Greetings Of The Festive Season ! Wishing You & Your Near Ones A Very Happy Diwali !
Slowdown, liquidity, jobs, automobiles, fiscal deficit – these 5 keywords have driven the narrative in first half of the financial year. Most of us were expecting a strong revival in the sentiments post a historic & stable political mandate in May 2019. But it turned out exactly the opposite.
The liquidity crunch which started with NBFC’s in Sept 2018, has spread to other parts of the economy. What started as a problem in one sector has become a ‘crisis of confidence’. Banks are unwilling to lend to corporates. Vendor’s are not willing to supply material without releasing old payments, and companies continue to seek extended credit. Investors, rating agencies are not willing to trust promoters with debt on their books.
Wait For Earnings Recovery Has Led To ‘The Quality Bubble’
Wait for earnings growth continues to frustrate investors. As we can see, the average PAT margins & profitability for most of the listed companies continue to struggle.
In such an environment, equity funds too have shifted their preference towards pockets where there is certainty of earnings & growth. The valuations don’t matter now. All that matters is ‘certainty’. This certainty is being termed as ‘quality.’ But we have seen the definition of quality also changes with time. As growth in other pockets bounces back, money will chase them as well. Todays ‘quality’ theme is over owned, over valued & growth continuation too is over estimated.
Connecting The Dots
However – if we take a close look at the regulatory environment, government response & adjustments in the economy, things are falling in place for a much wider economic recovery.
- Interest rates a are falling. The transmission is taking time, but it will eventually percolate as banks pass it on gradually.
- Capacity utilization across sectors are moving up towards 80%.
- Yes – there is a slowdown in infrastructure orders since election cycle & monsoon both have hit the economy during first half of the year. But that too shall recover as we move into the second half.
- Government has firmly set its target towards achieving 5 trillion $ economy, we will eventually get there. Some large scale announcements like corporate tax cuts, sovereign debt issue in foreign currency, bank recapitalization worth 70000 cr have been announced.
- The much awaited PSU bank consolidation, asset recycling / disinvestment programme of PSU’s has finally seen some action. In our view, disinvestment of BPCL, Concor, SCI is just the beginning. Markets will see far too many big ticket announcements as we move forward.
- Private sector is still struggling. Hence government will have to do lot of heavy lifting to kick start the investment cycle & go for aggressive spending programs. With lower fiscal deficit & further room to reduce interest rates, Modi government has far more firepower with them and can go really aggressive in the second half of the year.
The real benefit of corporate tax cuts lies in its ability to attract big ticket investments & healthier competition among states to have better regulatory environment. If GDP growth continues at 6-7%, we are likely to run out of capacities in core sectors very soon. Corporate tax cuts + sovereign bonds + aggressive disinvestment programme is likely to result in a roaring investment cycle. We are likely to see multibillion-dollar investments flowing into the economy, especially with 75% of the global sovereign debt yielding below 2%.
New Winners On The Horizon
All of this is likely to throw new winners in the Indian stock markets as earnings in manufacturing, cyclical commodities, natural resources / mining, PSU’s, corporate banks are set to recover. None of which are priced in the valuations today & these pockets continue to remain highly under owned.
We have adjusted our portfolio’s as per the realities of changing external environment & undervaluation at a stock specific level. We believe underpriced moderate growth stocks will deliver far superior returns than overvalued high growth stocks as we move into the year ahead. The strategy has not delivered a great outcome over the last 24 months. However, we are confident of superior performance as earnings in our investee companies are set to recover. Deep undervaluation gives us further comfort to keep on holding & ride through the painful periods like these.
Once again, wishing you a very happy Diwali from the entire alpha invesco team.
CIO – Alpha Invesco Research
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