India has somewhat restored normalcy despite rising coronavirus cases. How will this impact Indian economy?
Coronavirus related lockdowns impacted economic activities and RBI estimates FY21 GDP to contract by 9.5%. However, a large part of this loss of GDP is already behind us as the maximum loss of output was in June 2020 quarter. As the various phases of ‘unlock India’ are happening, we are seeing improvement in economic activity. This is reflected in many indicators such as diesel and petrol sales, electricity demand, e-way bill generation, monthly GST collections etc. The recovery is likely to be uneven with some sectors getting impacted more than others. However, one good aspect of the current epidemic is that unlike other natural disasters like floods, cyclones etc. the physical economic infrastructure is not damaged. Also the loss of human lives is limited, Thus, as economic activity resumes, the recovery can be quick.
India's GDP growth has contracted sharply. What would be its impact on equity market as returns in equity funds are linked to corporate earnings, GDP growth and inflation?
GDP growth and earnings for FY21 are negatively impacted by the current crisis. However, markets have taken cognizance of the fact that as economic activity normalizes, these losses can be recouped. Also, central bank and governments, both globally and in India, have come out with very supportive and growth oriented policies. Another positive factor is that Indian banking system, prior to Covid, was coming out of the corporate NPA cycle and its balance sheet strength is much better than what it was three-four years ago. Thus markets have recovered a large part of Feb-March 20 fall. Also, within markets, the sectoral / stock level performance has been proportional to the expected recovery. So sectors least impacted by the pandemic have done much better.
While some experts believe that Indian stock market is disconnected with the real economy, some feel that we are on the path of broad based recovery. Your comments.
We believe Indian economy is on the recovery path. We have seen month on month improvements in several indicators of economic activity as the lockdown restrictions are gradually withdrawn. Even prior to covid, our view was that business cycle in India was recovering as the corporate NPA cycle had come to an end and the impact of disruptions caused by measures such as demonetization, introduction of GST, RERA etc. were receding. The covid epidemic has only postponed the recovery. The capex/investment cycle in India peaked in 2007 and has been weak since 2013-14. Similarly, the real estate sector peaked in 2013 and has been in downturn since. Both these can see a revival while consumption and exports remain the more secular growth sectors.
Sensex is now back to its pre covid level of above 40,000 points in spite of several factors like the Indo-China border issue, rising covid-19 cases, slowing economy, US election, high fiscal deficit. How do you read this recovery?
The recovery in markets has broadly followed the recovery in economic activity post the gradual removal of restrictions. The market recovery is also supported by the very easy monetary policy followed by global central banks and weak US dollar. The impact of covid on earnings is also by and large reflected in the sectoral performance. Thus, while headline Sensex level may be similar to pre-covid, there is huge divergence at sectoral and stock levels. However, that does not mean that current valuations are very attractive.
How comfortable are you with valuations in the market?
We feel we need to be careful at current market valuation levels. The markets are trading above the higher end of historical P/E band. Even assuming normalization of earnings post covid, the markets are not cheap. On price to book basis also, markets are trading at the higher end of historical range. Thus, continuation of low inflation, low interest rates, abundant liquidity environment and some normalization of earnings post covid is factored in the current valuations.
Cash crunch created by covid-19 has badly impacted the health of several sectors. How have you changed your sectoral weightage in the covid-19 world. What are the sectors that you are overweight and underweight at this point?
We believe Indian economy is on the recovery path after a prolonged period of low economic growth. Thus, we have broad based our portfolios and bought into stocks that we believe will beneficiaries of this recovery. Also, we have reduced our weights in low beta sectors like FMCG, telecom, IT and pharma and added financials and domestic cyclicals. We have also bought some stocks where covid impact is higher but valuations are cheap as the timing of recovery is not known.
What according to you would be the new challenges for the Indian economy to grow in the post covid era?
The covid epidemic would have impact on societal behavior, faster adoption of digitization, realignment of global supply chains and probably acceleration of the degloablisation / regionalization trend. Some of these trends are quite beneficial for Indian economy. Indian policymakers should use this opportunity to fully exploit these opportunities.
You are a big fan of small cap funds. However, 10-year industry data shows that small cap funds have delivered returns at par with large cap and mid cap funds. Why should investors take high risk to earn at par returns?
We always view small cap as a more tactical play and not a buy and hold asset class as the inherent volatility is quite high. Investors should enter small caps when sentiment towards small caps is weak and valuations are attractive and exit when small caps become talk of the town. Small cap sector has undergone a bearish phase for the last three years and many stocks are trading at attractive valuation levels and investor expectations are low. Hence we feel investors would gain if they invest in small caps now with a three to five-year view.
Why do you think that equity markets will continue to remain the most profitable and attractive asset class in the covid storm?
We feel Indian economy is poised for economic upturn after last few years of sub-par growth. Corporate profits as a % of GDP was already low, at close to 3%, a level last seen in 2003. The covid epidemic has only postponed that recovery and not derailed it as the epidemic has not damaged the economic infrastructure or human capital. Equity is the best asset class to bet on in economic recovery.
