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Waiting for Godot

Nov 25, 2019

Waiting for Godot is a play by Samuel Beckett, in which two characters Vladimir and Estragon wait for the arrival of Godot, who never arrives, and while waiting they engage in a variety of discussions. It seems a fairly apropos representation of the much awaited emergence of growth debate in the domestic environment today.

A Look Back on Our Outlook Entering into 2019

This is the time of year that we traditionally review our investment outlook made at the beginning of the year. Recognizing that forecasts are by nature fraught with uncertainty, our view (Looking Ahead in 2019, Jan 7, 2019) was decidedly optimistic, non-consensus, and has essentially played out. By contrast, entering January 2018, the prior year, we were decidedly bearish, warning investors to trim exposure (The Illusion of Attention, Jan 25th, 2018), while the year prior, in 2017, we were tilting towards bullish (It Was the Best of Times, Nov 26, 2016).

Post a fairly strong 20%~ rally from the bottom this year, we delve further into the key factors impacting next year’s outlook in this commentary.

Blended Portfolio Yields Are at the Lowest in 15 Years in India

One measure of portfolio expected return is the combined the 10-year treasury yield and earnings yield on a 60/40, equity/bond portfolio. The blended yield for the U.S. stands at just 2.8%, with 1.77% from the 10 year, and 3.5% from the equities component of the portfolio.

In India, the blended portfolio yield is only slightly better, at 4.7%, with the bond yield at 6.48% and earnings yield (trailing) at a meagre 3.6%. (see chart above). To put things in perspective, the blended yield in Nov 2007 was a dismal 5.3%. In Mar 2009, it had risen to an attractive 7.5%. It was 7.5% in Aug 2013 as well, prior to the 2014 bull market. In other words, the blended yield on portfolios today is lower than it was in late 2007 and lower than Jan 2018.

The Blended Portfolio Yield on Equities & Debt Today is the Lowest in the Last 15 Years…
…This Suggests Forward Benchmark Returns Could be Muted

The Blended Portfolio Yield on Equities & Debt Today is the Lowest in the Last 15 Years

Nifty 50 Earnings Are Up a Solid 16.7%

Nifty 50 Earnings Are Up a Solid 16.7%

Mid Caps Have Delivered an Impressive Surge in Earnings

Mid Caps Have Delivered an Impressive Surge in Earnings

Chalk this up to low interest rates, low inflation, financialization, exuberance, Fed largesse, and a market that has run ahead of fundamentals. The obvious takeaway here is that forward long-term returns at the index level on blended portfolios could be muted.

But Earnings Reports Remain Solid for the Nifty 50 and Have Picked Up for Mid Caps…

We exclude Vodafone’s large loss and Bharti’s large gain from our analysis. With 493 companies reporting, top line growth is flat, and profits before tax negative, but the corporate tax cut has clearly aided earnings. Nifty 50 profits remain solid at 16.7% yoy, and mid caps have delivered solid earnings as well, aided by lower taxes.

We Expected the Monetary Transmission Mechanism To Show Progress By Now, Alas…

The transmission mechanism appears to be broken as lower rates are not feeding through to the consumer at the rate one would expect given the repo rate cuts. Meanwhile, financials have reported the highest top line growth of any sector at 20% and the highest profit growth. It is essential that the RBI mandate stringent rules on rate transmission. Until this matter is addressed, the normal feedback loops of lower interest costs and improving disposable income will not feed through the economy.

Investing Has Come Full Circle in the Past Decade

In late 2009, fear and skepticism reigned and revulsion for equities was the norm. Today, portfolios are fully invested in equities at high valuations. The cult of equity is well established. The pendulum has come full circle.

A New Era in Valuations Appears to Be Upon Us…

There was a time when a trailing P/E of 27.7 on the Nifty 50 led to general concern and worry. Today, the investment world is bought into the “high valuations mean nothing” rhetoric being proposed by well-respected fund managers. This argument for high valuations is supported by low interest rates, low inflation, global liquidity, domestic financialization, and the expectation that earnings will grow at high rates “forever”. We’ve been on that bandwagon ourselves, admittedly, but are now gradually weaning ourselves off it.

U.S. Manufacturing PMI Has Bounced Unexpectedly…

U.S. Manufacturing PMI Has Bounced Unexpectedly…

Globally, the U.S. PMI Data is a Welcome Surprise…

With much ado about the yield curve inversion a few months ago, and rising worries about late cycle dynamics, the recent PMI data in the U.S. has confounded many, indicating a pickup in economic activity. Other leading indicators are also suggesting a possible improvement in economic activity.

If it weren’t for Trump’s trade wars and a flatlining of business investment, the global economy would be in decent shape. Growth continues to trudge along at a moderate 2% pace, making it the weakest recovery ever and the longest business cycle expansion, and indications are it will likely plod along, aided by the Fed’s backstop.


