We have been on the wrong side of FII selling, we have been on the wrong side of Paytm listing. Suddenly for a market where everybody thought nothing could go wrong, are we slipping a bit?
Yes, so to some extent that is how the markets work, don’t they? This is something that we wrote about in my report sometime in early September where the title was Overstretched. One of the things that we noticed was that the proprietary India bull bear index was flashing red. It was signalling a 98-99% bullish reading and we thought that there was time for perhaps the market to cool off and this was just when we were going into the Fed meeting.
In the quarter ended September, we had India outperform say the US by nearly 10% or more and now in this quarter to date, India has underperformed by roughly a similar number, a little less. We had a big last quarter euphoria which was more India specific, when globally, we were in a little bit of a growth scare. Various things were happening; commodities were coming off, primarily India led. So there has been some mean reversion to that. It is the way I would want to think about it more than anything else.
What could be the trigger for the market now — earnings, Budget or inflation?
The big moving part is, all the companies we talk to seem to be confident of a reasonably positive commentary on demand. However, our opinion is that this might be coloured by the fact that over the last two, three months — September, October, November — we have possibly seen some bunched up of demand in the sense of some revenge demand opening up as well as festive demand. How much of this is sustainable or not is really the big question.
The answer to that question is something we are likely to get around January or so when numbers beyond the festive season, moving into December- January numbers start coming in. The early part of the next year is when we start getting answers to that. It is the most important thing because we are then perhaps in what would be called a post Covid economy. If we are in a post Covid economy, how does that economy look like? What we should not be forgetting is this phenomenal more than 18-month long bull market starting from March 2020, came about from action being taken by central banks as well as governments which caused demand to sustain and we would have a pretty strong post Covid economy globally. Now that argument has so far not been tested because everything we saw was shrugged off by the market as a one-off, impacted by Covid, this wave, lockdown etc.
Unless we have a third wave, Covid stops being a pretext. If Covid stops being a pretext, we truly start being able to see how the post Covid economy looks like. The other thing to note is that even when we make comparisons to 2019, I would say September, October 2018 and say that data is so much top or down, we tend to forget that the last part of the second half of 2019 was a very weak period for the economy itself. Things only started picking up around January and February 2020.
The finance minister had done a big tax cut around September-October 2019 because the economy was relatively slow. That base also gives way. Once we get into December-January-February and these high frequency economic numbers as well as company numbers start mattering, that is really the big thing because that decides whether we continue with our EPS upgrade cycle or not. We have seen very limited downgrades over the last few quarters. That is a welcome change from almost given downgrades that we used to see after every quarterly results over the last 10 years.
So that has changed for good. It is more to do with the fact that the current valuations of the market are suggestive of very high expectations and those expectations will be tested during December-January-February.
The other thing which companies mentioned is that a lot of them have taken confidence from this demand and are thinking of or have raised prices post the festive demand or have been raising prices to pass on the inflation worries or the cost inflation that they have seen. Whether that demand was real and whether it will stick on even at higher prices will also get tested. So a lot is at stake because from December onwards, we can no more use the pretext of Covid. It is going to be a reality check which the market has not seen for the last 18 to 20 months.
Do you think we are in for more of a surprise, more of earnings beat rather than normalisation, which some think could be a sugar rush Covid phenomenon?
Vikash Kumar Jain: In a way you are trying to compare the economic picture with the stock markets. We need to be very careful when we do that. Firstly, maybe nothing disastrous is going to happen to the economy; however, when we are talking about that we need to take into account, one very big factor which is the key to stock price movement is expectation. How we are placed versus expectations is what will define how stock prices move.
A simple thing that I would like to bring to picture again is the fact that we might not see a significant slowdown of the economy or a recession that we were talking about but the pickup that the market is baking in, may be much slower than what is expected. If any disappointment happens at very elevated valuations, that could lead to exaggerated impacts on the other side and that is something that we need to take cognisance of.
