Author : Aequitas
October the market breadth was very weak accompanied with low volumes across. FIIs finally turned positive on India within the last 15 days of October. This date holds special significance as this was the date given by the Bank of England to UK pension funds to finish unwinding their leveraged positions in UK Gilts. Once the UK pensions funds executed these transactions –
1. The investors globally heaved a collective sigh of relief, with Global Capital markets moving up meaningfully.
2. The Dollar index also moved down from a high of 113 to 109. This essentially means that Investors are not flocking towards US Dollar (The Ultimate safe asset class) and are willing to add Risk to their portfolios.
3. The Pound also appreciated by approx. 8% (Since Sept 27 till Oct end) to reach $1.15.
4. Indian markets too benefitted as FIIs invested approx. Rs 9200 crs in the last 15 days making their net investments in Oct in India at Rs 400 Cr.
Our Portfolio positioning remains the same as earlier –
• We have positioned our portfolio towards sectors which have seen a huge underinvestment over the past 10-12 years both domestically & globally and we believe that we are on the Cusp of a large Capex cycle where manufacturing, Material handling companies and infrastructure companies will come back very strongly.
• We remain overweight Auto, B2B manufacturing, Infrastructure and Capex oriented companies. With the Q2 results coming in, in Nov – we are looking forward to our portfolio companies showing some good results which we will share with you in the coming months newsletter.
Macros dividing markets / Central Banks more than social media
Till social media became popular – most of the world was not bi-polar but a majority had opinions which settled somewhere in the middle. The best example of this was Politics in any country – most of the citizens were OK discussing politics and politicians passionately but then going about their normal work and remaining friends. But after the advent of social media the fence sitters with respect to political opinions decreased significantly – so much so that the world today has a very large proportion of the population which straddles either to the left or the right. To add that this time the citizens are wedded to their biases much more strongly.
A similar trend was noticed after Elon Musk’s announcement of an $8 charge for the “blue tick” the opinions of Social media Influencers and consumers are also starkly divided – the biggest question however is–
Will it be the end of free lunch on Social Media? Will the influencers now have to pay money to keep their tribe together?
Something similar in playing out on the Global macroeconomic front – the world has never been more divided on the macro front – If one were to observe the data points that Fed is focusing upon – one were to believe that despite the rates hikes from 0.25% to 4.00% Inflationary pressures are very high due to –
• Unemployment – Unemployment in the U.S. is near its historic lows. A surging labor market means that for every job seeker there are 1.7 jobs.
• Higher Wages – This kind of job opening rate means that wages will continue an upward trajectory, increasing purchasing power of the citizens.
• Inflation – Despite the hike from 0.25% to 4% there is still no meaningful dip in the Inflation numbers. Already at a very uncomfortable 8.2% Increasing purchasing power means that inflation will be there for longer and stickier.
A lot of economists put this across as lagging indicators rather than leading indicators and expect that the Fed, in order to stay ahead of the curve, needs to take policy decisions looking at leading indicators rather than lagging ones.
And there are lot leading indicators point in exactly the opposite direction —
• Commodity prices – All commodities have cracked from their all-time highs. Except for energy and grain prices whether it is metals, or lumber – most have cracked significantly even on a YoY basis. Energy and grain are more a function of the Russia-Ukraine war rather than the excessive demand/crack in the supply chain/excessive printing of money.
• Inventory Glut – Across the world especially in the U.S. the best companies seem to have over ordered – Nike inventory up 44%, sales up only 3.5% and its inventory in transit is up 88%.
• Baltic Dry Index – Baltic dry index is a measure of all dry goods (finished as well as raw) across the world. It hit a peak of 5500 during COVID and now is back at 1350’s level – lower than where it was one year ago.
• Amazon – Which recently conducted its Second prime day YoY there is no increase. which means volumes have gone down and prices have gone up.
Fortunately, the above data points have not gone completely unnoticed. The above divergence in the leading and the lagging indicators has also caused a few Central Banks to start looking at things differently rather than just following the Fed in Aggressive Hiking. Eg. Bank of Canada has also started reducing the pace of Hikes by Hiking by 50 bps instead of the expected 75 bps.
However in all of this, the best part about the above is that when we look at India we are in an oasis of good news-
• We have Bank Balance sheets which are flush with Capital and are the strongest in a long time.
