August 2016: Glass half full?

Though the Nifty ended on a positive note for the month, equity market returns have been flat-lining for some time. The Nifty peaked at about 9000 in February 2015 and has traded in a narrow range since then. The market remains very stock specific with an existence of both undervalued and over-valued stocks. The economic situation too has a mix of positives and negatives.

On the negative side, one of the significant factors is the large bad debt situation with the banks (many of them PSUs). This continues to plague overall sentiment and credit availability in the economy. Several infrastructure oriented, capital intensive companies have stretched balance sheets and many of these companies are on the verge of bankruptcy. The downstream effect has been a weak capital goods cycle and several payment problems. Weak commodity prices have affected prospects of several companies operating in the commodity space. Many of these are legacy problems, and companies operating in these sectors are likely to see an extended period of pain. We have generally avoided capital intensive business in line with our philosophy to invest in cash generating businesses. The stock price performance of these large troubled companies is weighing down overall Nifty returns.

Over the long term, nominal GDP in India has been growing at about 15% (and real GDP has averaged about 7-8% pa). Over the past few quarters though, nominal GDP growth has slowed down to about 9%, partly due to a weak economy and largely due to lower inflation. The real question is whether GDP growth will revert back to historical trends and when. Though growth rates have not recovered yet, given the favourable Indian demographics, one is fairly sure growth rates will, at some stage, revert back to historical averages. The setup conditions for GDP growth to revert back to the historical mean are falling into place. Firstly, the Indian consumer is beginning to experience tailwinds – interest rates are coming down, and inflation is also down from the heightened levels observed 4-5 years back. Lower interest rates should boost consumption and a well spread, normal monsoon is an added positive. Secondly, the government is taking several administrative reforms, which should remove bottlenecks in the economy. Implementation of GST is a massive reform which should usher in a unified market and help improve tax compliance. Efforts are on to ensure that projects that been stuck for some time due to various reasons, are quickly implemented. This should get the capital goods cycle moving and also reduce the bad debt situation of the banks.

The Indian economy should revert back to its historical nominal rate of growth at some stage, in the not too distant future. In the meantime, our preference is to focus on companies that are currently doing well. Valuations are not very cheap, but neither are they very expensive for the stocks that we own. In the broad market, it is possible that some stocks are stretched on valuations and investors would do well to be careful. We are still finding a few opportunities that are moderately inexpensive, but attractive ideas are definitely far and few. Performance over the coming years will have to be led by growth and we believe the much talked about ‘India Consumption’ story should kick in at some stage.