We Remain Constructive, Yet Watchful, Due to 3 Key Reasons…

More money has been lost trying to avoid a recession or sell off than in actual sell offs. One, we believe the government will continue to come forward with additional stimulus and policy measures to help revive growth in the economy that will eventually bear fruit. Monetary policy is likely to remain accommodative.

Second, earnings have delivered a floor for the markets and with 16% PAT growth, and T.I.N.A., the trend is likely to continue for the next couple of quarters. Mid cap earnings have surprised positively. Select fund managers have generated respectable returns and are likely to continue to do so. Investors would do well to ally with these managers. We have shared our PMS performance below as one candidate to consider.

Finally, the U.S. economy continues to trudge along, a U.S. presidential cycle is upon us, and the Federal Reserve has the market’s back, stimulating the U.S. economy via bond purchases and rate cuts.

Reducing Portfolio Beta via Rotation Away from High Valuation Equities

Having said that, as we head into 2020, markets and the economy have diverged somewhat meaningfully. Avoiding the most expensive parts of the market and reducing beta risk in portfolios is a prudent choice in the current environment, post a fairly strong rally, in a weak economic environment with high valuations, and a stagnant consumer. We advise gradually reducing exposure to high valuation, low growth equities.

Multi cap portfolios that provide large cap quality and mid cap exposure now look attractive. Additional alternatives to reduce portfolio beta for risk averse investors, or for capital deployment, are structured notes, long short strategies, and low downside volatility funds such as Olympians. We’d gradually increase exposure to mid caps via Titans, our multi cap strategy.

PMS Strategy

We’ve pared down valuations on our multi cap PMS fund to 24 times FY20 earnings, and similarly our large cap PMS fund is now down to 29 times FY20 earnings.

A Sound Methodology and Prudent Management Can Generate Consistent & Meaningful Alpha

Finally, with much written about the demise of active managers, new research has come forward that states active managers do generate alpha but tend to squander it away over time.

Meanwhile, the Nifty 50 CAGR over the past 10 years is a sub-par 8.8%. One key factor for the mediocre index performance is index constitution. Passive investing is a decision that should be considered carefully in the India context, and alternative strategies to obtain market exposure make better sense.

Our PMS Funds Are Now Ranked #1, #2 on PMSBazaar Over 3 Years, 2 Years and 1 Year

The pmsbazaar rankings show that our large cap fund, is ranked #1 on 3 year performance, #1 on 2 year performance and #2 on 1 year performance. Our multi cap fund is #2 on 3 year performance despite owning 30-40% mid/small, and #7 on 1 year.

Our PMS Funds Are Now Top Ranked by PMSBazaar Over 1, 2 and 3 Years…
…A Sound Methodology and Prudent Active Management Generates Consistent Alpha…

Our PMS Funds Are Now Top Ranked by PMSBazaar Over 1, 2 and 3 Years

Our PMS Funds Are Now Top Ranked by PMSBazaar Over 1, 2 and 3 Years

Stock Selection Will be the Key Determinant of Returns

Rounding out the discussion at the stock level, listed below are a few representative stocks that have likely been a part of many investor portfolios. Even when the right stock is selected, holding on is no easy task. There are sharp drawdowns of 20% or more every 2-3 years. Volatility remains the price of admission, even for quality. Investing is simple, but never easy, but the rewards are well worth the effort.

Volatility is the Price of Entry in Equities…
…Wealth Creation Can be the Reward…
…Expect Volatility to Continue in the 2020s

Volatility is the Price of Entry in Equities

Fixed Income

Our Fixed Income view will be updated in our next commentary post quarterly update to our asset pairs methodology.

Technical Strategy

The Nifty has been sideways for last three weeks and failed to sustain above 12,000 levels. Nifty closed at 11,914 with marginal gain of 0.16%. Broader indices BSE Midcap and Smallcap were also flat for the week. For the third consecutive week Nifty has formed doji candlestick i.e. open and close around same levels indicating indecisiveness in the market. Thus, index needs to clear overhead resistance zone of 12,000-12,100 for breakout in market. Then Nifty can rally towards 12,350-12,400 levels. On the downside immediate support is seen at 11,800; breaking below which decline can be seen towards 11,490 levels. In Nifty monthly November options, maximum open interest for Puts is seen at strike price 11,500 followed by 11,900; while in Calls strike price 12,000 has huge open interest build up followed by 12,100. Nifty options distribution is suggesting stiff resistance in the range of 12,000-12,100 and support at 11,800 levels. India VIX closed at 14.87 down by 1.06% for the week. VIX has been largely sideways to negative which is supporting the Nifty at higher levels. However any spike in VIX above 17 levels will to sharp profit booking in market.

Technical Strategy

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