Greetings from Team Carnelian!
Wishing you and your family a Happy Diwali and Prosperous New Year. May this festival of light bring loads of happiness, peace and prosperity to you and your family.
Turn of Samvat is always a good time to reflect upon how the last year has gone, key learnings and what to look forward in the year coming ahead.
Samvat 2077 started amidst heightened fear and very low expectation. A year on, the fear factor has receded and expectations are very high. Generally, there is inverse relationship between risk and fear, hence one has to be watchful when fear factor (perception of risk) goes down.
At the onset of last Samvat we were grappling with extreme pessimism with questions like how long the lockdown will last, what will be its impact, when will we have vaccines and many more questions revolving around the same. Surely it was once a century crisis!
History has consistently taught us that bull markets are always borne on back of some crisis, as crisis usually brings some natural or forced structural shifts. During crisis we noticed 2 clear trends emerging:
Each business wanted digital solution to sustain its operations amidst lockdown
World recognised overdependence on China and wanted alternative to China
Fortunately, India is uniquely & competitively positioned to offer solutions to both of the global needs mentioned above.
Noticing above we launched our Shift Product during last pandemic with focus on two broad themes: IT and Manufacturing. In hindsight we were positively surprised by the pace of shift resulting in creation of significant wealth over last 1 year.
We saw spur in demand across IT services so much so that plethora of opportunities in the sector lead to high attrition rates. Within a span of 6 months there is a massive shift from fear of job losses to shortage of talent.😊 Similarly, we are seeing greater traction for Indian Manufacturing companies on account of China+1 strategy added with India’s focus on becoming Atma Nirbhar. While index has gained 52%, IT index has gained 70% and capital goods 86%.
Government has been very prompt all throughout the pandemic to support economy, we have seen introduction of PLI schemes to boost capex and also implementation seeing the light of the day, unabated government spending, introduction of schemes like Gati Shakti, Ayushman Bharat etc.
Even RBI has been very accommodative all throughout with no changes in the rates. India has also successfully executed 100 crore vaccinations at a record pace, which helped bringing back the economy to normalcy.
What lies ahead….(Samvat 2078)
While previous Samvat was one of the best periods for global and Indian equity markets, the journey to the next Samvat is likely to face plenty of speed bumps. Few of the things one should watch out are:
High commodity prices, supply chain bottlenecks
Likely increase in global interest rates & tapering of excess liquidity from the system
Valuation de-rating in cases where current rally is driven more by hope than facts
Disruption risk will certainly be more visible for select sectors resulting in terminal value risk
Reverse shift from organised to unorganised in sectors with low entry barriers
Huge Capital raise lined up in IPOs taking away liquidity from markets
There has been a stupendous rise in the prices of commodities across the board, logistical challenges, shortages etc. which has kind of taken the raw material prices and other costs through the roof – while we believe this is not sustainable and industry players have already started taking price hikes. This may dampen the margins for 1-2 quarters; however we believe margins will get normalised in the coming quarters.
Higher crude oil prices will impact India’s trade balances, however it’s tolerance level for higher prices in crude will be better considering that it’s non-oil trade deficit will see massive reduction from USD 90bn in FY19 to ~USD 61bn in FY22E (Source: Spark Research) on the back of steady increase in software exports and remittances. Over the long run higher crude oil prices will also accelerate a shift towards renewables where we believe India will play a leadership role.
What does it mean?
All these trends show one clear thing - rising interest rates & inflation: Interest rates & deflation seems to have bottomed out and we foresee gradual inching up in next Samvat. We do not see an out-of-control inflation but expect a mild inflation which is good for the certain pockets of economy and harmful for some.
This samvat one should align their portfolio keeping in mind this reality. Everything else will be subservient to this.
Focus on BRICs and benefit from this.
(B)anking and financials: Banks are well placed to capture the benefit of rising interest rates and mild inflationary environment. We have a banking sector which is well consolidated, capitalised and ready for growth with flush of liquidity. Mild rising rates help Banks as asset repricing is always faster than liability repricing and thereby leading to increase in NIM. With high growth and low credit cost, the operating leverage will be very high thereby leady to ROE expansion.
In nutshell, mild inflation coupled with strong balance sheet, ample liquidity, supportive central bank & upcoming capex cycle are the best ingredients for the banking sector to prosper. Moreover, sector consolidation will ensure market share gains for the players with strong balance sheet.
(R)eal Estate and ancillaries: RERA implementation and financial crisis led to sharp consolidation in the sector over last 4-5 years. Business model has got rechristened in favour of large, well capitaltised and competent players. After almost 7 to 8 years’ inventory levels have come down on the back of good demand and also in certain pockets we have seen prices starting to rise as well. Improvement in affordability ratio on account of lower interest rates has also helped uptick in the demand. With job creation picking up, demand is expected to remain robust. Mild inflationary environment always helps push up demand of housing. We see sharp value creation in the sector.
(I)T: Indian IT companies are all set to capture 4th wave of IT – Cloud being the new ERP. The pandemic has only accelerated the cloud and digital implementation across the globe. Robust demand environment coupled with weak rupee (rising inflation and CAD due to oil) augurs well for the sector. While higher attrition and cost escalation can be a dampener over next the 2 quarters, currency and demand gives a good cushion. This sector also offers a good hedge against any volatility in the environment.
(C)apital goods: There have been ample data points which suggest initial uptick in the capex cycle.
Significant deleverage as Net Debt Equity ratio of Nifty companies excluding financials have come down from 0.28x to 0.17x from Mar 20 to Mar 21 (Source: Ace Equity)
Number of Environmental clearances granted has improved from 1620 in CY 2018 to 3250 in CY 2019 and 4250 in CY 2020
Corporate profit as a % of GDP improved from 2.20% in FY19 to 2.69% in FY21
Further utilisation levels improved from 47% in June 20 to 69% in March 21 levels in lines with 70% as on March 20 (Source: RBI)
Capex plans announced by Corporate India so far are already encouraging
If India has to realize its manufacturing dream, capex has to happen. We see a big Pot of Gold here.
While there will be many speed bumps this year though no U turn, we continue to remain structurally bullish over the next 3-5 year period. Obstacles are what we see when we take our eyes off the ultimate destination, we are excited and focused on long term wealth creation.
This Samvat will remain a year to watchout for risks and focus on BRICs.