Dear Carnelian Family,
Wishing you and your loved ones a very happy & prosperous 2020.
What lies ahead
Let’s start with some flash back of events before moving to expectations from 2020.
Good Bye 2019!!!
2019 has been one of the toughest years for most people in their investing careers. It has been good for some and tough for many. We are sure most of us have been thanking that it’s over and look forward to the New Year with optimism.
Year gone by witnessed major events in India:
- After effects of NBFC crisis – a Lehman like scenario post IL&FS which led to many NBFCs, HFCs, Banks and corporate houses coming under serious stress
- Some of the large stressed Balance Sheets having contagious effect on the economy
- Negative developments like auto/real estate sales slump, real estate NPA issues, Telecom sector hue and cry, etc.
- Both direct and indirect tax collections have fallen leaving little room for fiscal stimulus
- US China Trade war has further added woes to the economy grappling with liquidity stress
- GDP growth rate at 6 year low
All this resulted into a constrained supply of credit which is oxygen for any economy and its growth, leading to loss of business and loss of jobs. This was probably the first time, investors incurred significant losses in the debt markets and mutual funds, which created wide spread panic and loss of trust. NBFCs were shrinking balance sheets, private banks became risk averse. Real GDP growth in Q2 plummeted to 4.5% (6 years low), also aggregate credit growth in Q2 down to 6% (lowest since FY 97).
Low inflation rate (WPI is almost zero) has further impacted nominal GDP growth rate (6 % for Q2 FY 20). With Inflation other than food under control, interest rates are coming down, however overall risk averseness has restricted supply of liquidity only to the stronger balance sheets despite of system being flushed with ample liquidity and decade low interest rates.
· - SIP inflows have been consistent all throughout (Investors have not participated in the fear psychology)
- General elections won by Shri. Narendra Modi led NDA, setting the tone for continuity of macro-economic policy actions initiated in the last 5 years
- Record FPI inflows - FPI inflows into India at approx. 1 trillion are highest in the last 6 years.
· Government’s proactive response: One thing which was constant during later part of 2019 was government and RBI’s prompt intent and action through various structural measures like:
- Corporate tax rate cuts - One of the lowest tax rates in the EM/APAC
- Rate cuts by RBI on a continuous basis
- Real Estate fund for last mile funding for stuck projects (A permanent solution to inherent ALM mismatch)
- Bank recapitalisation
- Partial guarantee scheme by government for NBFCs.
- Release of RBI surplus to government.
- Successful execution of bankruptcy code leading to resolution of big ticket IBC cases like Essar Steel, Bhushan Steel etc.
- Announcement of mega spending of about Rs.102 trillion in infrastructure projects over next 5 years
· On Global front - Positive developments in US-China trade negotiations with an agreement on a limited Phase-1 deal, better prospects of an orderly Brexit etc.
In light of above positive developments, we step into the new year.
Going ahead, the following developments are very important to assess the market.
· Fed, ECB, PBOC and RBI all pumping record liquidity
Fed, which was in a tightening mode since 2013 has changed its stance. In the last 5-6 years when the Fed was either increasing rates or downsizing its balance sheet, it resulted in dollar strengthening. Since, early 2019 it paused rate hikes, and in mid- 2019, Fed started reversing its stance on tightening coupled with rate cuts, likely to result in dollar weakening. As per Edelweiss report Fed BS is likely reach 2017 peak by June 2020
· Other central banks have also started following footsteps of Fed
65-70% of central banks have been in easing mode over the past six months including European Central Bank (ECB), People’s Bank of China (PBOC) and many others.
· Local liquidity with RBI and System has been very strong
Note: % YOY represents growth in RBI purchases of Gsec and USD to infuse liquidity into the system
Most parameters whether it is demand or growth have hit its low. One of the pre - conditions of opening up of risk appetite is ample liquidity. Once liquidity is available, it gradually finds its way into risk. That’s what has started happening although in a very slow manner through measures such as the Real Estate fund, credit guarantee to NBFCs - to direct liquidity to users of capital.
Like the credit freeze impacted growth and economy in every possible aspect, credit opening up will also slowly improve growth and the economic outlook, over a period of time. Further we are also seeing early green shoots like GST numbers slowly and steadily improving from the lows of September-October and good passenger sales vehicle numbers for the month of December.
The way to think about this is – imagine a pond in a farm with ample water supply to refill/circulate regularly. All the fish are living and growing happily. One fine day, shockingly enough, there is sudden breakage in the water supply and uncertainty looms over whether and if, it can get repaired and time of repair. This unexpected development leads to fish scrambling for water/survival. The farmer also holds on to the little reserve he has, as he is equally perplexed about the situation and what lies ahead just like everybody else. Death of the weaklings begins while the stronger/bigger ones are still trying to cope up with the situation. There is complete panic, fear and death like graveness in the pond. Hope seems feeble with the bigger ones too beginning to get impacted. Then suddenly some water drops comes, but the fish are not happy as they survival is unsure. Then some more water trickles in which improves the situation a bit but still far less than that’s required. Now think about this pond as the economy and water as money. We too had a shock and squeeze. Things are likely to get better as the supply of money comes in. Most sick players will die, some weaker players may survive and stronger ones will come out well. As the money flows, economy and business will grow and get back to happy days.
We believe that the banking sector in India will see sustainable credit growth with unprecedented lower credit cost in the future due to structural changes like bankruptcy code. For the first time we are seeing genuine borrowers more cautious than lenders.
Considering the overall risk aversion; globally 34% of sovereign bonds are with negative yields, domestically 95% of market cap being represented by A group stocks (highest ever), we believe that liquidity will soon start chasing returns and growth instead of safety-net. This is likely to reduce valuation gap between large caps and good quality mid-caps. Many of our magic basket stocks come from this hypothesis.
Considering the entire above backdrop, we remain very optimistic for Emerging Markets in general and India in particular. Though we must reiterate that while macro views are important, we will continue to hunt for bottom up opportunities within our overall risk-reward framework and enter 2020 with an optimistic outlook.
Investment success doesn’t come from “buying good things,” but rather from “buying things well.” - Howard Marks