Nov 3, 2020
The much-needed festive cheer, in this difficult year, is upon us and India bent the Covid19 curve, as well as corporate India is delivering better than expected earnings for the past quarter. However, parts of the world continue to grapple with the pandemic and its consequences. Europe’s second wave figures far exceed the first wave daily cases. Contrary to expectations of light-touch policy, swathes of Europe are going back into lockdown fearing an overwhelmed healthcare system in coming weeks. Interestingly, Bloomberg reported that a YouGov poll showed that almost three-quarters of the British population supported the partial lockdown being imposed in Britain. All the same, lockdowns will elongate the path of recovery as seen in the August GDP growth numbers of UK where the actual number came in at 2.1% vs an expected 4.6%. Even the German GfK institute consumer sentiment index fell to -3.1 heading into November from a revised -1.7 in the previous month.
China continued to expand in Q3 CY2020 although at a pace slower than expectations (4.9% vs 5.5%). As per IMF, China is the only economy in the world to show positive GDP growth of 1.9% in 2020. The US economy also rebounded sharply in Q3 CY2020 making the H1 CY2020 collapse possibly the shortest recession in its history.
Daily New Confirmed Covid19 Cases Per Million
As Europe renewed virus-related lockdowns amid a rise in Covid19 cases, global equity markets reacted negatively. Developed equity markets saw sharper correction compared to emerging markets as they closed in losses in the last month.
US Elections 2020 – The India Context
As we write this piece, over 91.5 million Americans (43% of registered voters) have already cast their votes to elect their next President. While Joe Biden is leading in the national polls, the race is a tighter one in the battleground states. There are enough swing states where Trump is ahead or within the margin of error of the polls and hence these states are crucial in a tight race. While the world waits for November 03, 2020 – the election day, the final results may be delayed beyond as states receive a record number of mail-in ballots.
In the Indian context, over the last three decades, the US-India relationship has improved under both Democratic and Republican Presidencies. The US is India’s largest trading partner and India is among the US’ top 10 trading partners. Despite the “Namaste Trump” and “Howdy Modi” campaigns, India lost its Generalised System of Preferences (GSP) status during the Trump administration and is no longer getting the advantages of being a developing country as far as the US is concerned. However, the trade tensions with China has created potential for India. Should the Democrats win the election, their stand on China may be softer but that wouldn’t alter the pandemic triggered change in supply chain diversification related policies of global companies. Further, a Biden administration maybe more accommodative in on the H1B visa issues, which could be positive for Indian IT companies.
Generally speaking, a Biden victory is expected to bring more predictability in international trade relationships, greater confidence in economic recovery and generally a more risk-on for equities. We hasten to add that the risk-on for equities may be dominated more by pandemic/vaccine news in the immediate term, post the election outcome. A delayed or contested result in the interim is likely to cause higher volatility.
India: On The Path To Recovery
The economic recovery in India is encouraging. After a tepid August, high-frequency indicators appear to be gathering momentum. Daily e-way bills generation for the last week of October was highest since the pandemic broke out. Power consumption, FASTag traffic volumes all indicate normalization in activity. GST collections for the month of October (up 10% YoY) were highest since February 2020. PMI data too showed strongest growth output in 13 years rising to 58.9 in October from 56.8 in September. Auto volumes are not lagging behind with strong demand in the ongoing festive season. Most of the auto players reported double digit volume growth and many of them have recorded highest ever monthly sales in the month of October. While, people may still not visit restaurants very frequently or go out for watching movies in multiplexes, all other on ground activities have returned to normalcy. All the high frequency indicators clearly suggest a V shaped recovery in the Indian economy as the lockdown restrictions got lifted.
Auto Sales Have Seen A Sharp Recovery
PMI Has Also Rebounded Sharply
Quarterly Results – Optimism Is In The Air
We have maintained through our previous notes, that this earnings season would be important to watch. July-September 2020 is the first quarter since the pandemic broke out that most of the businesses were operational for the full period. Expectations were of subdued topline growth except in case of IT & Pharma. However, the actual earnings data shows better than anticipated growth in domestic sectors. Despite Covid impact in Q2, most companies reported mid-single digit to low double-digit growth. Moreover, the management commentaries have been optimistic on growth in the second half of the fiscal, boosting investor sentiments. A common narrative across companies has been a resilient demand from rural India and encouraging signs of recovery in urban India.
In addition to revenue growth, we have also seen a sharp margin expansion as a result of strict cost control measures. Earlier in Q1 as lockdowns were imposed, most companies undertook various cost-cutting measures, the benefits of which flowed to Q2, resulting in margin expansion. While, many of the costs (such as marketing, travel) will have to be incurred as businesses achieve normalcy, some cost savings are permanent in nature and will therefore aid margins to that extent. In this quarter, it is more apt to compare PBT numbers as against PAT as a lower tax rate introduced in September 2019 had led to a reversal of tax expense in base quarter (i.e. Q2FY20).
