POST COVID OVERALL MARKET OUTLOOK

FROM THE DESK OF CAPT. D.GANESH RAJA

DATED: 26.06.2020, FRIDAY

The COVID-19 pandemic which seemed to be a local issue in China has become a global crisis with massive losses for the human lives and economy.

As Divine would will I was locked out of home during course of writing this report, in a ship which I decided to take after about 7 years and what a time to choose. We might think about many things but somehow an unknown power seem to move things.

Humanity would find a way out of the pandemic but there would be far reaching ramifications.

To begin with, this might be the beginning of end of China as we know it. The clout and the arm twisting which was evident in political and economic front by China everywhere might come back to bite it.

Manufacturing outsourcing due to cheap Chinese labour was the buzzword in developed nations but the pitfall was that of losing long developed skills sets and overdependence on a single country. India is the immediate destination anybody would think of due to large population, functioning democracy, robust financial system albeit having its own set of problems.

In addition to wishful thinking, let us synthesize the issues at hand after viewing the parts. The parts in this synthesis we would be looking at are:

1) Demand destruction due to reducing trade with China.

2) Way forward for advanced nations who were relying on Chinese manufacturing.

3) Opportunity for India on immediate term and long term and steps to be taken quickly to capitalize on this.

4) Global factors in delinking from China

5) Roadmap.

PART 1

DEMAND DESTRUCTION DUE TO REDUCING TRADE WITH CHINA

The large factories were guzzling up commodities to produce goods for the world marketplace . If someone else has to make wealth in this kind of an event then someone else has to lose wealth. Some of the prominent industries which I can think of in China are steel, chemicals, synthetic textiles, shipbuilding etc. Japan and Korea have already decided to move their factories out of China. USA and UK are definitely miffed and some EU nations have been vocal on its criticism of China .

There might be opportunities for erstwhile steel mills to revive in other parts of the world. The Chinese have to reduce production which would suffice local consumption. The possibility of China breaking up which we will discuss later might fragment the capacities thus reducing the clout.

Chinese shipbuilding will suffer which could possibility revive yards in EU in addition to increased business to yards in Japan and Korea.

Movement of goods due to relocation would benefit container and heavy lift carriers. Reduced oil demand due to China out casting doesn’t augur well for tanker market initially but later if China breaks up, which cannot be logically proven noe but my gut feeling, it would be different scenario altogether.

I am not sure what are all the industries China does bulk exports but they need to be examined. Auto ancillaries is one sector which Chinese have built capacities. Other major exports like Electrical machinery, Computer goods etc. presents opportunities for competing economies, like India.

The demand for major commodities like iron ore, bauxite , coal, coking coal etc. might be subdued due to demand destruction but the users of these commodities like steel , aluminium and power sector industries might see good time ahead. What I mean is the industries outside China.

PART 2

WAY FORWARD FOR ADVANCED NATIONS WHO WERE RELYING ON CHINESE MANUFACTURING

I guess everything is a cycle though we ourselves might get caught in it and might not predict it before it happens. The world was going gung ho about globalization but now with “Global reset” button due to COVID-19 pandemic “Nationalization” would be the mantra. The “Global reset” has been a theory I have been advocating for quite some time in my known circles though I did not know that it will happen due COVID-19. Basically you cannot outsource so much that you lose touch with your core skills. The nations have to get back to their drawing board and nurture their own industries even if the cost is little higher because the price you pay obliterates all the savings in case of an event like this.

Every nation, every race has its own unique skill sets and the beauty is they must be supported for their tradition to continue.

There might be slight decrease in lifestyle but of what use is lifestyle when life itself is at stake. Countries, especially the vulnerable ones like Spain, Italy have to find their footing in due course. This pandemic might be a blessing in disguise to revive their core skills.

PART-3

OPPORTUNITY FOR INDIA ON IMMEDIATE TERM AND LONG TERM AND STEPS TO BE TAKEN QUICKLY TO CAPITALIZE ON THIS.

1) Getting the labour force back on track by giving immediate monetary support and restoring livelihood is of paramount importance.

2) Stake purchases in large companies by Chinese companies must be stalled by special Act in parliament if required.

3) Indian Pharma companies have risen to the occasion by increasing production of drugs and the great gesture by the Corporates in standing with PM and even grater gesture by India in sending the much needed critical drugs to various countries.

4) I can see India being a steel manufacturing capital of the world, not shipbuilding though. Shipbuilding I see gradually moving to Japan, China and EU. Companies with captive mines will be key beneficiaries.

5) Skill development must be done on a fast track in collaboration with foreign companies with sector specific set of skills for the workforce. Top 100 global companies in the world have already decided to ramp up investment in India, so the workforce needs to be ready. US & Japan have already already taken their decision to move out some manufacturing out of China and this trend is going to gather further steam.

6) Outdated labour laws need to be amended.

7) Domestic auto industry relies on China up to 27%. Large well established companies like Motherson Sumi , Minda industries etc, have the capability to quickly ramp up capacities . There would be ample opportunity for other smaller players as well due to increased demand.

8) A renewed thrust has to be given to the domestic textile industry which has progressively lost global market share compared to cheap Chinese goods like cotton, cotton blended goods etc. might get lease of life.

