Market Capitulation – a foundation for the Next Bull Phase
After being in a denial mode for a long time, in August 2011, stock markets around the world capitulated. As the month began, the initial reaction was triggered by the United States losing its AAA rating, it had held for 70 years. S&P’s down grade of the USA sovereign credit rating by one notch from “AAA” to “AA+” dealt a symbolic blow to the world’s economic superpower. The news of a likely default of a few European countries also became louder during the month. There were many interpretations on the likely impact of these events causing panic in global markets. In a recent interview Warren Buffet, the legendary value investor has observed: “There is no comparison between fear and greed. Fear is instant, pervasive and intense. Greed is slower. Fear hits.”
The Indian markets that are now more closely linked to global indices: the benchmark indices declined sharply by 8-14% during August 2011. Apart from selling by the FIIs, the fall was also triggered and more accentuated by a few India specific issues: concerns over governance deficit, high oil & commodity prices, a weak political leadership that may not be able to push ahead with reforms, sharp increase in interest rates by RBI to control sticky inflation, falling corporate profitability, amongst others.
It has been our consistent view that, it is both difficult and futile to predict the equity market and the economy. We have presented below a compilation of some loud thinking by some eminent commentators on what may be in store over next six months:
Some hard facts
It is likely that the US downgrade and continued trouble in Europe might have far-reaching impact on the developing world. Some views of international investors are summarized below:
While it is extremely difficult to predict global liquidity flow and its drivers, a few trends seem to be visible:
It is extremely difficult to understand what will happen to US and Europe in coming days and months. While in the short run, investors may shun all countries, all markets and all companies, we believe, ultimately growth will outweigh all other factors. In a similar fashion, over the medium term, investors will have no choice but to chase countries and companies which are in growth phase.
Corruption – Four men with a mission
While Anna Hazare has been in the limelight, we must acknowledge the contribution of an unlikely combination of a group of four men with a mission: a Gandhian, a judge, a bureaucrat and a sleuth. Together this fearsome foursome is giving the government sleepless nights. But for their crusading zeal, the scams rocking the ruling dispensation might have been buried and forgotten, like many others in the past. They have little in common except their mild manners and quiet personalities. Yet between them, Anna Hazare, Chief Justice of India SH Kapadia, Comptroller and Auditor General Vinod Rai and CBI Director AP Singh have put corruption on the national agenda.
We may not be able to eradicate corruption totally and that too immediately, but surely their efforts will help reduce corruption and also demand better governance.
During August 2011, the composite portfolio of QuestPMS declined by 7.6% as compared to 8-14% drop in the benchmark indices. We have presented the performance of the composite QuestPMS portfolio as on the last trading of August 2011 across time periods and against various benchmark indices:
Although the QuestPMS portfolio comprises of companies that are classified as mid cap, (weighted average market capitalization of ~Rs.3,200 crores), the decline has been much lower even during the last one year. A notable feature is that since inception in October 2007, after all expenses and fees, the portfolio has delivered an absolute return of 17.2% compounded annually. During the same period, all the benchmark indices have fallen by 8-21% on a comparable basis. The performance of QuestPMS can be attributed to a continuing to emphasis on investing in high quality companies at a price that offers a good margin of safety.
The QuestPMS portfolio has companies that are largely in non-interest sensitive sectors like agri inputs & agri machinery (28%), railway products (15%), specialty chemicals (15%), healthcare & medical devices (13%), engineering & infra service providers (10%), defense suppliers (7%) and software (5%). We continue with our philosophy of remaining fully invested at all times with cash component being at just 7%.
In terms of profile of management: multinational companies form over 36% of the QuestPMS portfolio. Some more data on the fundamentals of QuestPMS will not be out of place. Average turnover of the companies in the portfolio is ~Rs.1,800 crores and, is projected to grow at 22% and 23% respectively during 2011-12 and 2012-13; earnings are expected to grow at ~21 % and 35% cent respectively. The average return on capital employed is in excess of 25%. Taken together, the companies in the QuestPMS portfolio are debt free. Also on average, these companies have cash that is ~21% of the market capitalization. At current prices, the QuestPMS portfolio companies are trading at a weighted average PE multiple of 12 times FY12 EPS.
Market volatility a great opportunity
The Indian equity market today is discounting the worst. Although the market has digested the large negative news, both internal as well as external, there may be some more pain left. Due to risk aversion, it can be safely assumed that all categories of investors (be it FIIs, MFs, Insurance companies or individuals) are under invested. In our opinion, once the dust settles down, the market upturn could be quite quick and sharp.
So is this the time to start buying selectively? We once again look at the legendary investor, Warren Buffet: “Be fearful when others are greedy and, be greedy when others are fearful.”
One must be prepared for some more correction, some more volatility, but all this correction, all this volatility also provides a great opportunity to buy into quality businesses. Even when the broader markets are not doing well, few select sectors and companies are doing extremely well. In our view, the era of momentum play is over. From here on, it is going to be a stock pickers’ market.
For us mere mortals, last month’s stock market meltdown has a grinding Groundhog Day feel to it, as in “oh no, not again…”. But for Warren Buffett it’s invigorating. Today he’s his usual chipper self, saying “it has never been better.” And why not? As Buffett reminds us, “The lower things go, the more I buy. We are in the business of buying.” For Buffett right now, at least, this is not a time for fear. This is a time for action.
August 30, 2011
To know more about Quest and QuestPMS please visit our website: www.questinvest.com
DISCLAIMER: This communication does not constitute or form part of any offer or recommendation or solicitation to subscribe or to deal with QuestPMS. The views expressed by Ajay Sheth, Portfolio Manager QuestPMS are his personal views as on the date mentioned. These should not be construed as investment advice to anyone. This communication may include statements that may constitute forward looking statements. The statements included herein may include statements of future expectations and are based on the author’s views, observations and assumptions and involve known and unknown risks and uncertainties that could cause the actual results, performance or events to differ substantially or materially from those expressed or implied in such statements. The author does not undertake to revise the forward looking statements from time to time. No representation, warranty, guarantee or undertaking, express or implied is or will be made. No reliance should be placed on the accuracy, completeness or fairness of the information, estimates, opinions contained in this communication. Before acting on any information contained herein, the readers should make their own assessment of the relevance, accuracy and adequacy of the information and seek appropriate professional advice and, shall be fully responsible for the decisions taken by them.