Oct 29, 2019
“If past history was all that is needed to play the game of money, the richest people would be librarians.” – Warren Buffett
The Age of Abundance
The age of abundance is over in the U.S. So says Youngme Moon, author, Sr assoc. Dean, Harvard Business.
With respect to India, we think the age of abundance continues to gain steady momentum. Urban consumers are actively seeking better quality of life choices. Luxury cars, high end mobiles, uber vacations, luxury residences and bucket list experiences are the vanities of the urban middle class and elite. We suspect the non-agri rural population and off-grid services workforce harbour desires as well, directed at clothes, smart phones, scooters, motorcycles, refrigerators and air conditioners and the like.
This divergence in attitudes between nations provides a telescopic vision of what the future holds for emerging economies such as India.
The Market’s Message
As Mr. Buffett has noted, a knowledge of past history is not all that is needed to succeed in the markets. If that were true, accountants and librarians would be the richest people on earth. Today, the market stands a scant 3.5% from all-time highs, despite global gloom, doom and fear. The market’s message, as we read it, is this: The business cycle in India is at a bottom, and we trust this regime to deliver attractive returns in equities, implement investor friendly policies, cleanse the rot in the system, uplift the poor along the way, maintain relative fiscal integrity in a world that has all but abandoned it, and do what it takes to deliver growth for the economy. Within that, one major reform, the corporate tax cut, is already paying meaningful dividends to shareholders and is a key reason for the rally higher.
Earnings Reports Off to a Promising Start Despite Tough Conditions Last Quarter
With 143 companies reported, market participants are are enthused with earnings reports to date. Granted, sales have decelerated to 7.0% yoy in the current quarter, at least an 8 quarter low. However, operating profits have remained remarkably consistent in the mid-teens, and interest costs are trending lower, as the benefits of lower rate structures start to show through in company financials.
Net Profits are Up 16.1% YoY for the Nifty 50 Quarter to Date, 14.9% YoY for the Broader Market….
Operating profits – core measures of business viability – are up 14.3% for the broader market. Net profits are up 14.9% for the broader market and 16.1% for the Nifty 50. Operating and net margins are healthy, 23.8% and 10.0% respectively for the broader market.
Despite Sales Deceleration, Tax Benefits Are Adding Meaningfully to Net Profits…
Companies are Finally Enjoying Operating Leverage…
…Sectorally, Financials and Staples Continue to Dominate the Index
The Corporate Tax Cut Is Leading to Meaningful Profit Acceleration
Interest costs have come down, and are likely to continue doing so in coming quarters as companies pare down debt. The highlight, however, is taxes paid, which have declined -3.4% year over year this quarter to date. Profitable companies stand to gain, as these companies can pay down debt, strengthen balance sheets, reduce interest expense or re-negotiate loans at attractive terms.
Financials Continue to Lead Markets
Sectorally, Financials continue to deliver consistent top line, operating and net profit performance. Most sectors – with the exception of autos – are delivering positive earnings growth. It’s been a while since healthy fundamental earnings growth has come through at the index level, without adjustments.
Large Caps Continue to Deliver Steady Bottom Line Performance…
Large Caps Continue to Dominate in Price Action as Well…
Nifty 50 EPS Revisions and NTM Earnings Est. Have Spiked Higher Post Earnings Announcements
…While Mid Cap EPS Revisions and Earnings Show No Sign of Resurgence
The Large to Mid Trailing P/E Has Swung to Neutral…
…But Historical Bottoms Have Occurred at Significant Discounts
We Continue to Favor Large Caps and Remain Watchful on Market Action on Mid Caps
As a result of strong earnings announcements by a host of large caps, Nifty 50 EPS revisions, and next 12 month earnings, have bounced higher in the last week. No such upgrade is evident for mid caps. As we stated in September, our asset pair model was warming up to mid caps, but we recommended conservatism in any tilt, staggering allocations over time, and stated that it is normally prudent to follow the market, not lead it. (Black Gold Rises, Sep 16, 2019). That remains our base case.