A lot of time we see the stock markets correcting. For example, post the rally that we saw from 2009 to 2011, there was still a reasonable correction in the stock market and that was not really baked from any big recession that came in but simply because the expectations had rallied and there was a reality check which said that maybe things will not improve so fast so quickly.
That is a phenomenon that one needs to bear in mind. Of course, there are other factors as well. For example, how would equities look and compare to debt as yields start going up? That is something which we will have to see. So maybe the relative attractiveness of equities will be lesser and expectations could be found to have some reality check. Those are two things that we need to take cognisance of and the answer to that will determine the side that we take.
But we need to keep in mind that we are at very elevated expectations and we should not just close our eyes and say that yes we are in the early phases of an economic recovery, this should last longer. Historically, watching the economy and investing in stocks has not led to great results and that is something that we need to keep in mind because expectations are a very important part when it comes to investing in stocks.
What is the feedback you are getting from your foreign clients?
Coming back to the September report, as we mentioned, India was over stretched. This was not just on the sentiment, but if I were to look at other factors like momentum, valuation relative to Emerging Markets or Asia ex benchmarks, all were looking very stretched. The rally that we have seen in the dollar index over the last six-eight months from the lows is something which anyway makes emerging markets less attractive. Together with whatever was happening in China, it had made the emerging markets basket less attractive.
Now within that, if we find India very expensive, then that is another worry. What we have to think about is what was happening through July to September which really allowed our markets to do much better and it was more an India driven rally and anything big happening globally was a few things on which India was looking significantly better than other markets.
Also, unlike many of our Asia peers or EM peers, the Second Covid Wave had peaked sometime in early May. So, there was a continuous decline in Covid cases. There was a gradual re-opening which made us look much better on a relative basis. There was incremental regulatory concerns in China which made India again look much better. ALl these things along with the fact that the commentary from the perspective of the general perception of the Indian government also helped the markets. But a lot of that might be unravelling.
People are now asking questions whether valuations in China have become attractive enough and they are pricing in the risks that people are fearing. We have seen a trend of laggards doing well in the last quarter which has also impacted Indian markets. The other thing is that the vaccination as well as Covid situation wise, many of the other peers that we have are looking much better than how it was in the July-September quarter.
From a shorter term perspective, foreign clients are not really jumping to buy India at this juncture. But we must not forget that in the last six-seven years, there have been four-five years when Indian domestic investors have put in more money than foreigners. So if the FII selling just abates and domestic buying continues, that itself could be a reasonable point. But I have to concede that foreigners are not really queueing up to buy India like they were at the start of the year.
What is it that foreigners are buying? Laggards are paying catch up, autos have started becoming hot again maybe because of the EV play?
In the auto sector, we need to divide the space into sub-parts and each one of them have their own drivers in the way the market is perceiving them. For example, there is this two-wheeler bit where there is this worry around disruption which could pretty much sustain and that is where one needs to be a little bit more careful from a top-down perspective.
There is a four-wheeler segment where immediate disruption worries are a little lesser and there is the other bit where commodity prices could come off because of the kind of demand worries that we are seeing in China. That is the other tailwind that people are talking about. However, the overarching thing about autos that one has to keep in mind is we are still not 100% sure of how strong demand will be and how quickly the supply chain worries could get sorted out.
So those are certain factors that one needs to ponder but broadly we have to think about it from a top down perspective unless, of course, one is welcomed to take a bottom-up view. While the value might have started coming in some of the stocks, but the two-wheeler segment does not look like great players. A couple of very disruptive launches could happen which could keep the worries high over there. Within four wheelers, it is more about the demand but there are other segments like CVs, tractors, etc, where perhaps the metal prices coming off could have a slightly bigger positive impact as compared to the others and the demand concerns are lesser. That is the kind of space we like to be in. Of course, we do have a couple of bottom up picks in our portfolio for autos. They have been doing okay in this particular quarter.