Vijay Kumar Gaba

Stagflation is an economic environment with rapidly rising prices, a weak labor market, and low GDP growth.

The recent corporate commentary throws light on some important economic trends. These trends, which might have been developing for few years, are becoming more established on ground now.

The most discussed trend since demonetization (November 2016) and GST (July 2017) has been the transfer of market share from smaller unorganized businesses to the large organized businesses. Import substitution (Make in India) has been another trend that has gained significant currency in past 4-5 years. This has manifested most prominently in the capacity building in chemical and renewable energy space. These trends have obviously helped the larger publically traded companies to grow bigger and more profitable. The buoyancy in stock market, a representation of these larger companies, is aptly reflecting these trends.

One trend that has escaped the popular narrative and closer scrutiny is selective stagflation in the economy. We may say this is an integral part of the overall ‘K” shaped economic growth. The rising inequality and falling affordability of a larger part of the population has happened with sharp rise in prosperity in the top decile of the society.

The recent corporate commentary hints that this divergence in affordability might have started to impact their performance now.

Mass affordability worsening with rise in premiumization

As per a recent survey conducted by the brokerage firm Nomura Securities the affordability of mass segment has been adversely impacted, leading to slowdown in consumption demand. In the case of automobiles, the survey indicates that festive season sales for two-wheelers and entry segment cars have been slower whereas for premium segment (cars priced >INR 1mn, mostly SUVs) has been significantly strong as higher income segments continue to do well (SUV mix up from ~39% in FY21 to ~55% in Sep-21). The sharp price increase for vehicles since Mar-20 seems to have impacted affordability for the mass market.

In the case of Consumer segment, rural market growth for FMCG (as per Nielsen) has seen a substantial slowdown in Aug/Sep (+2.5% y-y) vs. Jan-Jul (+12.5% y-y). In contrast, urban consumption has held on much better due to the easing of restrictions. Since rural consumption is driven more by mass segments, poor affordability has likely hit the demand. On the other hand, urban consumption should benefit from re-opening-led recovery. In the case of Durables segment as well, while retail sales sustained healthy growth in July, the momentum has slowed substantially from August with likely low single-digit growth in Sept. In electricals, while housing sales have picked up, supported by a cut in stamp duty rates, they are still annualizing close to 2018-19 levels only.

The brokerage concludes that the prices of white goods/appliances have increased by ~10-15% and W&C by ~35% in the past one year. Current commodity prices (Aluminum and Copper) are further up ~20% q-q. Unless commodities/oil cool off, firms will face a difficult choice of raising prices further and risk demand impact or endure margins pressure. The brokerage believes latter is more likely.

…as consumption demand return to pre Covid levels

The brokerage firm India Infoline highlighted in a recent note that “FY22/23 sales for some consumer sectors can be higher than even previous pre-Covid estimates, as unaddressed demand, in addition to the normal demand, is fulfilled. We have seen this play out in paints, and believe that this is now unfolding in jewellery too. Further, this could also materialise, albeit to a lesser extent, in Apparel. While there is no pent-up demand in Grocery, a full normalisation is not built into the consensus estimates We believe that in QSR, though, significant normalisation is already built in.”

The note emphasizes, “Apart from market-share gains from the unorganised segment and

income impact on the target audience being lower than on the overall economy, return of unaddressed demand is a big factor in certain sectors.”

Inflation replaces the pandemic as risk in the Corporate commentary

The ongoing corporate quarterly results reporting season is progressing rather well. Most of the companies that have reported till now appear to have recovered from the Covid-19 pandemic shock. The business leaders appear to have gained market share. Balance sheets have strengthened with deleveraging and/or higher cash. The working capital management has improved sharply across businesses. This may reflect on slightly lower RoE for now. Margins are under pressure, as the companies have not been able to pass on the raw material to the customers.

Employee cost a mixed picture

The sectors like manufacturing and construction have witnessed cut in employee costs, whereas the IT Services etc. have seen rise in employee cost. Read with strong inflationary trends, this clearly indicates that a large section of population may be facing Stagflationary situation.

Rural vs Urban demand

The trends in rural demand growth vs urban demand growth are also mixed. For example, Colgate reported strong rural demand, while Nestle & HUL reported moderation in rural demand.

Market consolidation accelerates

Most market leaders emphasized focus on market share gains at the expense of profitability, while mid and small cap companies emphasized focus on protecting the profitability. Obviously, we are witnessing a shift from small to large in terms of market share.

Covid-19 no longer a key concern

The commentary for future prospects is much better this quarter, as compared to the previous 4-5 quarters. In the last quarter, most companies had highlighted the likely third wave of the pandemic as a key risk. However, in this season, the Covid-19 is not highlighted as a key risk by most of the companies which have reported so far.

Banks’ results have not shown any notable rise in stress on asset quality due to the pandemic; though credit growth remains below par.

Ecommerce and organized distribution channel growing fast

Most consumer facing companies have reported acceleration in growth in ecommerce channel.

Working capital improvement

Most companies are reporting substantial improvement in working capital due to better channel financing, efficient inventory management, internal controls, efficiency in collection, etc. This is reflecting on credit growth, especially short term borrowings from banks.

Highlights of corporate commentary

The following are some of the key results of the consumer facing companies, that are indicative of the underlying economic and industry trends.

Polycab India Limited (Wires, Cables, Home Appliances) – Earnings downgraded

The revenue for the quarter was 48% higher yoy, with cables growing 44%; Appliances growing 41% and EPC revenue was higher by 60% yoy.

