This is the first of the Monthly letter meant to give the market outlook to all the members of Vantage Investment Advisory. And unfortunately the financial markets are in a precarious shape as this is being written. But only in an environment of gloom & doom can we get the best companies in cheapest valuations and build a rewarding portfolio. So let’s jump into specifics.
The core symptom - inflation. There are numerous reasons, most of which many of you would be able to recite in your sleep (excess liquidity infusion esp. by US Fed, record low interest rate, Russia - Ukraine crisis etc. etc.) and there is no point this letter to highlight what you know so well. So let’s focus on what is our best guess of what it is likely going ahead.
US exporting inflation
Within 30 days RBI has increased the repo rates by 90 bps in two tranches (first 40 bps followed by 50 bps in recently concluded MPC). This was as inflation continued to stay outside the 6% limit of RBI (two recent readings of CPI: April - 7.8%, May-7.04%). But the larger problem at hand is US Fed has increased interest by 75 bps (with inflation hitting 8.6% in May) taking the interest rate to 1.75% for the ‘most’ developed nation in the world. Another piece that has shocked the market is Fed officials are now expecting interest to be raised to 3.4% by end of the year from 1.9% that was expected earlier. And by the very nature of risk premiums that each country has, Emerging Markets like India will have to further raise rates to maintain the difference between the two. So even under the assumption that local inflation cools, USA is going to export a good deal of inflation to India (and world). The brunt of which will have to bore by businesses and citizens of India alike.
Going to get worse before it gets better
Raising interest rates to tame inflation has lag built into it. Most of the time it will be increased much more than needed before the realization of the same seeps in. This means temporarily interest rates can be taken or made to stay at elevated levels. RBI governor has said they are moving in direction of ‘soft landing’ of economy, but how much will be adhered to it anyone’s guess.
It will be useful to keep in mind the externalities that can positively impact the macro situation of India. Improvement in any (of few of them or all of them!) can be taken as cue to take more exposure in riskier bets.
Crude Oil on the boil
At $100 per barrel Indian economy is greatly balance with fiscal deficit 6.5% of GDP. Anything more is going to increase the pain. Crude Oil has single handedly given the largest pain to Indian macro in the last 6 months. European & American sanction on Russian oil has taken away a large amount of supply which is not being filled up by slow increase in production by OPEC+
Crude Oil is currently trading at $113 after reaching a high of $130 Crude. While India has been buying discounted crude from Russia it has not been significant (~$10 discount) due to increase in freight and transportation charges. Any improvement in the geopolitical situation will beneficial to world but more so to India, so watch out for that.
Extent of Monsoon
Food forms over 45% of the CPI (Consumer Price Index) basket and good monsoon can go a long way in increasing the production. Recently the heat wave across India has not only reduced the yield but also increased the need of artificial irrigation leading to increase in the production cost. The monsoon has timely entered India through the coast of Kerala but how widespread and extent of shortfall, if any will decide the extent of positive impact.
Rupee from weak to weaker
USD/INR is trading at a record low. Currently at 77.96 after reaching an high of 78.28. While importing pricier crude has a role to play, strengthening of dollar by raising the interest rate (by US Fed) has a greater role here. All time high trade deficient of ~$18 billion for India is not helping the case either.
Improvement in an any of these will provide the much needed macro tailwind to propel India’s growth.
Silver Linings
Attractive Valuation
Amidst all these dark cloud cover, NIFTY TTM (trailing 12 month) P/E ratio is at 18.9. Last time this level was seen was in March, 2014. P/E has gone below the lowest point of NIFTY in COVID crash of March, 2020. This not only gives a sense of strong earnings but also indicates time is ripe (and ripening further) for longer term value investment.
Attractive levels for entry (stock/index) are being shared regularly shared to all members from time to time.
Cool off in Metal Prices
Price of Aluminum, Copper & Palladium have gone lower than what they were quoting in September, 2021. Steel is also off its highs and looking like some more downtrend is on the cards. The second order impact is that this will reduce input cost in sectors such as Real Estate, Constructions & Automobile.
COVID crash like recovery for Markets?
It will be prudent to step away from recency bias that every crash will recover faster than time it took to go down. This was a signature style of the post COVID crash era but with the regime changing from extremely low interest rate to extremely high interest rate and that too at a heightened speed such quick recoveries (except some technical bounces) can be a thing of past for a while.
Last 12 months data suggest that domestic money (retail, HNI investors etc.) has gotten stronger than ever but not enough to counter the wrath of Foreign Institutional Investors (FII) who seem to be on selling spree. So until FIIs stop or at least slow down, stocks are going to have a difficult time going up. Cost of capital will increase and equity asset class will get more competition from debt instruments to attract fresh capital.
Thus, we expect a more grinding road to recovery i.e. larger time correction.
Playing in different terrain needs appropriate change in strategy. Some of them at Vantage being:
Increasing allocation to Value from Momentum picks
The phase of markets after March, 2020 to mid of mid of 2021 was one which had high momentum. We played that market accordingly. Making hay when the sunshine. But, now there are dark clouds and momentum will not be the smarter of the available paths to travel this road. So we have increased our focus to value investment, slowing down momentum appropriately.
Accumulation of stocks at specific levels
Instead of trying to buy each dip we are sharing high probable levels for members to buying quality names at attractive valuations.
Sector specific accumulation
Larger move comes from stock specific head or tailwinds. And recent correction has been deeper in few sector compared to others. We are trying to pick up those which offers better value than others. In such instances 4 or 5 stocks which clears Vantage filters of growth, RoE, RoCE, valuations & management commentary while belonging to the particular sector in focus is being shared with members.
Hidden Gems : Less discovered value picks from Mid & Small Cap
The time to build a rewarding long term portfolio is when going gets tough for equity markets. While well know stocks lends a strong foundation to the overall portfolio, investing in less discovered business with interesting growth & earnings prospects can be rewarding in a 3-4 years time frame especially when there is opportunity to acquire the business at lower valuation than it was available in the past.
First ‘Hidden Gems’ report was recently released to our members. And we are on lookout for more such stocks.
Lastly before we end this letter, we want we want to highlight that setting right return expectation from equity markets is the way to make your investment more financial rewarding and less stressful. And by the very nature of equity asset class the returns are going to be lumpy. But, if you zoom out this asset class has stood the test of time to generate wealth like no other!