Dear Investor,
The month of May has seen a good recovery in the broad markets. The drop in global rates, relative strength in the INR and a drop in crude prices on prospects of US-Iran settlement are all positive for sentiment towards India. Yield seeking global investors came in first enticed with the strengthening INR and the month of April saw the index doing relatively better. In May, Hedge fund and HNI activity strengthened as INR stabilized and negative sentiment associated with India-Pak subsided. The breadth of the market has expanded. Most indicators, ex of US bond yields which have moved up again, have been supportive based on recent trends. Higher US yields are digested because it is accompanied with stable to strengthening INR.
It is time for alpha
Jan and Feb saw a large correction in the high earning growth spaces. We had communicated that the drop in these spaces is more on account of technical factors such as INR depreciation rather than anything else. With the technical factors now behind us, we believe that since the high growth spaces continue to deliver strong growth and may have the potential for continued growth, we think it is time for alpha. Our belief is simple. Markets tend to follow earnings growth. Our portfolios are constructed of some of the highest growth spaces in the country and have a high EPS growth quotient. Corrected for valuations, we believe this construct has the potential to provide sustained alpha over a period of time.
In some manner, we liken the period to the 90s when IT sector emerged new. It delivered strong growth for several years . and helped managers generate strong alpha. In the same manner over the past few years, we have seen EMS, New tech, Renewables, China +1, defence, EVs , capital market plays, luxury as a space, hospitals, etc all get a much better representation in the market. These spaces are relatively younger and offer the combo of relatively higher quantum and longer sustenance of growth. Our portfolios are positioned to capture opportunities arising from such evolving themes, in line with our investment philosophy. The Q4 result season currently underway, has again shown that the newer spaces have seen strong growth in earnings while traditional spaces, more present in the index, are delivering growth close to the nominal growth of the economy. Most large companies are no longer the growth leaders. Overall, result season, has been better than expected. Versus a small 2-4% earnings growth expectations for various cohorts, the earnings growth that we have seen is much stronger and closer to double digit. Commodities have led the earnings growth but even ex commodities, earnings growth has been quite strong. Good thing is that the better than expected numbers have come in almost across the board. Growth in EBITDA (Earnings before Interest, Tax, Depreciation and Amortization) is more than the growth in sales, indicating a good support from margin increase in this quarter. We believe that sustained growth in earnings focus, across market cap spectrum, may provides better outcomes for investors rather than a focus on market cap segments only and our portfolios are constructed accordingly’
Risks on the horizon: It may be an opportunity
The risks that are currently fore-seen are
1. The decision on Trump tariffs after the 90day period is over.
2. Also more geopolitical issues may crop up. Israel-Iran situation can potentially develop Further.
3. Downgrade of the US credit rating by Moody’s is increasing bond yields.
4. New risk in the form of COVID has emerged.
On COVID, as yet, the symptoms for most people seem to be flu like. If the severity remains under check, then it may not become a major concern. However, travel and tourism based industries may experience a slowdown.
Our thought is that markets follow earnings growth and the prospects of it continuing. Geopolitical events are not bad for earnings, in most cases they result in better business prospects. If we see markets of Israel, they have been doing very well. Even market of Russia, has recovered sharply from the lows hit when sanctions were imposed. The risk of US duty outcomes is more on account of volatility in currencies and interest yields rather than business. We export to US less than USD100bn in total. A slowdown in exports of any order does not impact our USD4tr economy much. Given our keenness to do business with the US, chances are that we get a more favorable term, resulting in some better market access into the US. Mostly hence, the outcome would either not matter much or may be a marginal positive. Moreover, if we see the contours of the Indian UK FTA, our gains are seen in spaces which are of marginal presence in the market such as textiles and leather. Hence, a direct impact is very limited. The threat of a USD yields moving up sharply or significant currency volatility on inflation and economic slowdown worries, is also low because now this is no longer in the unknown realm. Market participants appear to be factoring in the likelihood that the US may retain the 10% import duty across a broad range of goods.. If the final outcome is same/similar, currency and bond markets may remain stable.
Moody’s downgrade of US is pushing bond yields higher but is keeping USD relatively weaker. USD has depreciated against Euro and Pound. While yields sensitive FPI may reduce exposure, leading to some pressure on the part of the market where there is F&O. However, the activity of levered Indian ultra HNIs and hedge funds is, as yet, not impacted because they are more sensitive to currency and that is holding steady. This could aid our alpha generation as we are positioned away from the index.
If currency markets remain stable, oil continues to be sub USD70/bbl and with DXY index remains below 100, indicating some movement away from the US dollar, these factors could support the outlook for Indian equities getting tail-winded. Any correction in the market on account of currency and bond market movements may present potential investment opportunities. This year has already witnessed two cuts in Indian regulated rates and now there is expectations of 2/3 more cuts compared to earlier forecasts of two cuts for the entire year. Lower oil, lower inflation, lower interest rates and better relative growth in our investee spaces contribute to a constructive environment for our investment approach.
Hence, while there are many worries, they may not negative outcomes for the markets unless a nasty surprise comes about. In most cases, there may be a positive response as the risk sorts itself out.
While domestic investors have continued to invest, FPIs have been less consistent
In the month of Jan and Feb, we witnessed strong FPI selling as bond yields and currencies became volatile. This changed over March and FPIs have been strong buyers on several days as currency stabilized. If we look over last two years, while FPIs have been very keenly followed, overall, they have not bought or sold much. Cumulative FPI investment over last two years is a negative USD3.7bn.
In the same period, domestics have poured in USD103bn. We have been maintaining that domestic money flow into the market appears to be part of a structural trend, as India gradually shifts from a country of savers to a country of investors.
Valuations
While markets have recouped some losses from the bottom and particularly after March 15, digesting the impact of trump tariffs on Apr 2 and the India Pakistan war around May 10th, various indices are still 5-15% lower than the peak reached in mostly Sep 24. A part high growth part of the market has recovered and many stocks in some spaces like defense are at new highs. However, many high growth names are available over 20% lower than their last one year highs
With lower Indian yields, lower inflation with expectations of more cuts and with sustained earnings growth differential vs the index, we think these spaces would attract investor attention over the next period. We believe that the next period should see growth style of investing which we follow having an edge over the value style.
Thank you
Happy Investing
May the Good Times Continue
Source: Bloomberg, MOFSL, RBI, NSE Indices, MOAMC Internal
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