CAN INDIA CONTINUE TO UNDERPERFORM

The year 2019 started off exactly I thought it should in the global context with a bounce back in the US Markets and a revival of Emerging Markets driven by low valuations and increasingly dovish outlook from most central banks. However India has underperformed significantly during this period with the markets absolutely flat YTD whereas the Emerging Market Index is up by 8% in the same time period. Such underperformance and lack of correlation is very rare. We need to evaluate the reasons and the way forward.

A few of the reasons that are relevant are

  1. Indian Markets never crashed the way some other EM’s corrected and as such the valuation gap between India and the EM Basket was high. This has led to more flows into other markets
  2. A series of corporate governance issues related to groups like DHFL, Essel Group, Vedanta, ADAG in quick succession and slow pace of resolution of the ILFS debt issue
  3. Very high real rates in India relative to rest of the world where most large economies today have negative or low real rates and in India the real rate is almost 3%
  4. A mixed set of corporate results mainly due to a few companies and squeeze in margins as raw material prices shot up suddenly last year and could not be passed on and
  5. Election related uncertainty which is playing in the minds of people and potential investors

There has been an unprecedented sell off in the broader markets even as large cap indices have held up. The actual impact on most peoples portfolio is much more negative than the indices reflect.

In my view this period of uncertainly is one of the best for long term investing as stocks are available cheap and even high quality companies in the mid sized category have seen a significant dent in valuations.

The Union Budget was positive for the economy. Many of the things can only be implemented post the full budget however whatever has been announced is positive for consumption growth as the farm waiver will put Rs 75000 Cr into bank accounts which will be immediately consumed. All of you need to understand that any tax break or break to corporates normally ends up having a saving and spending element. However since this is to the bottom of the pyramid it will be fully consumed. The middle class tax break is also positive for consumption. Besides this there were several measures for the real estate sector. Other than that there was nothing major except for a statement of intent which does not carry much weightage till the new government is formed. Overall it was positive for Consumer Durables, Non Durables, Autos, Housing etc.

This was followed by the monetary policy which rightly was dovish. Many people just want to blame the government however the MPC has been excessively hawkish even as inflation kept on plummeting. Ideally they should have cut by 50bps for a immediate cut in market rates however it would have been too much of a hit on the ego as they had a tightening bias just a few months back.

Commodity prices have also fallen substantially and crude is also down 30% from the peak of three months back. The extended winter is expected to keep food prices lower for longer and thus have a positive impact on retail inflation.

As is always the case in the run up to the elections there is some slowdown in investment demand as order flow reduces and implementation slows down. However this is just temporary as underlying growth trends continue to be positive.

In conclusion we are currently at a stage where economic growth is likely to remain strong in India, margins pressures are likely to come off and growth outlook improve. Historical evidence of post election performance from India as well as other markets reflects that markets always do well after elections irrespective of the disposition at the Centre. A recent example of this is from Brazil where markets are up nearly 40% from where they were two months prior to the elections.

The reforms that have been carried out including RERA, GST Implementation, IBC etc will also have a far reaching positive impact on the performance and efficiency of the economy. Most banks have started reflecting improved balance sheets which is critical for liquidity flow into the economy.

With easier monetary policy likely in the USA and Eurozone we will see a resurgence of Emerging Markets performance. We have just seen an initial move and we should still see a substantial upmove. The spanner in the works could be a breakdown of US China trade talks, but given the huge investment by both sides into the process there should be some resolution if not complete.

Under the circumstances the current underperformance of India is likely to be temporary rather than permanent. Consumer Goods, Autos, Cement as well as select mid caps across sectors present good investment opportunities.

Remember exactly a year back there was Euphoria but buying at that time did not make money. Today there is lack of conviction and such times are best to invest.

Markets are more likely to follow global cues where we have seen a huge underperformance by India which can get corrected via a post budget rally in February. Overall outlook for risky assets globally is positive with the US Fed easing out on rate hikes, ECB indicating easy policy for some more time and China also adding stimulus. In India interest rates continue to be too high relative to global rates and thus we see lack of competitiveness across sectors except cash rich ones. This needs to be corrected and keeps the potential growth rate at least 1-2% lower than what can be achieved.

We have also recently seen some issues related to corporate governance where stocks have got sold out. However this is more likely to be isolated rather than a systematic risk. The DHFL episode has impacted sentiments negatively across the mid cap universe.

The results season has been quite positive with good delivery across sectors. Some sectors like Autos have seen a slowdown and margin squeeze which should get corrected going forward. Overall outlook remains good. There could be volatility ahead of elections however the full year should be good and we need to use sell offs to buy good potential stocks.

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