On price action, mid caps continue to underperform large caps, across all time frames over the past 5 years. Small caps have delivered an impressive showing on net profits to date this quarter, but two-thirds of the increase is attributed to only 3 names – Indian Bank, PNB Housing Finance, and Bank of Maharashtra.
Outlook
Equities
Bullish Rewards Year to Date
Since late last year, we have maintained a positive bias on equities (Reversals in Crude, Midterms & Earnings, Nov 12, 2018, Looking Ahead in 2019, Jan 7 2019), and bonds (Back to the Future, Apr 1, 2019). If our managed portfolios are one representation of our strategy, up 14.7% (multi-cap) and 19.0% YTD (large cap), the call has paid off with two months left to go this calendar year.
The Economic Data Has Taken a Turn for the Worse
We remain watchful of global and domestic economic data. Over August and September, the economic data has taken a decided turn for the worse, both domestically and globally. However, our views on the market are forward looking by design.
Financialization Trends Remain Strong
One strong trend that remains a key reason markets have held up this year is financialization. The mutual fund industry is adding on average 7-8 lakh folios every month. That’s a large, persistent flow of new capital entering the markets. The financialization trend is strong, undeterred by market volatility.
Quality is Working, But…
On the flip side, while quality growth has rewarded investors handsomely, the notion that quality growth companies are buys at price earnings multiples of 70-100 times is a notion we’re entirely uncomfortable with.
Time will tell if we are in a new era on valuation. For now, the market remains comfortable with high valuations, and so are we.
Outlook – Improving Earnings and a Meaningful Tax Cut
While it’s still early days, earnings have provided a measure of optimism and an improved valuation floor. The corporate tax cut has been a clear offset to rising interest costs. Many companies caught in the shackles of excessive interest expenses and leverage have received a lifeline of sorts.
A consumer tax boost would be a welcome next step, as the consumer spending catalyst is critical and at this point a flicker rather than flame. Despite the gap, we continue to choose to be aligned with the market’s message, despite continued negativity around credit markets and real estate.
The cycle in India, remains buffeted by the Nirmala Sitharaman put, RBI’s rate cuts, financialization, a pro-growth agenda and now it would appear, earnings. As Jamie Dimon pointed out recently, 5-6% growth is “pretty good”.
Fixed Income
Corporate Strategy, Accomodative Policy, Contained Inflation, Sluggish Growth
Corporates will look to actively pare down debt in the short term, and this should be a positive for spread compression. Alongside an accommodative RBI, fiscally prudent Finance Ministry, and globally accommodative rate actions, we look for interest rates to steady at these levels with a minor bias towards lower rates. Our bond portfolio positioning remains unchanged, favouring corporate and PSU bond funds and short duration.
Technical Strategy
It was a week of consolidation for the market after the up move from recent swing low of 11,090 to 11,714. The Nifty largely trade sideways to negative and closed at 11,583 down by 0.67% for the week. Broader market indices BSE Midcap lost 0.5% while Smallcap saw a gain of 0.2% on weekly basis. Nifty is facing resistance at 11,700 levels where previous swing highs are seen. Thus, it needs to cross above 11,700 levels on sustainable basis for market to rally towards 12,000-12,100 zone. Immediate support on downside is seen at 11,450-11,400. However, on the downside 11,100-11,060 is the critical support zone for the market now. In Nifty October monthly expiry options, maximum open interest for Put is seen at strike price 11,000 followed by 11,500; while for Call maximum open interest is seen at 12,000 followed by 11,700. Nifty Put-Call option distribution data is suggesting is support at 11,400 levels and resistance at 11,800 levels. India VIX declined by 3.86% to close at 15.32 level for the day. VIX moved below 16 levels and sustaining below it will be positive for the market. However moving above 18, could lead to profit booking in market.
