Macro Variables – Are they relevant now?
The major macro variables that we look at to gauge the direction of the economy and the markets are GDP, IIP, CPI etc. But these variables may remain not very relevant in the immediate future as they may not be assessed or estimated properly due to lack of enough information arising from the complete lockdown of the economy. There is drastic fall in the productive economic activity at present. The GDP forecasts from reputed institutions put the number at 1% to 2%. This is low and indicates a virtual absence of any economic activity. Another variable is the price level or CPI. With the demand destruction due to the lockdown and the closing down of businesses and industries, it is less likely that the price level could expand. On the contrary, it is most likely going to contract and will fall to the lower range of the RBI inflation band, from the current level of 5.9%. The sum and substance of this is that the macro variables would correspond to that of a depressed economy till the lockdown ends and economic activity picks up. Therefore, what is relevant for us is to watch the extent to which we have been able to contain the spread of the pandemic and how fast we are able to get back to normal work. It would be only after a month or two that we will be able to get a more or less accurate idea about the ground level economic realities after the introduction of the lockdown.
Are there major risks to a Positive View? What are the different scenarios?
The scenarios may be vastly different from each other. The recovery may be slow and longer than expected. There is also a possibility that there may be an uptick in the markets, and thereafter, there may be a sell off again before the market resumes its northward direction. With the actual progress in the restoration of productive economic activity and demand, the markets may move in tandem with the economic recovery. There is lot of discussion on whether the recovery will be V-shaped or U-shaped or is there a possibility that it may be L-shaped. While there may not be any clear indication coming from economic variables as of now, one thing that we could be more or less certain is that the recovery in the domestic economy and markets is likely to be faster that what it would be elsewhere. This confidence emanates from the fact that the response from the government and the local authorities has been swift and well ahead of the issue actually raising its head. Significant policy measures have been initiated but it is expected that more may be in the pipeline from the government.
What does our analytical framework indicate?
The analytical framework that we make use of for our analysis in relation to equities is the tripod – liquidity and interest rates, earnings growth and sentiment. The first element, that is, both liquidity and interest rates are eminently favourable at this juncture. The official rates have come down, both repo rate and cash reserve ratio. The second factor, that is earnings growth, is closely related to GDP growth, there is a strong positive correlation between the two. Under the current conditions of lockdown, where economic growth will be at its lowest levels, and there is virtually no productive activity happening, the rate of GDP growth is expected to be very low, low single digit levels. This makes making an accurate forecasting of earnings for the immediate time period cumbersome and less meaningful. But this variable would remain elusive to accurate estimation. The third variable, that is, sentiment, is neutral. Domestically the sentiment has been positive for a long time after the fall in the markets during sept-oct 2019. The negative impact to the markets came from selling by FPIs both in equities and debt in response to developments in China and other territories where the pandemic is growing.
A Case for Equities
A strong case for equities rests on two basic parameters, the Price to Book or P/B and the Price to Earnings or P/E.
Price-to-book (P/B)
The lowest P/B in the last 20 years was 2.12 in April 2003, and thereafter, it moved up to 6.23 in Dec 2007. At present the Nifty P/B is close to 2.60. This shows that, from a long-term investment perspective, the intrinsic value of the assets is much higher than the price at which they are offered. This makes domestic equities a clear buy. For a very long time now P/B has been used extensively for value investing, and a P/B less than 3 is usually considered very attractive. This is an opportunity that has presented itself after long 17 years. It is imperative that we make use of this and build a portfolio or add to an existing portfolio in a phased manner.
Price-to-Earnings(P/E)
The equity market valuations, which seemed relatively expensive a couple of months back has corrected significantly,
and it is currently in a reasonably priced territory. On a trailing-twelve-month (TTM) basis Nifty 50 PE is trading at a PE of 21 as against the last 10 years average of more than 22. Similarly, the Nifty Midcap 50 is trading at a P/E of 18 as compared to 10 years average of close to 30. In this connection, it may be emphasised that the P/B measure
complemented by P/E makes a strong case for domestic equities. This is a clear signal for starting to invest in the
markets as markets look inexpensive based on long term parameters. This has also more or less eliminated the premium against other emerging market indexes.
Other Factors
The other factors that lend adequate support to better markets are the accommodative monetary policy, the availability of liquidity in the system, and also the probability of a faster than expected recovery in the domestic economy and therefore, of the markets.
Investment Perspectives
Central to our equity investment advisory has been the recommendation for investments in a graduated fashion or in a phased manner. Systematic investment plans would be an ideal vehicle. We would like to underline the importance of the same mode on investing again. Companies which have good cash position and market share would be the ones
which are in apposition to wade through the waters and reach the shore. The importance of investing through well
managed funds is more important today than at any time in the past, both from the mutual funds and the PMS space. It is advisable to invest into large caps and midcaps, given their relative risk-return profile. A selection of schemes in both the categories based on Emkay EnEf Model will be shared with you separately. Even in the PMS space, it is advisable to focus on schemes which have a portfolio of quality companies which have a market leadership. The PMS offers from Emkay reflect the quality aspect of the stocks that form the portfolio.