• We have a credit offtake which ~18% is at a 10 year high. So much so that Liquidity is now Net Negative / Neutral (Where all Western Nations are grappling with excessive Printing of money).
• We are after 11 years seeing a broad based Capex taking place in the Private sector.
• Whereas China is seeing its housing market collapse, we are seeing a resurgence in our housing market. A report by ANAROCK, a real estate consultant, suggests sales in top 7 cities are likely to exceed 3.6 lakh units in 2022 against 3.43 lakh units sold in 2014.
• Our GST collections are beating the most optimistic expectations and are on the way to Rs 17-18 Lac crs for FY 22-23.
• Our Direct Tax collections are up by 16% (due to the invoice matching) and are also on track to beat all previous estimates.
• Except for rural demand which is tepid, Demand across the board is strong.
• We have weathered the energy challenges pretty well despite the Crude prices.
• Energy challenges across Europe have increased the export basket of India in a very big way.
• COVID protocols and China + 1 have opened for India a lot of doors which were hitherto closed due to China’s predatory pricing.
The challenges that we see for India –
• We too have hiked our interest rates to tame Inflation. The Interest rate hikes should not dampen the animal spirits that we are seeing after a long time from the Private Sector.
• Our exports for FY 22-23 are targeted towards $500 Billion. Since all 3 large Blocks – The US, EU and China have their own respective challenges. Their demand could suffer. Global demand slowdown could pose a problem in us meeting our exports targets.
• Since India is a Current Account Deficit Nation, in order for the Indian Rupee to be stable we need an FPI inflow of approx. $100 Billion per annum. So far this year we have had a net outflow of $ 33 Billion (in the listed equity side) which the Indian Capital markets have absorbed very well. However, for INR stability we would need to have a buoyant FPI inflow which helps our CAD in check as well as keeps the Rupee stable.
Given the above we @ Aequitas are cautiously optimistic over the next couple of quarters and would be very keenly looking at earnings growth of the companies in our portfolio.
We told you so —
While we don’t intend to gloat over this but when we said last year in all our communications both through personal and public platforms that all the New age B2C businesses are very exciting and as businesses we like them a lot but we will not invest in them as they are highly overvalued,
A lot of investors came back to us and said that this is the new economy where there is a permanent shift in paradigm and that we don’t understand this enough as we are still using the same old value yardsticks to value the new age companies.
One year has gone by since their IPOs and post the Lock Ins the results are for all to see.
And it’s not only in India that we have seen stocks which were FADs that have corrected – we were also seeing the Big Tech getting valued to the moon in the US. In fact in a lot of our meetings internationally we voiced our opinion on the high valuations as a lot of investors had invested in NASDAQ . Where a lot of investors were seeing higher valuations as evidence that they will take over the global economy, we were seeing risks.
For our investors safety we focus on following 3 Risks –
• Valuation Risk – Risk of buying Stocks without Adequate margin of Safety. Nonadherence to this results in investing in FAD sectors. Stock prices perhaps is the only thing which is a screaming buy at higher valuations. Infact the dearer the valuation the more the stock screams a buy. More often than not, buying into FAD stocks leaves you behind with a lot of pain in your portfolios. Not giving into this temptation of buying into high valuation companies is a cornerstone of our investments. In fact a lot of times we look at Price/ Sales as a very important metric to separate the grain from the chaff.
• Earnings Risk – Most of times at higher valuations are accompanied by higher Earnings. The Risk of assuming that higher than normal earnings will continue forever also leaves investors with stocks which just don’t move and cause drag to the portfolio returns. More often than not, whenever earnings are higher than normal there is a “reversion towards mean” either due to a change in economic environment or increase in Competition. We @ Aequitas would like to ideally get into companies when they are coming out of their bottom cycle in terms of earnings, thus giving us a very long rope for making money from our investments.
• Balance Sheet Risk – A leveraged Balance sheet can work wonders by catapulting companies into higher trajectory in good times for companies but when the interest rate cycle changes and the interest costs start piling up the same Balance sheet starts getting weaker by the quarter. Cognisance of all of the above risks is a cornerstone of our Investment thesis and ensures that we do not make errors of commission.