9) Global chemical industry was mainly driven China , which can come to India now.

10) Chinese manufacturers were having a dominant presence in earth moving equipment. Companies in this sector need to aim big to quickly capitalize the demand.

PART -4

GLOBAL FACTORS IN DELINKING FROM CHINA AND ROADMAP.

1) When it is the question of survival we tend to come to basic necessities, which the COVID-19 scare has demonstrated. This is what advanced economies need to do, going back to basics which is what the case of economic activity in first place. Globalization , the grand dream which has skewed the global wealth distribution needs to be rested and each economy has to look at its own immediate needs and examine their core competencies. The predatory tactics which the Chinese started employing started unnerving many.

2) Talking of basics the advanced nations, especially European nations need to introspect the very way of living. Just carefree, all fun attitude shunning responsibility has led to this state of affairs. That needs to change. I would say that the declining population also needs to be reversed in these nations. I might sound fundamental but they have to get married, raise children, and take care of their elderly etc. etc. all basic old school stuff. The recent death rate due to COVID-19 might prompt them to think in these lines. Domestic agriculture is something which many nations have to do for self-sustenance. Also these countries have to relook at the traditional industries which these countries have been strong but somehow have drifted to oblivion.

3) The overambitious belt and road program which was a thorn in the flesh for India , seems would meet its doom because it crisscrosses through many nations and China’s equation with the world stands changed . Doomsday for Pakistan which was blindly supporting China seems imminent.

4) Local businesses who would try to import from China must be discouraged by imposing huge import duties. This will encourage investment in domestic economy instead of easily importing.

5) The Chinese are flushed with funds and are lapping up assets I heard and would like to deploy the funds most productively. India has already amended FDI norms as a pre-emptive measure. I am sure other countries would be planning something similar. It seems there are many assets in Italy which have Chinese ownership. So special laws need to be passed after group of nations come together to enact international laws to revoke these asset purchases and protect their own turf. Then they can pick and choose whom they want to invite to invest in their respective economies. This has to be done very tactfully if those nations want to move their assets out of China, which might prevent by local laws.

6) It seems highly unlikely that these aren’t disgruntled member in the political class of China , who would want to change things. Breakup of China in the next few years cannot be ruled out.

US has been hit real hard by the COVID-19 pandemic. The large loss of precious lives might change the way they think. They really have to relook at their healthcare system.

7) International community can come together to form a joint forum to file a case against China in International Courts to make good the loss of lives and economic loss, so that the fine would amount to at least 5 years of China’s GDP . The economic blow would create ripples in international economy but it will be for long term good. Maybe it is the scheme of things that whenever someone becomes so powerful and thinks that nothing can destroy their might , something unthinkable happens . When Germany had become a tyrant nation under Nazis the world united to fight against them. The British empire to in which sun never set , saw its empire end , so this time it is no better. China would not have been resented if they had done things differently. Their acts were always viewed with suspicion and Corona virus scare just happened to reaffirm it.

8) Now looking purely from investment perspective in this scenario, it will be viewed which country could tide over the pandemic relatively better compared to others. India scored in this aspect. The myth of advanced healthcare systems of developed nations stands shattered.

5- THE ROADMAP

So with this backdrop we will try to devise an investment plan with sector allocation to various asset classes. This is just a view based on “just in time” feel and the merits and demerits should be viewed individual before proceeding with the actual investment. We are initially trying to give stability to portfolio and gradually move onto growth stocks.

1) To start with I don’t see a runaway rally in stocks for next six months at least. This I can say because of one my proprietary indicators which has never failed indicates so. We might see gradual sliding of markets till 8000-9600 band, before markets attempt to scale 11000 levels. The Elliot monthly count would give clue to the market movement.

2) Gold as an asset class in these uncertain times would be a natural choice but with China expected to receive a blow and sidelined by international community, their purchasing power would be greatly diminished. So in my opinion probably the present rally would stay in force for some more time before these factors take effect. Real gold purchase would be better.

3) Government to incentivize the economy has already announced aggressive stimulus package as envisaged earlier. Government bonds might be a good place to park some money. Need to look at mutual funds investing in Government securities. One can also explore buying bonds directly.

4) Governments all over have embarked on a massive fiscal stimulus to support their economy and India is no different. To rewind back to Lehman crisis in 2008 this was exactly the scenario but the scare has come in a different form. Here the challenge is to bring people back to work.

Looking at my current assignment with a PSU , it can be seen that it gives greater stability where the targets are not entirely profit oriented . Large scale layoffs would only worsen the situation. So in my contrarian view PSUs offer greater stability in this scenario, however efficiencies compared to private sector counterparts affects profitability ratios, but these are times to look at value and not profitability growth and projections thereof. In case things rebound and Government revives disinvestment program PSUs have huge value unlocking to offer. Due to these reasons part allocation has to be done to PSU dedicated mutual funds as below:

i) Aditya Birla Sun Life PSU equity fund : It has 24 companies with 63% in large cap, 14% in mid cap and 7% in small cap. Expense ratio is 2.36% which is a bit steep.

ii) SBI PSU fund: Has 20 companies, 59.4% in large caps 15.78% in mid-caps and 19.96% in small caps. