Dear Investor,
Hope you are doing well. The following chart depicts our returns compared to BSE 500 TRI benchmark
We wanted to start this month’s memo by drawing inspiration from the memo of Legendary investor Howard Marks. The memo is titled after his memo “Nobody Knows”. His memo was written during the peak of the COVID crisis, the message and where we are however is apt for the current context. I wanted to start this memo with a kind of a rhetorical question:
Did we correct anything post the 2008 crisis or was it a debt patch work? The signs of the current crisis were loud and clear in 2018. The zero interest rate regimes and spends backed by more Debt, just made sure that the problem got magnified. India and Germany to an extent are the only two exceptions amongst large economies where the fiscal debt has been controlled. Refer chart below:
Refer to our 2019 note: “Burn Baby Burn”, “Burn More” — Prescient Capital for a read of the situation in 2019, pre-pandemic. The COVID liquidity package just delayed the downward trigger by 2 years and made the problem even bigger.
In the midst of all this global macro-economic chaos, a lot of you may have asked this question: Is India insulated from these events? Surprisingly, India has so far weathered the storm well and the Rupee hasn’t moved south much when compared to other leading currencies of the world. This however, is a static view as the global macros can deteriorate even further. The US, Europe and China (that constitute ~ 80% of global GDP) are slowing down and have a significant Fiscal debt overhang. Nobody knows or can predict the impact of the same on India and its equity markets. It is also not worth spending time to assess the same as the effort is best spent elsewhere. India will slow-down due to rising interest rates that directly affect spend on housing, automobiles and brown goods. The rise in prices to pass commodity inflation has also delayed/postponed the demand. Brands are working hard to pass on the high price inventory and re-kindle this demand. On the flip side, commodity and energy prices have cooled off and are likely to help in improving corporate profits. We have also seen corporate India spend heavily on CAPEX to address both domestic and export demand. All this implies that investing from hereon will not be based on macro/secular trends/momentum. We believe that bottoms up investing is key for making and preserving returns for the next 18-24 months.
How are we spending our time: We are focusing on the companies in our portfolio, assessing them for the impact of a global slowdown, and re-evaluate their inclusion in the portfolio. Over the last 6 months, we have taken the following actions:
Moved out of US focused drug formulations/intermediate companies due to a significant competition and price erosion and now the risk of slowing demand.
Moved out of our IT sector bets where the trade-off between future growth and valuation was not in our favour. As we see things right now, the IT sector is slowing down due to a global slowdown. The IT sector may grow at a lower rate, and hence the valuations have to correct further for the sector to be investable.
Domestic demand is expected to accelerate post the commodity cooldown. We have invested more in companies that have a domestic consumption play: Domestic Branded Pharma, Consumer Staples, Branded building material.
We have invested in auto and auto ancillaries due to strong growth prospects in domestic Passenger vehicles and 2w EVs. We have capped our position in auto-ancillaries that are exporting or are evaluating them carefully QoQ for sustainable growth.
Increased allocation in BFSI across retail and commercial vehicle finance. We had to exit and limit our drawdown in a leading housing finance company after its MD put in his papers. We may invest more in regional banks/NBFCs investing in secured assets such as gold and working capital. We see revival in rural demand through the Microfinance route too. We however plan to stay away from MFIs as the risk reward is never in the investors favour.
We have added companies in manufacturing that have a dominant client base/order book in India.
Sectors where we plan to deploy more capital in the next 1-3 months: domestic demand based manufacturing, domestic pharma, FMCG and BFSI.
We believe that the next 12-18 months will see high volatility in equity markets. There may be multiple rallies and multiple troughs. We plan to exit richly valued companies during these rallies and deploy aggressively during these corrections. We believe that times of uncertainty are best for returns in equity markets. Hence, if you have long term capital that you wish to deploy, this may be a good time.
We want to end this memo with a quote from Howard Marks: “Waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer’s simple: if something’s cheap based on the relationship between price & intrinsic value you should buy and if it cheapens further, you should buy more”.
Thanks
Prescient Capital