JULY MUSINGS AND STOCK MARKET UPDATE

Sandip Sabharwal - Uncategorized - JULY MUSINGS AND STOCK MARKET UPDATE

The current month saw significant divergences in performance across markets and asset classes. On one side the commodity rally continued with soft commodities joining in, bond yields continued to hover around lower levels despite a pick up in economic growth, Covid continued to form new waves in different countries even as the efficacy of Vaccines is being clearly seen, inflationary pick up globally has been significant and not the least the Chinese crackdown on various technology companies created a huge performance disruption. Overall it was an interesting month to say the least.

The sharp sell off in the Chinese Markets too the returns of the Emerging Market indices into negative territory for 2021 in the last week of July. What was surprising was that the China selloff had a muted impact on other Emerging Markets with there being some selloff but not as much as would have been expected usually. Stocks like Tencent in China went from a Multiyear High to a Multiyear low in just a few weeks. This is a way is also a reflection of the fact that we should not be lulled into complacency just because markets are not volatile and not reacting to adverse news. The problem that the Chinese Selloff can pose many emerging markets is that most of the flows into EMs have been ETF Flows. As investors see negative returns we can see redemptions which could hit all Emerging Markets.

The other interesting thing this month was the big sell off in Cryptocurrencies followed by a sharp bounce back by the end of the month. As the Cryptocurrencies were on the verge of breaking down we saw them getting support from the usual suspects i.e. tweets from Elon Musk. The next one year in my view will be critical for cryptocurrencies as the US Fed Tapers and ends is purchases and eventually we move towards higher interest rates. If they can survive these moves then is possible they could become more mainstream. I still do not believe that there is any intrinsic value in Cryptocurrencies.

The inflation debate is not getting strongly divided. It is getting tougher to believe the transitory inflation theory that is being propounded by many central banks. Doubling of most commodity prices is real not transitory. Steel, Crude, Polymer, Copper, Coffee etc among many commodities are at multiyear highs. As unemployment falls this will lead to a significant spike up in sustainable inflation. As investors this is what we should be most worried about. I will be happy if inflation is indeed transitory but will not bet on it.

Most markets developed and emerging were flat in the current month except for China. Key is to see if this is a consolidation for a higher up move over the next few weeks or distribution leading to a correction. Valuations are high and as such we could actually see an increase in volatility and corrective moves over the next 6-8 weeks. However this will be a correction and not end of the bull market

The current quarter results season is a tough one to analyse. There are several reasons for this right from the base quarter of last year being one of a severe shutdown, the huge move in commodities that we have seen which makes it tough to distinguish actual growth from just growth seen due to higher value as prices have gone up to the impact of the second wave lockdowns on incomes and retail delinquencies relevant for many banks and NBFC’s. On top of that we have an uneven monsoon because of which overall cropping this season is lagging last years levels. Inflation has gone up substantially for most people. Fuel prices are up nearly 50%, most consumer durable companies have hiked prices by 10-15% etc. So logically this should impact consumer demand, however some companies say that bounce back in demand is strong. On top of that we have divergent views from large companies in the same industry. For example while Bajaj Auto said that the scenario is tough and sales will be flat in the second quarter TVS Motors gave a bullish outlook. While HDFC Bank, Bajaj Finance etc results showed growing retail lending stress some large banks continued to indicate that they will not be impacted much. On the consumer durables side also some companies indicated that there is no major pent up demand this time while others have indicated otherwise. A clear trend will be visible in the second quarter numbers and results as this will be the first proper like to like quarter in the last one year.

On clear growth sector seems to be technology where all companies have indicated high growth conditions across large and small companies. This has benefited the smaller companies more as is true in all upcycles as they have much higher operating leverage. The challenge for them will be growing attrition and high wage pressures. Most banks and NBFC’s saw stress in their results and second quarter will be critical for them. Pharmaceutical sector results have been mixed and commodity companies have had blowout quarters driven by record prices. Most durable and non durable companies saw significant margin stress in the current quarter as pass through of the high cost pressures has been slow. On the mid cap side of the market we have seen divergent performances with some companies doing very well and others faltering. The challenge for the markets is the 42% consensus earnings growth projection for this year for the Nifty Companies. This will be very tough to achieve.

One interesting factor that came out of various management commentaries has been that most companies are looking to do significant capital expenditure. This should now after more than a decade lead to a new private sector Capex Cycle. This will create opportunities in some under owned capital good stocks. This is a good opportunity space in the current elevated markets.

Overall I would still like to tread cautiously at this stage. However it is very clear that the economic expansion cycle should last a few years at least. The IPO Blizzard at very high valuations is also disconcerting as companies coming for IPO’s are coming at valuations which are twice that of similar listed companies and then getting listed 50-100% higher. The amounts being raised in the IPO’s is good risk capital for companies raising this money however from the investors perspective it might not be as great going forward. The last two months have seen the Nifty and Sensex being flat while Midcap’s have continued to see momentum. Right now midcaps are trading at a substantial premium to large caps. This is usually unsustainable in the long run. Predicting when markets will correct is tough and that is the time when bigger allocations should be made to the markets. However the correction will give strong opportunities as the economic cycle should play out over the next few years