Indian Markets – May 2022 Outlook

The indices are indeed slipping over the last few weeks. Traders and investors appear to be worried about uncertainty related to inflation globally as well as in India. The Ukraine war is not showing any signs of ending. There seems to be some escalation with Sweden and Finland rumoured to join NATO which is only adding to the confusion. On the domestic front, the interest rate hikes are also weighing on the street, along with the slide of the rupee vis-a-vis the dollar. There is also some unfortunate news about moral hazard in a couple of leading fund houses which has dampened some of the sentiment in Indian Markets – May 2022.

We cannot say when the market will bounce back. We believe that nobody can predict and catch the bottom. However we feel that the Nifty PE, having slipped below 20 and now getting very close to the Covid bottom level of 18.5 is giving an opportunity for long term investors to cautiously increase equity exposure. The noise about inflation, interest rates must not disturb the long term investor who is focused on owning strong businesses.

Small & Midcap Space

The small and midcap space comprises several hundred stocks of which the midcap universe is only 150 in number going by the standard definition. These have a market cap of half to a billion dollars each. The small cap space is more numerous and clearly one must avoid very small companies which are prone to volatile stock price movements, not always for valid reasons. Within the midcap space there are many proven companies that have already run the marathon and one must go with quality companies. In times like this the long term investors must be cautiously optimistic and look for growing companies that are keeping pace with inflation and GDP growth. One must avoid leverage while investing and also those companies which have high debt levels.

Is the market expensive?

Going by the PE levels mentioned above, the market is less expensive than it was earlier. Nifty PE was 40+ during February 2021 and improved with the growth in corporate  India’s earnings. We are not seeing any major slowdown in earnings for quality companies and hence believe that the market is approaching a fairer valuation.  Nifty at 16k with higher earnings than during the covid crash, is not relatively expensive. One must be stock specific in their picks and have a 5 year horizon to create wealth by investing at these levels.

The LIC IPO

We have been cautious about all IPOs in the past and advised clients to avoid glamorous and even the not so glamorous ones. With respect to LIC, while it is a market leader, we are concerned about their steady reduction in market share. Since markets always look forward, the Price to Embedded Value ratio is also at a ‘discount’ compared to the large private life insurers. This may not be an anomaly that will get addressed soon. To use a software parlance, it is a feature and not a bug; bugs can be fixed relatively quickly. We are also cautious having seen the experience of GIC Reinsurance and other large PSUs over the long term. 

On Recent Mergers

We are seeing a few mergers in the industry of late. Mergers have always been one of the strategies opted for by corporates looking for inorganic growth. The recent spate of reforms such as GST, have pushed the corporates to formalise operations which has benefited the larger players. This has tilted the slope towards more and more consolidation in corporate India. 

Recent mergers such as that of HDFC Bank and HDFC highlight this trend towards consolidation, tapping economies of scale and synergies from better utilisation of combined resources. We will continue to see mergers going forward, but it is unlikely that every company will eagerly look for a suitor. At the end of the day, the merger has to be a win-win for both organisations and their stake-holders.

We do not recommend that the retail investor jump  into each consolidation as an arbitrage opportunity. Globally M&As have been a case of Easy to wed but difficult to consummate. The key to a successful merger is the existence of synergies and a fair valuation. Even way back in 2000, the Satyam-Maytas fiasco has taught us that share-holders have been quite active in opposing deals that are detrimental to their interests.

That does not necessarily mean all mergers are against share-holder interest. Every deal needs to be looked at individually. Investors must avoid taking positions based on initial news announcements. Stocks going up/ coming down on announcement of a merger is probably good news for traders, but investors need to digest all details and take an informed view.

Indian Rupee’s Relative Strength

In the past, we have seen INR dipping against the USD and then stabilising. With interest rates set to rise further in the US, there is a case for further depreciation of the INR, but we do not foresee a steep fall. The Indian economy is faring relatively well compared to other large economies, and it will eventually see inflow of capital, as valuations turn attractive. However, INR may not reclaim earlier levels of, say 75 to 1 USD. FIIs will eventually come back once the currency stabilises, as they have to look at dollar denominated returns. 

Conclusion

We have framed our rules of investing as the ‘Roots and Wings’ investment philosophy, which essentially focuses on companies with strong balance sheets, aligned promoters and growing sales & earnings. By Roots, we mean low debt, consistent ROE/ROCE, promoter integrity and stamina. By Wings, we mean growth in sales/profit / cash flows and the the ability to maintain a steady market share. These rules do not change just because market levels have dipped by 15%. 

As equity ands SEBI Registered Investment Advisors, we advise clients to invest in sectors that are crucial for the global economy as well as those that are powering India’s economic growth. These include technology, Financials, Consumer staples, Manufacturing and  select pharmaceutical stocks. We especially like long-term plays on India’s consumption and infrastructure growth. Because we cannot predict the bottom of the market levels, a staggered investment schedule helps. A long-term investor need not worry too much about the noise and take advantage of any opportunities to bulk up in select counters.