Cable business, where the company is market leader, saw increased competitive intensity, as the demand environment was poor. Most of the revenue growth in cables was due to price hikes. Though the price hikes were inadequate to cover for the raw material inflation. Gross margins contracted sharply by 690bps while operating margins were down 510bps. PBT was down 7%.

The company was however able to gain market share across categories. The management emphasized that for now the focus shall remain on market share gain, rather than margin improvement. Accordingly, the management has guided for low double digit EBIDTA (11-13%) margins in the second quarter.

RoE of the company is expected to decline by 200bps in FY22 to 16.5% from 18.5% in FY21, despite marginal improvement in EPS. Working capital improved.

Havells Ltd (Wires, cables, lighting, switches, Appliances) – Earnings downgraded

Revenue grew 31% yoy, driven by (a) strong volume growth due to higher demand from real estate, industrial and infra segments; and (b) higher prices due to sharp rise in raw material cost. EBIDTA margins declined 340bps yoy, due to lag in taking price hikes to pass on the higher raw material cost. Steep cut in advertisement and promotion (A&P) cost helped in checking the sharp decline in margins.

The company reported market share gains from unorganized sector. The management expects the trend to continue. It also expects the margins to improve as price hikes are taken. Working capital improved.

Management buoyant on 2HFY22 prospects; though the rate of growth could be lower due to higher base effect.

Market feedback: Some MSME component supplier to the appliances manufacturers have reported significant order cancellations, delays in payment, and poor inventory levels at smaller and mid-sized OEMs. There are clear indications that the market consolidation trend may continue and accelerate in coming quarters.

Orient Electric (Consumer electronics) – Earnings retained

The company reported 37% yoy rise in revenue and 290bps lower EBIDTA margins. PAT was up 7%.

ECD segment margin were impacted due to steep rise in input costs, however, Lighting segment saw improvement in margins due to high growth in consumer lighting business. Discretionary spends was lower than normal, whereas expenses other than discretionary resumed to normal levels.

The management highlighted Strong recovery in B2C demand; unorganized share will shrink more with change in star rating. OEL will gain market share, backed by its strong team, brand, and distribution (increasing presence in south and rural India).

Working capital has improved due to better channel financing and internal controls.

Colgate-Palmolive (Oral Hygiene) – Earnings downgraded

Colgate reported 5% yoy rise in revenue with 4% rise in volumes. EBIDTA margin declined by 220bps due to higher raw material cost; employee cost and ad spend. The management expects the cost pressures to continue in 2HFY22.

The management apparently stays focused on market share gains rather than margins. Increased promotional intensity and new product innovation is driving volumes with lower realization.

The management does not see any pressure on rural demand, which continues to remain resilient. Market share gains continue, with strong penetration trends.

Nestle (FMCG) – Earnings downgraded

Revenue grew by 10% yoy, whereas EBIDTA grew 6% due to margin contraction of 90bps. Gross margins were down 240bps due to surge in raw material and packaging material prices. Lower employee cost checked the margin decline.

The company reported moderation in rural growth, while the urban growth remained resilient. The management stays focus on volume led sales growth with new sales channels and new capacities coming on stream.

Hindustan Unilever (FMCG) – Earnings downgraded

HUL reported a strong 11% yoy sales growth and 9% EBIDTA growth. Gross margins declined by 140bps, despite 7% price hike across portfolio. Cost savings helped cheking the margin decline, but raw material inflation is expected to continue to keep margins under pressure.

The management highlighted improving trends in urban markets, while the rural demand has moderated. The management feels that the rural demand moderation appears transient, but this could be a risk to growth ahead.

Tata Consumer Products (FMCG) – Earnings retained

Tata Consumer reported a yoy revenue growth of 9% YoY and EBITDA margin contraction of 70bp. The margins compressed mainly due to higher A&P and other expenditure.

Revenue in India Branded Beverages/Foods grew 13%/23% YoY. Revenue from Tata Starbucks grew 128% YoY.

The company managed to reduce its working capital days by 16 days in 1HFY22 as it has moved towards a cash and carry model for the general trade channel.

The company had gained market share in Tea (+190bp YoY) and Salt (+160bp YoY) in FY21. The trend continued in 1HFY22). It doubled its direct reach to 1.1m by Sep’21. The company is establishing a strong S&D channel, which would act as a key growth driver.

Jubilant Foodworks (Food) – Earnings upgraded

The company reported 37% yoy rise in revenue and 33% rise in EBIDTA. Lower staff cost helped in protecting the margins.

Delivery and takeaway continue to drive growth with 36.8% and 72.2% growth respectively vs pre-Covid levels. The Management commented that there was an initial dip in delivery as dine-in started to recover, but it still continues to be meaningfully ahead of pre-Covid levels.

Company highlighted meaningful demand uptick helped it to more than make up for lost operating hours in closed stores. Growth was seen across town classes, with stronger growth in smaller towns and non-metros; stores are now operational at ~95%.

The management highlighted that the Ticket sizes are higher compared to pre-Covid levels and company expects it to remain high due to change in channel mix (delivery mix to remain elevated even as dine-in normalizes) and increase in delivery charge. Apart, the company is also using premiumization and personalization to drive ticket sizes higher.

Kajaria Ceremic (Building material) – Earnings upgrade

The company reported a 36.6% yoy rise in revenue and 25.6% higher EBIDTA. The maker of premium tiles operated at full capacity, as unorganized players in Morbi struggled with higher gas prices and poor export demand due to higher freight cost.

The company managed to pass on the higher raw material and logistic cost; improved working capital materially.

The management commented that Demand from tier II/III/IV towns is very positive and urban demand is good owing to keenness for large premises. The company is expanding tile capacity by 12.4m sq.mtr. by Q4 FY22 at Rs2.5bn-2.75bn capex. Despite the expansion, the headcount will be the same for the next three years.

