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Sailing amidst uncertainties

Updated: May 9, 2022

Most of us are surprised lately with the movement of markets and the tug of war which is at play almost daily between Bulls and Bears. This precise nature of markets is causing worry to most investors.

We have also been highlighting through our several letters, how India is uniquely positioned to capture the dream run over next 5-7 years, especially driven by major shifts in the manufacturing space owing to series of domestic and global factors (link), IT space, Banking & Financial Services, Real Estate, Consumer Discretionary and many more. However, the said journey is surely not going to be without the speed bumps. In our January letter (link), we had highlighted the possibilities of head winds due to rise in inflation and interest rates, & liquidity withdrawal, which can lead to a bit of derating of markets.

There is no denial that we are amid global uncertain environment which may continue to test the patience of investors over the next few quarters. Just as the world was beginning to come out of havoc caused by the pandemic and the business was getting back to normalcy, investors are again grappling with another set of uncertainties/ fear factors ahead of us:

  • Geopolitical tensions - Russia Ukraine War

  • Supply chain issues – availability of raw materials, logistics etc.

  • Covid Situation in China

  • Inflation

  • Rising Interest Rates

  • Unwinding of Central Banker’s balance sheet

The combined result of all the factors will surely result in high volatility globally across all asset classes. There is risk building in the global macro-economic environment which could impact global growth. India can’t be an isolated island as stated by the RBI Governor.

The key question, grappling all of us, is how one should sail amidst uncertain and volatile environment?

While the investors with short term horizon would surely get scared out of the above situation, investors with long term horizon should continue to scout for green shoots and emerging opportunities, as uncertain times are best times to pick structural growth stories….

Few things we are watchful of:

Supply side challenges:

While the world was still grappling with supply chain shocks created by Covid, Russia-Ukraine war has further aggravated the same. While some of the issues like logistic headwinds, commodity inflation, talent crunch will get addressed over short term, however issues like chip shortages, certain commodities where incremental capacities would take time to come on stream would continue for little longer.

Governments and corporates are implementing structural solutions to the problems mentioned above by creating capacities and diversifying supply sources.

Inflation causing unwind (ICU):

Considering heightened inflationary trend (highest levels in last 3-4 decades in few advanced economies) across the globe, all central banks have aligned towards monetary tightening measures.

Fed announced the start of a program to wind down its balance sheet by ~USD 47.5bn a month for the next three months followed by ~USD 95bn a month shrinking. Last time around in 2017, the unwinding sent across jitteriness to the markets, that led to stopping of unwinding by Fed.

Federal Reserve also raised interest rates by 50 bps – the largest since 2000 and indicated the possibility of further 50 bps hikes in the next two meetings. The steps announced in the latest Fed meeting marks the most aggressive tightening of monetary policy at one meeting in decades.

RBI raised REPO rate by 40 bps coupled with an increase in CRR by 50 bps, the first sign of rising interest rates and liquidity tightening to keep the inflation in control. However, RBI categorically mentioned continuation of accommodative stance to facilitate the economic growth.

While rise in interest rates would aim to keep inflation in check, it may also result in demand/growth dampener. One should be very cautious, that if inflation continues unabated hindering demand than it could result into stagflation kind of scenario which would put economy in a precarious (ICU) situation.

While all the concerns mentioned above are there and real and will surely add fuel to the market volatility, however there are series of green shoots visible on the ground on Indian front are:

  • Unleveraged balance sheets of corporates

  • Domestic Banks with strong balance sheets, robust asset quality and ample liquidity

  • Global opportunity unfolding for Indian companies – China +1

  • Government Push - PLI and many more which we have highlighted in our letters to you previously.

  • Moreover, valuations are much more benign and offers decent margin of safety.

The long-term story is intact, however, at the same time one should be very cautious and watchful in the current uncertain environment.

In our view, it would be best to go slow and in disciplined & staggered manner as we sail through this period of heightened volatility and uncertainty.

It is very difficult to predict how all the above would eventually play out in the next 6- 12 months, but if one has conviction on the long term basis, then one can stay put and add during the turbulent times as investment made in turbulent times are the best vintage in any portfolio.

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