Bounce, Not A Recovery

Time To Respond To Uncertain Economic Environment. Re-shuffle & Build A Defensive Portfolio.

Recent rally in the markets has surprised everyone. Speculation is ripe & there are clear signs of bubble building up in certain pockets of the market. Especially the most fancied names on the street. 

Apart from the optimism surrounding corona virus vaccines & reducing death rates, present bullishness amongst investors is based on two major assumptions – 

  1. Business will get back to normal within 12 months as we start unlock down process & jobs will be restored to levels that we saw in January 2020. 
  2. Incomes will be restored & consumers will have the money to spend.

These are extremely dangerous assumptions. In our view it is better to be cautious & use present rally as an opportunity to change the face of the portfolios. 

  • The economy is in a tailspin & recovery may be slower than expected. 
  • Markets are factoring in the most optimistic scenario. Promoters are cancelling deals, raising funds – but investors are more bullish than the promoters. 
  • Present bounce is an opportunity to create some cash & have a buffer.
  • Get out from stocks where the old business model has been destroyed due to Covid – 19, these businesses will take few years to recover & get back to the levels of January 2020. Avoid discretionary / high end consumption plays.
  • Look for stocks that have the balance sheet to survive present downturn. Businesses that are offering steady state earnings & will come back faster once the recovery starts. Look for businesses that are dealing with essentials & productivity.

Road To Recovery Is Going To Be Bumpy & A Long One

During the initial days of Coronavirus, i.e. March 2020, we held a view that it is going to be a temporary setback & lock down is a temporary phenomenon. 

However – as the lockdown got extended, and economic activity yet to reach its earlier peaks, the damage may be bigger than most of us are expecting.

There are 3 scenario’s that are arising because of the present situation. 

1] Optimistic Scenario

Economy will get back on track & we will get back to normalcy within next 12 months. India will come out present scenario with minimum damage. 

2] Realistic Scenario

Indian economy will have to bear huge economic costs, but we will get back on track in 2 to 3 years. In this scenario there will be huge uncertainty over who is going to pay these costs ? Private sector & households, government or the financial system ?

3] Worst Case Scenario

The virus is here to stay for next few years without any vaccine coming in, India goes back by several years as per capita incomes take a huge hit & unemployment shoots up. And there could be a long delay in recovery, which could take as long as 5 years.

In our view, the markets are factoring in the most optimistic scenario at this point. The scenario is worrying & the real pain will come out post second quarter of the current financial year. This downturn is quite different from what we have witnessed in the past. 

Usually incomes drop later as the downturn gets deeper. However present downturn has started with an income drop. Not just in India, but globally. We are in a tailspin where –

Income have dropped >> Leads to less spending & demand destruction >> Leads to production cuts & further job cuts >> Leads to further drop in income, job losses & demand destruction. 

In our view the news flow on the economy has not bottomed out. It will get even more negative a we move into Q2. Real pain in the financial system will come out once the moratorium period is over.

Corporates Are Conservative, But Investors Are Bullish

Companies typically spend in line with their revenues and profits, so lower revenues and profits will flow through to spending cuts. Companies will remain conservative for next 1 year at least. Which means, no capex & no new jobs for time being.

The conservative stance of corporates is visible. Reliance Industries has raised almost 20 billion US $ , all major private banks i.e. ICICI / Axis / Kotak / HDFC are planning to raise more money. JSW Energy has cancelled their proposed deal to acquire power assets from GMR Infra. Adani has cancelled the proposed acquisition of Snowman logistics. All these are signs of extra caution & things that are about to hit the economy. 

Despite this, investors have become more bullish. In fact, more bullish than the promoters. There is just too much speculation going on in the markets. 

On top of corporate pain – we may witness huge negative wealth effect as real estate prices across urban centers take a hit. Even the households which were leading the high end consumption as their wealth soared in the last decade are going to remain conservative on their high end spending.

What To Do Now

Uncertainty is at its highest in history. No one has seen a challenge of this proportion in their lifetimes. Yet, as investors, we have to take decisions. Since investing is all about responding to changes & benefitting from future developments. 

For now we plan to do 3 things – 

  1. Get rid of the stocks where business models have witnessed a huge disruption. Create cash & have some buffer. 
  2. Only safeguard against this uncertainty is a combination of bulletproof balance sheets, stable businesses & low valuations. So look for such businesses. 
  3. Avoid consumption & discretionary businesses. Bet on businesses that are on the productivity side. Liquidity & government support is going to flow into productivity & not into consumption.

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