The management highlighted that Freight costs increased from $1500-2000/container to $7000-8000 for China whereas gas prices increased by 300-400% in Europe in the last 1.5 months leading to €1.5/sq.cm cost increase.

Asian paints (Building materials) – Earnings retained

Asian Paints revenue grew 32.6% yoy. The company witnessed strong growth momentum in both urban and semi urban areas. The company reported strong market share gains from both organized as well unorganized firms. It strongly expanded its ‘Rurban’ footprint by adding 40k new retail points in the past two years.

The management highlighted that Pick-up in industrial activities and housing construction have led to strong double-digit growth in the industrial coatings business and in the bath and kitchen businesses.

Margin pressure (gross margin down 966bp YoY in Q2) was high, due to sharp cost inflation (20% YoY inflation impact on raw material basket). However, if input prices remain stable, APNT is confident of improving margins in the next couple of quarters – It guided for margin normalization by Q4, led by price hikes, efficiency in raw material formulations and overhead cost savings.

The company also reported RoE contraction and working capital improvement.

Titan Company Limited (Consumer discretionary) – Earnings upgraded

Titan reported 64%.6% yoy rise in revenue and 209% rise in EBIDTA. Lower staff cost and other expenses protected the gross margins which were down 690bps.

Jewellery sales grew 65% YoY and margin was up 500bp YoY to 12.2%. Watches sales grew 71.8% YoY to INR6.9b with EBIT margin coming in at 13.1% in 2QFY22 as against -3% in 2QFY21.

The company is witnessing market share gains across every region and city according to the management. TITAN has a strong growth runway, given its market share of less than 10% and the continuing struggles faced by its unorganized and organized peers.

There are two types of investors in Indian stocks markets – (i) who own all Tata group stocks and all internet and related businesses like IRCTC, IEX, IndiaMart, InfoEdge etc.; and (ii) the others who own none of these. (It’s a Joke or Irony only time could tell.)

A survey of Indian investors indicates that presently the investor positioning and opinions are deeply and widely divided. The survey in the form of a free unstructured discussion with some professional, household and institutional investors was conducted over past two weeks.

Indian investors – A divided house

Based on the discussions, the investors in Indian equities could be divided into the following ten broad categories –

(i)    Fearful - Investors who are fully invested and are overweight in equities and/or cryptocurrencies but are uncomfortable with the current price levels and volatility. This category mostly involves High Networth households who have significantly increased their active involvement in the financial markets over past couple of years. Most of these investors have earned good return on their capital. They are moderately leveraged. Most of them have yet not defined any strategy to moderate their exposure to risk assets, though they are afraid of severe market correction and erosion in the value of their portfolios. Some of them are exploring investment in real estate by taking some money out from financial investments. They have been consistently reducing exposure to debt instruments and increasing allocation to equities and other risk assets.

(ii)   Fearless - Investors who are exclusively trading in risk assets like equities and cryptocurrencies, and are not bothered at all about the current price levels or volatility. These are mostly household investors (not necessarily high Networth) who have taken to trading in financial markets as their full time occupation in recent past. They enjoy the high volatility and are least bothered about the things like valuations, business models, sustainability etc. They have moderate to high leverage; and mostly have negligible allocation to debt securities.

(iii)  Optimistic - Investors who are deeply convinced about the “India Story”. They believe that the valuation premium for Indian equities is justified given the high growth potential, changing global supply chain landscape, increasing level of organized businesses and larger role of Indian businesses in the new economy. These are mostly professional and institutional investors. Many of these have recently increased their allocation to equities given the pressure on bond yields. Only a few of these would advise leveraged positions in equities at present level.

(iv)   Cautiously optimistic - investors, who are convinced about the long-term ‘India Story”, but find the present price levels unsustainable in the short term. These investors are a mix of professional investors, institutional investors and high networth households. They have been reducing their equity allocation for past couple of months. Paradoxically, some of these have increased the allocation to high yielding (credit risk) debt.

(v)    Hopeful - Investors, who misjudged the markets in the past 20 odd months. They either reduced their equity allocation significantly after pandemic breakout; or during the market rise in the past 6-9 months. These are mostly professional and household investors. They are overweight on debt, gold and alternatives like arbitrage funds that have yielded very poor returns over the past 20 months. These investors are sincerely hoping for a major correction in the equity prices so that they can correct their mistake by increasing their equity allocations. Ironically, many of these investors have increased their allocation to foreign equities in past one year to compensate for lower allocation to the best performing Indian equities. Their arguments for investing in Asian (mostly Chinese) and US equities are varied and mostly unconvincing. For example, a veteran investor allocated 10% of his portfolio to US Tech stocks, while vehemently arguing against the valuation of Indian IT and internet sector. Similarly, a professional investors, who listed meltdown in China as one of the key risks for the market, is invested in a global fund focused on Asian Tech sector (mainly Chinese semi conductor and internet stocks).

(vi)   Happy - Investors, who stayed composed and disciplined during the market volatility and religiously adhered to pre-determined asset allocation. These are mostly professional investors and high networth households. Many of them have changed their strategic asset allocation to increase the weight of equities in past one year; while maintaining a conservative debt profile. These investors are closely observing the markets for any lucrative opportunity, but are not perturbed by the present volatility.

(vii)  Dismissive - Investors, who have materially cut their allocation to risk assets like equities in the past 20 odd months and are regretting their decision badly. They are mostly household investors. They are regularly convincing themselves that the entire rally from March 2020 lows is farcical and the prices will correct to those levels in next one year. Though, many of these are actively looking at real estate to make up for the opportunity loss of equities. Interestingly, some of these are actively trading in commodities.