While more than half the companies are yet to report their results, sentiment is certainly positive. All eyes are on sustainability of current positive demand trends and the margins in coming quarters. Nifty EPS has already witnessed some upward revision in last fortnight and further upgrades cannot be ruled out.
Both, Nifty and NSE500 reported positive revenue growth
Portfolio Strategy Commentary And Actions
We have been cautious on equity markets since the time pandemic started which was also reflected in defensive construction of both our portfolios – Sanctum Indian Olympians and Sanctum Indian Titans. However, as we see the reduction in total cases in India and revival of the economy on the ground, we believe adding pro-cyclical stocks could potentially generate alpha in the coming months. While, we have refrained from stacking up high beta stocks, we have added some cyclicality to our portfolios. Even as we tweak portfolios, our focus on high quality stocks remains unwavering. Most of the businesses we own are market leaders with lean balance sheet run by superior quality management and are likely to be “last man standing” if the cycle was to turn adverse.
In Sanctum Indian Olympians, we are almost fully invested now. The latest addition to the portfolio being MRF tyres. MRF is the largest tyre manufacturer in India with presence across segments (CV, PV, 2W, ancillary) and strong market share in high margin replacement segment. We believe, MRF will be a key beneficiary of ban imposed on imported tyres as well as revival in tyre demand (especially replacement segment). The company generates healthy return ratios and has a debt free balance sheet. In Sanctum Indian Titans too, we have added some cyclical ideas such as ICICI Bank, Kansai Nerolac and Nocil over the couple of months. However, we are also cognizant of the event risk the US election poses and hence as a precautionary measure have opted to partially hedge our portfolio.
Sanctum Smart Solutions, our momentum-based portfolio is also hedged about 35% to protect portfolios in case of uncertainty. We had hedged in October as well, but the markets rallied in the initial days of the month before turning volatile thereby costing us some performance. Banking sector was the top gainer last month and the biggest contributor in the portfolio, helping shore up the performance. Asian Paints was also a standout performer in the portfolio. Though IT witnessed profit booking in last two weeks, Infosys and TCS were positive contributors. Our exposure to Pharma and Reliance, which witnessed profit booking, detracted performance in the portfolio. We have also cut exposure to mid and small cap from 34% to 19% as they have lagged benchmark indices.
Technical Commentary
Surge in late September-early October saw the Nifty hitting highs of 12,025 and then plateau out. For the last 3 weeks Nifty has been sideways to negative awaiting clarity on the US election before giving a decisive move. For the rally to continue towards 12,450 and then 12,765 levels, 12,000 needs to be decisively taken out. However, currently Nifty is below 21-day exponential moving average and if sustained below 11,650 levels, the index is likely to remain under pressure leading to decline towards 11,300-11,250 levels. Below these levels, the next support is seen at 10,780-10,700 (September low as well as the 200-day moving average). India VIX after stabilizing in the region of 24-19 levels over last couple of months could rise in absence of clear winner of US elections.
Midcap and Smallcap indices have been consolidating gains for last couple of months after reaching key resistance levels. Smallcap index has been holding above 13,900 levels with upside facing resistance at 15,450 levels, thus rangebound between 13,900 and 15,450 levels. Breaking either side could lead the index to 12,835-12,780 levels and 17,100 levels on the lower and higher side respectively. Midcap index has resistance at 15,380 which needs to be crossed for rally to extend towards 17,000 levels. On the downside a move below 13,900 can lead to a decline towards 12,950.
Fixed Income
The RBI continued to adopt unconventional measures to ensure pressure on yields is eased. After ensuring the centre won’t borrow more than the stated amounts in the revised calendar released in June 2020, the SDL (state development loans) sold off sharply as the markets assumed that states would borrow more if not the centre. In response, the RBI announced OMO in SDL for the first time ever. SDLs recouped losses.
The MPC minutes released earlier last month turned out to be more dovish than the policy release suggested triggering sharp G-sec rally. However, as inflation remains sticky, we don’t expect any rate cuts at least until March.
Conclusion:
As mentioned above, in case of delayed or contested US election result, markets could turn volatile. Hedging cost generally escalate immediately preceding such events and therefore may not be very effective now. However, irrespective of the party in power, a new stimulus package is expected in the US and that could give the rally some more steam. If Indian economic recovery and corporate earnings growth continues to hold up, we could be beneficiaries of higher FPI flows sustaining the rally longer. For now, we continue to be neutral on equities.