insurance companies reduced the net outflows to $1 bn YDT with some buying during August month.

Source: Bloomberg, BSE, DreamLadder Capital Research

b) Normal Monsoon: Likely to be the best in the last 5 years

Cumulative rainfall (as on September 11, 2019) is about 3% ahead of its long-term average. Rainfall has significantly improved during the previous 2 months as the cumulative deficit was running at ~9% at the end of July and ~35% at the end of June. Out of the 36 subdivisions across India, rainfall so far has been normal in 16, excessive in 11, and deficient in 9 sub-divisions.

Source: IMD, CLSA, DreamLadder Capital Research

c) RBI’s dovish stance continues

RBI has cut the policy rate for the 4th consecutive time (cumulative 110bps) since Jan 2019. Moreover, their forecasted inflation at 3.6% for the next three quarters, has also below their comfort zone of 4%. Reported CPI came at 3.21% for the month of August 19 as compared to 3.15% during July 19, well below the 4% target of RBI. As a result, RBI has been maintaining its accommodating stance and liquidity in the system has improved over the past couple of months. RBI injected ~Rs.1.2 tn of permanent liquidity during Q1FY20 through FX intervention and OMO purchase.

Source: Bloomberg, KIE, DreamLadder Capital Research

d) Government policy measures to bolster growth

In the supportive macro environment (subdued oil price, normal monsoon and surplus liquidity), the government has announced a series of reform measures in the past few weeks aimed at reviving the economy. There is also an expectation of a likely stimulus package for housing and auto sectors along with the frontloading of infra spending to bolster economic growth. We expect these steps to start showing results in the next 6-12 months.

Valuations & Recommendation

The corporate earnings growth has been muted for the last 8 years largely on the back of poor performance of Corporate banks, Metals and Capital Goods sectors, etc. FY20 has not been any different so far. Street started with a 24% earnings growth estimate for FY20 and this expectation is down to 15-16% post-Q1FY20 result season.

Source: Bloomberg, NSE, Edelweiss, DreamLadder Capital Research

Nifty 50 is trading at 18.5x FY20E and 15.7x FY21E (consensus earnings) which are reasonable, especially given the low-interest rates. Despite the downgrade risk, earnings growth is likely to improve (consensus estimates for NIFTY 50 is at 18.7% CAGR during FY19-21E) and therefore, the P/E’s will move lower and would look more reasonable.

Source: Bloomberg, Kotak MF, DreamLadder Capital Research
Source: Bloomberg, MOSPI, DreamLadder Capital Research

How should you play it?

In view of the expected recovery in earnings as well as the comfort which we derive from reasonable India’s Market Cap/GDP ratio (Buffett Indicator), we recommend increasing allocation to equities, especially in multi-cap/large-cap funds in a phased manner. Investors with higher risk appetite and slightly longer horizon should also look at mid-cap/small-cap or thematic funds.

Source: ICICI Prudential MF
Source: Bloomberg, Kotak MF, DreamLadder Capital Research
Source: Bloomberg, Kotak MF, DreamLadder Capital Research
Source: Bloomberg, Elara Securities Ltd, DreamLadder Capital Research

NIFTY Mid-Caps & Small-Caps relative valuations vis-a-vis NIFTY 50 has corrected back to the lows of 2014. Even for NIFTY 50 which has given 5.6% return since Jan 2018, the top 15 stocks have delivered ~25% return while the other 35 stocks witnessed ~20% decline.

Unless you are very lucky to own those 15 stocks in your portfolio, your portfolio must be bleeding. Therefore, we recommend using the Mutual Fund route for taking exposure in equity, which is no doubt, remains the best asset class to own, from a risk-reward perspective.

Our two-cent advice…

Our two-cent advice would be “Never believe in buying equity/MF & forgetting”. This does not mean that you should not buy for long-term but your portfolio does require continuous review. You should also not let your emotions overpower your investment decisions.

Remember that returns from equities help create wealth over the long-term. So, it is always beneficial to stick to your investment strategy rather than chasing quick returns or stopping losses overnight. The volatility won’t matter much if you are taking advantage of ups and downs in the market by regularly investing through the SIP route.