(viii) Hypocrite – Investors who are cautious and fearful in their personal capacity, but are advising others to increase the weightage of risk assets in their portfolios. These are mostly professional and institutional investors. A couple of fund manager who sounded extremely cautious in their comments, were actually seen aggressively marketing their small cap funds a few hours later.

(ix)   Explorers – investors who are consistently looking for profit making opportunities in the market, regardless of the benchmark index numbers, pockets of over exuberance and popular trends. These are mostly professional and institutional investors, who are either running ahead of the market in identifying new trends and rotating their portfolios to position for the likely emerging trends; or discovering the pockets of under valuations and positioning their portfolios with the assumptions that these pockets will soon converge with the broader market trends.

(x)    Observers – these are mostly passive or inactive investors, who observe the markets from a distance and have little position of their own. They are financially unaffected by the market movements; however many of them are very aggressive and emotionally charged about their opinions about markets. They love to express their views and offer advice to fellow investors.

While you discover what category you fall in; it might be worthwhile to also figure out- do you truly belong where you are, or you just drifted to this category unintentionally/unconsciously.

The recent visuals of the massive destruction in Uttarakhand due to rains are heart wrenching. The repetitive loss of human life due to frequent natural disasters in past decades is extremely frustrating.

The recent floods and landslides in the Himalayan state are stark reminder of the fact that no lesson has been learned from the 2013 Kedarnath tragedy. Unmindful construction in the path of rivers and rain water drains; cutting of millions of trees to build/widen roads; and unsustainable strain on the sensitive ecology due to excessive tourist flows has not only continued unabated post 2013, but has actually increased.

Since 2013, the State has witnessed multiple natural disasters almost every year. The visuals of rain water storming the Nainital town clearly indicates that the natural rain water drains have been obstructed/encroached and forest cover for the city has been denuded.

There is nothing to suggest that this fight between the Nature and our greed will stop any time soon. The development planner must understand that construction of development edifice which are directly in conflict with sustainability and core beliefs must be rejected out rightly.

Unfortunately, we have not seen any policy drive to this effect despite frequent natural disasters; though many efforts to the contrary have come forth. The major road project in the Garhwal Himalaya to connect the four sacred temples in upper reaches through a wider road network is only one example of the unsustainable development.

The stated objective of the project is to make it more convenient and safer for the pilgrims to visit these sacred temples. As a frequent visitor to the region, I can vouch that the ecology of the region is already facing serious threats. This widening of roads has not only caused cutting of numerous trees, but is also resulting in massive increase in vehicular traffic and number of pilgrims visiting the region. Rise in pollution & garbage, pressure on infrastructure, massive construction of room capacities and other conveniences is actually destroy the sanctity of the place itself; and killing the sacred rivers that originate from there.

(Image sourced from the Internet. All rights acknowledged)

There are two types of investors in Indian stocks markets – (i) who own all Tata group stocks and all internet and related businesses like IRCTC, IEX, IndiaMart, InfoEdge etc.; and (ii) the others who own none of these. (It’s a Joke or Irony only time could tell.)

A survey of Indian investors indicates that presently the investor positioning and opinions are deeply and widely divided. The survey in the form of a free unstructured discussion with some professional, household and institutional investors was conducted over past two weeks.

Indian investors – A divided house

Based on the discussions, the investors in Indian equities could be divided into the following ten broad categories –

(i)    Fearful - Investors who are fully invested and are overweight in equities and/or cryptocurrencies but are uncomfortable with the current price levels and volatility. This category mostly involves High Networth households who have significantly increased their active involvement in the financial markets over past couple of years. Most of these investors have earned good return on their capital. They are moderately leveraged. Most of them have yet not defined any strategy to moderate their exposure to risk assets, though they are afraid of severe market correction and erosion in the value of their portfolios. Some of them are exploring investment in real estate by taking some money out from financial investments. They have been consistently reducing exposure to debt instruments and increasing allocation to equities and other risk assets.

(ii)   Fearless - Investors who are exclusively trading in risk assets like equities and cryptocurrencies, and are not bothered at all about the current price levels or volatility. These are mostly household investors (not necessarily high Networth) who have taken to trading in financial markets as their full time occupation in recent past. They enjoy the high volatility and are least bothered about the things like valuations, business models, sustainability etc. They have moderate to high leverage; and mostly have negligible allocation to debt securities.

(iii)  Optimistic - Investors who are deeply convinced about the “India Story”. They believe that the valuation premium for Indian equities is justified given the high growth potential, changing global supply chain landscape, increasing level of organized businesses and larger role of Indian businesses in the new economy. These are mostly professional and institutional investors. Many of these have recently increased their allocation to equities given the pressure on bond yields. Only a few of these would advise leveraged positions in equities at present level.

(iv)   Cautiously optimistic - investors, who are convinced about the long-term ‘India Story”, but find the present price levels unsustainable in the short term. These investors are a mix of professional investors, institutional investors and high networth households. They have been reducing their equity allocation for past couple of months. Paradoxically, some of these have increased the allocation to high yielding (credit risk) debt.

(v)    Hopeful - Investors, who misjudged the markets in the past 20 odd months. They either reduced their equity allocation significantly after pandemic breakout; or during the market rise in the past 6-9 months. These are mostly professional and household investors. They are overweight on debt, gold and alternatives like arbitrage funds that have yielded very poor returns over the past 20 months. These investors are sincerely hoping for a major correction in the equity prices so that they can correct their mistake by increasing their equity allocations. Ironically, many of these investors have increased their allocation to foreign equities in past one year to compensate for lower allocation to the best performing Indian equities. Their arguments for investing in Asian (mostly Chinese) and US equities are varied and mostly unconvincing. For example, a veteran investor allocated 10% of his portfolio to US Tech stocks, while vehemently arguing against the valuation of Indian IT and internet sector. Similarly, a professional investors, who listed meltdown in China as one of the key risks for the market, is invested in a global fund focused on Asian Tech sector (mainly Chinese semi conductor and internet stocks).

