Nikhil Vora
Stark contrast between India?s macros and equity market performance?Remembering Marilyn Monroe!
In the past 11 months, whenever the investor/analyst community has considered India from an investment point of view, the top points of discussion have been the lack of economic reforms, policy paralysis, stubborn high inflation rate, RBI unrelenting in lowering the interest rates, slowing private investment and the earnings growth of Corporate India compounded by wildly gyrating weak currency, widening twin deficits and the looming spectre of sovereign ratings downgrade?overall, a perfect cocktail for dampening the investor sentiment towards the Indian equity market.Marilyn Monroe?s famous quote ?If you can?t handle me at my worst, then you sure as hell, don?t deserve me at my best? perfectly fits the prevailing situation in India. And for those who did put up with the worst of India and did not lose faith, the rewards have been handsome. In just the past 11 months, the Sensex has returned a staggering 22% till date, amongst the highest returns in a calendar year over the past five years! Apparently, either analysts are overly pessimistic about ?textbook? headline indicators or investors are considering factors other than macros while investing in India or both! Overall the year?s performance has vindicated several of our beliefs.
India has been a ?bottom up? market Over the past one year, pessimism has increased exponentially, fuelled by the worsening economic environment. However, we tend to overlook that India has been a ?bottom up? market all along. A ?top down? approach can lead one to keep waiting for the ?rising tide that lifts all boats? and you never know when that elusive tide will come.Meanwhile, corporate India continues to recalibrate its strategies to the changing conditions. A case in point is that in the past period of rising interest rate regime, balance sheets of select Indian corporate have more or less not grown, which although has slowed earnings growth, in hindsight will appear prudent. Currently the cash-to-debt ratio of Indian companies is higher than in the previous downturn. As we go forward, with inflation and interest rates having nowhere to go but down, the salutary effect of reductions in both will cause earnings growth to return for corporate India. However, the timing of this elusive ?rising tide? remains uncertain.
Can India?s ?sins? be pardoned? ? Saath Khoon Maaf!
India?s macroeconomic and political scenario has progressively worsened over the past two years. For most part of this period, decision making by government remained paralysed, domestic currency has seen unprecedented fluctuations, the high inflation period has stretched the longest ever, which in turn has caused the RBI to hold on to its aggressive monetary policy stance. Not surprisingly, all these factors have culminated into a downtrend in corporate earnings. However, we believe the economic principle of ?diminishing marginal returns? holds true for negative news as well. We argue that India?s ?sins? may no longer warrant an incremental negative outlook. Investors have been fatigued with negative news flows. Consequently, even a marginal incremental positive can lead to improvement in sentiment, as was seen post the diesel price hike in September leading to a rise in FII inflows. Compared to the net outflow of $0.4 billion in CY11, India has witnessed FII inflows to the tune of $19billion in CY12!
Think of India as a stock
In our latest thematic strategy report, A stock called India, we put forth our view that though a country and a company appear to differ on several counts, we observe that global investors evaluate countries like they evaluate companies and stocks. Like a company goes through phases of high growth, stagnation and consolidation for higher growth, countries too follow a similar path of rapid economic growth followed by periods of decline. Currently, India appears to be in one such period of slowdown, caused by both global economic factors and slower domestic growth momentum. However, just like companies that take strong corrective action become favoured by investors, we believe India has also started taking appropriate steps to be back in the reckoning among global investors. Post Chidambaram being back as finance minister, several stagnant items on the government?s agenda have seen movement? from diesel price hike to progress on GST to GAAR being reviewed. Further, the FM has set the priorities straight ? controlling fiscal deficit without having to resort to additional borrowing?to be achieved by divestments, reducing non-plan expenditures and tightening plan expenditure. Consequently, FII inflows in the second half of the year have far exceeded those in the first half of the year. This validates our argument that just like a change in management can lead to rerating of a stock, a change in key government decision maker can lead to improved investor sentiment.
India remains a ?bottom up? market for 2013 as well
India?s macroeconomic factors such as inflation and interest rates will eventually improve, while the government?s pace of reforms will probably continue to fall short of expectations. Irrespective of both, we believe India will continue to remain a ?bottom up? market. Opportunities for above average returns will continue to be available for diligent investors that seek out fundamentally solid businesses that are rightly placed to benefit from evolving macro and socio ?economic scenario in India. While sectors having deeper trade linkages with global economy will continue to remain affected, those sectors based on India?s consumption story will benefit from favourable and evolving demographic scenario.
We expect the evolving economic scenario to reflect in the changing composition of the leading indices such as the Sensex. Our study of the Sensex composition since 1991 has revealed that weights of sectors peak out at 25-30% of Sensex. Further, certain sectors pass through ?cycles? in which their Sensex weights bottom out and peak out over a period of time. In the past five years, ?Financials? have dominated the Sensex with a current weight of 27%. We believe the Financial?s Sensex weight has ?peaked out? and will reduce, going forward. On the other hand, considering the strong structural consumption trend in spite of unfavourable economic environment,we believe the current weight of ?Consumer/Pharma? at 18% of Sensex will continue to increase . We believe a similar ?rotation? among sector leadership is already underway and will take the shape of more consumer stocks entering Sensex and other major indices.We maintain ?consumption? as a key theme to play out in 2013. Our best structural ideas are United Spirits, Jyothy Labs, Den Network and Financial Technologies.
The author is managing director, IDFC Securities
