SETTING UP FOR A SECOND HALF RALLY

After a below par 2018 which was driven by volatility and sell off in Mid and Small Cap stocks which got exaggerated as the ILFS issue blew up and was followed by DHFL, ADAG Group, Pledge share issues etc. This negative sentiments gained further steam with liquidity issues, high interest rates and then the elections season when government expenditure died out and led to a further economic slowdown.  In my view we are now in a place where in my view all negatives are in the price and we will have a much better second half of 2019.

There are several reasons why I believe that my view will play out. The primary among them is that I believe that the growth in India has bottomed out and from here on we will see a steady and significant recovery over the next 2-3 years starting now. The value of  a stable government at the Centre cannot be discounted at all. A change would have led to huge disruption. With continuity we are likely to see several steps to recover consumption as well as investments. Many initiatives like significant infrastructure investments in Roads, Water Projects, Urban Infrastructure projects, Housing for all and the newly proposed piped water for all will continue and grow rapidly.

A large part of the bank cleanup is behind us. Some remnants of the past and newer issues related to NBFC’s etc will continue but is too small as far as the overall system is concerned to have any long term impact. A stronger banking system and a shift towards larger banks will lead to strong gains from many large corporate banks.

Consumption slowed down significantly over the last few months. Many of the reasons for the same are inexplicable, however a contributory factor was the uncertainty surrounding the election outcome and people holding back consuming. This should reverse now. The importance of low inflation in this entire paradigm should not be underestimated as when inflation remains low disposable income remains strong. This combined with the fiscal stimulus in the form of Rs 85000 crores going to farmer accounts, housing and water project investments etc will result in both employment generation and increased consumption. Urban consumption will also pickup as confidence returns.

With inflation low and global liquidity ample as well as the probability of reducing interest rates globally the RBI and MPC has also turned dovish with rate cuts done and further rate cuts expected. Many people wonder why this has not lead to positivity till now. For this you need to go back to last year when the Urjit Patel led MPC unnecessarily increased rates twice in succession which was followed by the ILFS crisis and liquidity drying up. This pushed back economic recovery by nearly 6-9 months. The last two cuts were just a reversal of the hikes done last year. The first real cut happened this month and should be followed up by more cuts going forward. Unlike many developed economies where there are other structural issues interest rate cuts work in India and will lead to a faster economic growth. Given the issues in the Chinese economy we should see that commodity prices will remain low for the foreseeable future keeping inflation and inflationary expectations low.

Most of the negatives related to the Trade Wars is already in the price. If the tensions become greater we could see a slowdown in overall market move. However the probability that they will tone down rather than increase the rhetoric is greater at this stage.

Although it does not feel that way the markets are up 10% this year already however the Mid Cap index is down 1%. The sectors to look at will be corporate banks, high quality NBFCs, Auto Stocks, Consumer Non Durable and Durable stocks, Infrastructure stock etc. Many good companies in these segments can move up by 10-20% in the second half. As things settle down Mid and Small caps will also start performing as historical analysis of Mid Cap performance indicates that they do better when economy is accelerating, interest rates are coming down and inflation is low. All these things are present at this point of time. After being overall cautious over the last three months I am now bullish. This does not mean we will be much higher next week. However we will be much higher by the end of the year.

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