(vi)   Happy - Investors, who stayed composed and disciplined during the market volatility and religiously adhered to pre-determined asset allocation. These are mostly professional investors and high networth households. Many of them have changed their strategic asset allocation to increase the weight of equities in past one year; while maintaining a conservative debt profile. These investors are closely observing the markets for any lucrative opportunity, but are not perturbed by the present volatility.

(vii)  Dismissive - Investors, who have materially cut their allocation to risk assets like equities in the past 20 odd months and are regretting their decision badly. They are mostly household investors. They are regularly convincing themselves that the entire rally from March 2020 lows is farcical and the prices will correct to those levels in next one year. Though, many of these are actively looking at real estate to make up for the opportunity loss of equities. Interestingly, some of these are actively trading in commodities.

(viii) Hypocrite – Investors who are cautious and fearful in their personal capacity, but are advising others to increase the weightage of risk assets in their portfolios. These are mostly professional and institutional investors. A couple of fund manager who sounded extremely cautious in their comments, were actually seen aggressively marketing their small cap funds a few hours later.

(ix)   Explorers – investors who are consistently looking for profit making opportunities in the market, regardless of the benchmark index numbers, pockets of over exuberance and popular trends. These are mostly professional and institutional investors, who are either running ahead of the market in identifying new trends and rotating their portfolios to position for the likely emerging trends; or discovering the pockets of under valuations and positioning their portfolios with the assumptions that these pockets will soon converge with the broader market trends.

(x)    Observers – these are mostly passive or inactive investors, who observe the markets from a distance and have little position of their own. They are financially unaffected by the market movements; however many of them are very aggressive and emotionally charged about their opinions about markets. They love to express their views and offer advice to fellow investors.

While you discover what category you fall in; it might be worthwhile to also figure out- do you truly belong where you are, or you just drifted to this category unintentionally/unconsciously.

…and how they view the market

The investors in different categories analyze the present market conditions and trends from their own vista points. Obviously, they have divergent views, opinions and outlook for the markets. The following are some of the market views that are interesting to note.

Perception versus realty

While it is fashionable to talk about the stocks from some business groups (e.g., Tata, Adani etc.), the top gainers since first lockdown (23 March 2020) and second wave (01 April 2021) amongst the NSE500 group show no clear pattern or trend.

The top 25 gainer since first lock down do have significant participation of Adani group stocks and midcap IT Services, but otherwise the stocks and sectors are diversified. An overwhelming majority of stocks are small cap and there is no large cap stock in top performers. These stocks belong to a variety of sectors like IT Services, Energy, Telecom, Textile, Specialty Chemicals, capital goods, and pharma etc.

Contrary to popular perception, specialty chemical, pharma, and metals have scant representation in this group. Internet and retail are totally absent from this group. There is only one Tata Group stock (Tata Elxsi) in top 25 list, and no metal stock, except Jindal Stainless.

The list of top 25 underperformers is also quite random and lacks any clear trend or pattern. Apparently, Banks and Microfinance Institution appear to be top under performers. But most names included in the list have company specific reasons for their underperformance and do not necessarily represent any trend.

If we look at the market trends since second wave, a similar randomness is observed. There is no clear pattern or trend visible from the top outperformers and underperformers during April-September 2021 period. No Tata, Adani, Internet, Retail, IT services, PSU dominance is visible. Auto, Consumers and Hospitality stocks are also absent from the lists.

If we observe the sector-wise trend over the two time frames April 2020 to September 2021 and April 2021 to September 2021, we do get some interesting trends. For example,

Trends and patterns since first lockdown till September 2021

(a)   More sectors have underperformed the Nifty50, then the number of sectors that have outperformed; implying that the rally since lows of March 2020 has actually been much narrower than it is perceived; even though the broader markets have outperformed the benchmark indices by wide margin.

(b)   The global trends (IT and Metals) have dominated the markets since first wave. Contrary to popular perceptions, Pharma has been an underperformer.

(c)    Financials have underperformed materially, despite significant improvement in the operating performance and asset quality.

(d)   Realty sector has outperformed though not significantly.

(e)    Small cap (123%) and Midcap (76%) have significantly outperformed the benchmark Nifty (32%).

(f)    FMCG (and hence MNCs) have been the worst performers in this period. It would need lot of explaining to rationalize the outperformance of commodities when the consumption demand and capacity utilizations are at poor level.

(a)   In post second wave period, more sectors have outperformed the benchmark Nifty than the number of sectors that underperformed. The gap between the performance of smallcap/midcap and benchmark Nifty also widened further.

(b)   The domestic sectors like Realty, Infra, PSUs, Media and power joined the list of outperformers alongwith the global sectors like IT Services and Metals.

(c)    Surprisingly, Automobile has been the worst performing sector in this phase, despite some superlative performance from auto major Tata Motors.

(d)   Financials continued to underperform, despite popular perception of PSU Banks doing very well.

(e)    Pharma and Consumers also remained notable underperformers.

(f)    Given the rise in inflation (building material), rise in bond yields and expectations of monetary tightening; the bullishness in Realty while the lenders continue to underperform and the household participation in equity market is rising sharply is also a subject for deeper analysis.

Given the total randomness of the market performance, it is difficult to draw any meaningful conclusion from the performance during April 2020 and September 2021.

So far there is little sign of any sector’s overwhelming dominance on the market. Nonetheless, there are some small pockets of over exuberance and unsustainable valuations, where the investors need to tread with extreme caution.

In particular, the themes like renewable energy, ecommerce and hyperinflation have driven prices of some stocks to levels which may be unsustainable even if we extrapolate current business trends to 20yr forward.

Indubitably, renewable energy is a paradigm shift in global economics and may be a great business opportunity; but the assumption that all renewable energy producers and their ancillary units will make enough money to justify current valuations appears mostly off the mark.

The assumptions that current commodity prices will sustain the slowing growth, tightening money, declining consumption and normalizing supply chains even for a year appear absurd.

It is therefore likely that we might see a major sectoral rotation in next 6months, while the present broad trend (broader markets outperforming the benchmark) continues.

 The Ministry of Power, Government of India, recently issued Draft Electricity (Rights of Consumers) Amendment Rules, 2021 for public comments.

The amendment seeks to stipulate the following three rules to the existing rules:

“1.   “In view of the increasing pollution level particularly in the metros and the large cities, Distribution Licensee shall ensure 24x7 uninterrupted power supply to all the consumers, so that there is no requirement of running the Diesel Generating sets.

2.    Consumers, who are using the Diesel Generating sets as essential back up power, shall endeavor to shift to cleaner technology such as RE with battery storage etc in five years from the date of the publication of this amendment or as per the timelines given by the State Commission for such replacement based on the reliability of supply by the distribution company in that city.

3.    The process of giving temporary connections to the consumers for construction activities or any temporary usage etc. shall be simplified by the distribution licensee and given on an urgent basis and not later than 48 hours. This will avoid any use of DG sets for temporary activities in the area of the distribution licensee. The temporary connection shall be through a prepayment meter only.”

The proposed amendments appear to be governed by the desire to minimize the air pollution levels in India through all means. Prima facie, this is a well-intended thought and should be welcomed. However, a careful analysis of the context and proposed measure would suggest that these rules take the zeal for ESG a little too far.

Insurance value of DG backup ignored

These rules simply ignore the “insurance” value of the power back-up provided by the power generating sets (DG Sets).

These rules also seems to be denying the modern world where there are significant number of mission critical and life-saving functions that cannot afford power outage even for few seconds. Hospitals for example cannot afford to risk power outage in ICUs and lifts. Large apartment buildings cannot afford power outage in lifts. Data centers and banks’ servers cannot afford power outages even for few seconds.

DG Sets provide insurance against power outages to these functions. The power back up that relies on nature (solar and wind) may not provide adequate insurance cover in cases of natural calamities like cyclones, prolonged sun outages due to persistent rain etc.

This is the insurance value of DG Sets that prompts use of DG Sets in cities like Mumbai, where the distribution companies are obligated to ensure 24X7 power supply for past many decades.

The rules assume that most large buildings will have enough roof top and other open space to install solar panels that would generate adequate electricity to keep the battery bank charged to support the emergency and mission critical functions. This assumption may be mostly erroneous.

Whereas the rules put onus of supplying the uninterrupted power on the distribution licenses, it does not speak about grid failures, in which case distribution companies will be helpless.

The proposed rules also seem to be disregarding the available data on sources of air pollution in large metro cities. Numerous studies have indicated that the share of DG Sets in overall air pollution in large cities may be miniscule (2%). This level will fall further significantly after implementation of CPCB-IV norms in DG Sets. It is therefore important to focus on industrial clusters and farms for pollution control (through DG Sets) rather than large cities, IT Services clusters and residential complexes.

It is pertinent to note that in past 3 years, there have been some instances of implementing ban on use of DG sets during months when pollution levels usually spike. For example, in 2018, the Supreme Court-appointed Environment Pollution (Prevention and Control) Authority (EPCA) had banned diesel generator sets only in Delhi during the Graded Response Action Plan (GRAP). The Delhi Pollution Control Committee (DPCC) had issued a large list of exemptions where DG Sets were allowed. These included DG Sets used for essential services such as medical purposed (hospitals or nursing homes or healthcare facilities) elevators or escalators, railway services or railway station, Delhi Metro Rail Corporation services including its trains and stations, airports and interstate bus terminus, lifts of housing societies, etc.

Technological evolution of DG Sets denied

While the draft amendment rules emphasis on adoption of cleaner technology, they fail to acknowledge that DG Sets are also evolving fast in cleaner technology terms. The present genre of DG Sets emits significantly lower smoke and noise as compared to the legacy DG Sets. Moreover, the technology evolution of DG Sets and diesel (as a fuel) continues as we read this. Ethanol based generating sets are already being tested and gas based generating sets are in use at some places. But given the uncertainties of supply chain of ethanol and gas, diesel continues to be the most preferred fuel for power backup systems, for now.

ESG may be crossing some redlines

These rules are not isolated instance of the whole ESG paradigm crossing the red line of pragmatism & purpose; and venturing into the realm of over zeal and activism.

There is absolutely no denying the need and importance of the consciousness about good environment, sustainability and governance practices. But these practices must be pragmatic and not suffer from dogmas.

For example, we have seen a lot of ESG conscious investors shunning companies like ITC Limited, which has been amongst the few companies with positive water and carbon emission footprint for long, and embracing largest refineries and plastic producers as fully ESG compliant.

Setting tougher emission norms for DG Sets, like BS VI for vehicles, would be far more effective than replacing these with solar powered backup. DG Sets meeting the enhanced emission norms will be used in across the country and in all sectors. Therefore, the impact on environment will be much more impressive.

The government agencies and businesses which tried to transgress the territory of the Niyamgiri Devta (an epitome of environment and sustainability) may not be taken seriously if they talk about ESG. It has to be imbibed as a way of life not a goal to be scored.

Fear, paranoia and resilience prevails in 1HFY22

The financial year FY22 started with the country reeling under the impact of an intense second wave of Covid-19 pandemic. The images of citizens struggling for life saving drugs and Oxygen, overcrowded cremation grounds and corpses of the victims of pandemic floating in the Ganges were imprinted on peoples’ consciousness. For once, disease, death, and desperation dominated the popular narrative.

The life seemed still with everyone becoming fearful and paranoid. It felt that spirituality and austerity would dominate the behavior of common man for many months to come. The government went into overdrive to build health infrastructure, provide assistance to helpless citizens and planned, what would eventually become, the biggest public vaccination drive ever in history of mankind. The austerity and fiscal discipline did not appear to be anywhere in the list of top priorities.

The macro economic data for 1QFY22 however presented a slightly different picture. Private consumption was the largest contributor to the growth and government had refrained from spending much.

The 1QFY22 growth came in better than most had anticipated as the sporadic lockdowns did not affect the economic activity. The recovery in 2QFY22 appears to be much better than estimates, with many indicators reaching pre pandemic levels. The growth estimates for FY22 have been accordingly revised upwards by most agencies.

…did not impact financial markets

The financial markets also did not reflect the sentiments peddled in the popular narrative. Despite, the government incentives to promote local manufacturing; acceleration in award of contracts for large infrastructure projects; the government support and incentives for MSME credit; significant expansion in digital banking ecosystem; revival in real estate market, etc. the credit demand growth is persisting at multi decade low levels.

The stock market has witnessed heightened activity, with benchmark indices gaining close to 20% in 1HFY22 on the back of much higher participation from the household investors. Mid and small cap stocks dominated the activity, indicating the strong dominance of the sentiment of greed over the sentiment of fear.

The market rally has been rather intriguing, given that environment for equities has not been very supportive from conventional wisdom viewpoint.

The following factors, which have bothered the equity markets historically, have been conspicuous by their exalted presence.

·         The energy prices (Achilles heel of the Indian economy) have climbed sharply higher. The second round impact of the energy inflation have also become visible in higher costs of production and freight.

·         Food inflation has persisted at elevated levels. In fact, headline inflation has persisted above the RBI comfort zone for many months, terminating any chance of further monetary easing by RBI. The debate now circles around the tightening schedule of RBI.

·         The vulnerabilities of the Chinese financial system have been exposed with one of the largest real estate developer defaulting on its debt obligations.

·         The central bankers of developed countries gave clear signals that the monetary easing has peaked and their next step would most likely be the monetary tightening.

·         RBI has shown tolerance for higher yields and slightly weaker INR.

·         Institutional investors have remained on the fringes for most part of the 1HFY22.

·         The cold war like condition between US and China has intensified further. Polarization of global trade majors is also increasing

·         Geopolitical situation at northern borders remains alarming, with no resolution in sight for Sino-Indian standoff at LAC and increasing influence of China and Pakistan in Afghanistan.

·         The strong leader of Germany lost elections to the left alliance, reinforcing the trend of the left leaning socialists gaining power in most of the large countries, the environment for free trade and globalization continues to worsen.

·         The weather has been extremely erratic world over. Unusual weather pattern were seen across continents. Unusual snow fall and drought in Latin America; Drought, extreme heat and wild fires in North America; floods in Europe, China and Indian sub-continent caused extensive damage to crops and supply chain disruptions. The prices of industrial raw materials and food increased materially world over.

·         The corporate earnings have been stronger than the estimates in 1QFY22, but the valuations in many pockets are seen prohibitively high. The valuations in commodity sectors like metals and chemicals etc. seem to discounting the current inflationary trends to the eternity.

Money in pocket may not reconcile with profits shown in SM timelines

Regardless of the presence of the supposedly adverse factors, the equity markets have remained quite resilient so far.

However, in past couple of weeks the volatility in markets has increased significantly. While various commentators and observers have attributed the rise in volatility to one or more of the above listed factors; it is pertinent to note that these factors have been present, and widely acknowledged for past many months. It would therefore not be justifiable to attribute the market volatility and jitteriness to these factors alone.

The anecdotal evidence indicates that in view of the above listed factors, the participation in equity markets in past six months has been rather tentative and lacking in strong conviction.

Most investors appear to be actively trading, frequently booking small gains/losses. Thus, even though the benchmark indices have shown strong gains in 1HFY22, not many personal portfolios may be showing the matching gains.

Now, as the market commentary turns to “cautious optimism”, “fairly priced”, “Long term Story in tact” from “abundant opportunities”, “recovery trade”, “TINA for India” etc., the unconvinced investors/traders lacking in conviction are turning even more nervous.

Of course greed is still the dominating factor and not many market participants are taking money off the table; they are even quicker in booking profit and losses.

Sector shopping in search of quick gains is also gaining higher momentum leading to faster sector rotations, giving an illusion of abundant trading opportunities. Obviously, the money in pocket is not reconciling with the money being made on social media timelines.

Money made on Twitter wall is exponentially higher than what broker’s statement is depicting and that is making the investors/traders both nervous and greedier for now. So expect, the current state of volatility and low returns to continue for few more months at least.

Economy fast recovering to pre pandemic levels

As per the consensus estimates, Indian economy shall recover to pre pandemic level latest by the middle of FY23; in what is popularly called a “V” shape recovery.

The growth thereafter is expected to be more moderate. The normalized long term growth trajectory may however not reach 6%+ level (seen in pre pandemic period) till FY27 at least.

Corporate earnings - 2QFY22e growth to be moderate as base effect withers

Nifty 4QFY21 and 1QFY22 EPS growth was the strongest in more than two decades. Poor base effect and strong pent up demand were the primary causes attributed to such sterling corporate performance.

However, these factors are seen tapering from 2QFY22 onwards, and the cost pressures are rising. We may see revenue growth as well as margins moderating this quarter.

…though the long term earnings trajectory earning to remains robust

Regardless of the moderate 2QFY22 earnings growth, the long term earnings growth (Rolling 5yr CAGR) trajectory is expected to remain strong for FY23 and later years.

Markets – Greed dominates the Fear

During 1HFY22 the market performance was dominated by the cyclical sectors like Real Estate, Metals, Energy and Infra. IT Services was the only non-cyclical sector that continued with its good performance from 2HFY21. Financials and Auto were the major underperformers.

Given their underperformance for much of the past 3-4years, sectors like Realty and Metals were significantly under-owned, it is therefore likely that most investment portfolios might have underperformed the benchmark indices.

 

FII remained net seller while DII were small net buyers in 1HFY22

During 1HFY22 over Rs59716cr were raised through 26 IPOs. This compares with Rs54576cr raised through 33 IPOs in the entire FY21. However, an analysis by the brokerage firm MOFSL highlighted that almost 52 per cent of IPO investors sold shares on the listing day. This clearly indicates towards lack of conviction amongst investors, including institutional investors, in the new businesses. Most IPO investors appear taking this as a trading opportunity to make some additional money from the funds lying in the savings account earning a pittance.

India outperformed the peers by wide margin

During 1HFY22 the Indian equities outperformed the major global market by wide margins. Nifty gained close to 20%, whereas the second best Index S&P500 of USA gained 10%. Amongst peers Brazil was the worst performing market with a loss of 7%.

Market outlook and strategy

As of this morning, there is great deal of uncertainty as to the shape of the global order that would emerge in next couple of years. It is highly unlikely that we would get much clarity over next 6-12months. To the contrary, it is more likely that the conditions become even more uncertain and unclear.

Insofar as India is concerned, I continue to feel that 2HFY22 may just be a continuation of 1HFY22, with some added complexities and challenges. The country may continue to witness protests and unrest. The consolidation of businesses may continue to progress, with most small and medium sized businesses facing existential challenge. Disintermediation and digitization may also continue to gather more pace.

The normal curve for the economy may continue to shift slightly lower, as we recover from the shock of pandemic. A large part of the population may continue to struggle with stagflationary conditions, with nil to negative change in real wages and consistent rise in cost of living. Geopolitical rhetoric may also remain at elevated levels.

Market Outlook – 2HFY22

The outlook for markets in the near term is mostly negative.

Macroeconomic environment - Neutral

Global markets and flows - Negative

Technical positioning – Negative

Corporate earnings and valuations - Negative

Return profile and prospects for alternative assets like gold, real estate, fixed income etc. - Negative

Greed and fear equilibrium - Negative

Perception about the policy environment - Positive

Outlook for Indian markets

In view of the positioning of the above seven key factors, my outlook for the Indian equity market in 2HFY22 is as follows:

(a)   Nifty 50 may form a short term peak in next couple of months. The process of forming the top has already started. In case the market follows the trajectory of 2HFY08, we may see the top around 18700-18900 level, followed by a sharp correction. However, if Nifty follows the pattern of 1HFY07, we may see top around 18200-18300 followed by a sharp 20% correction and a sustained rally thereafter.

(b)   The outlook is positive for IT, Insurance, large Realty, healthcare, agri input, and consumer staples, negative for commodities, and neutral for other sectors.

(c)    Benchmark bond yields may average below 6.5% for 2HFY22. INR may average close to 74 in 2HFY22.

(f)    Residential real estate prices may show a divergent trend in various geographies, but may generally remain strong. Commercial and retail real estate may also continue to see recovery.

Key risks to be monitored for the market in 2HFY22

1.    Relapse of pandemic leading to a fresh round of mobility restrictions. (Less likely)

2.    Significant worsening of Sino-US trade relations.

3.    Material tightening in trade, technology, and/or climate regulations in India and globally.

4.    Hike in effective taxation rate to augment revenue.

5.    Material escalation on northern borders.

6.    Prolonged civil unrest.

7.    Stagflation engulfing the entire economy, as inflation stays elevated and growth fails to meet the expectations.

8.    Premature monetary tightening.

Investment - Strategy

Asset allocation

2HFY22 may be a difficult period for investors, in terms of high volatility, poor expected returns from diversified portfolios and poor return from long bond portfolios as yield firm up. In view of this, I shall continue to maintain higher flexibility of my portfolio; keeping 30% of my portfolio as floating, while maintaining a broader UW stance of equity and debt.

Large floating allocation implies that I shall continue to trade actively in equity. 30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for 2021 continues to be ~7.5%.

Equity Strategy

I would continue to focus on a mix of large and midcap stocks. The core criteria will be old economy cyclicals which are cheaper from historical and contemporary perspective, have decent market share, are changing business model to suit the new conditions, and would benefit from economic recovery.

I would target 6-7% annualized price appreciation from my equity portfolio.

Miscellaneous

I have assumed a relatively stable INR (Average around INR74/USD) and slightly higher short term rates in investment decisions. Any change in these assumptions may lead to change in strategy midway.

I would have preferred to invest in Bitcoin, but I am not considering it in my investment strategy due to inconvenience and unease of investing.

Factor that may require urgent change in strategy

·         Material rise in inflation

·         Material change in lending rates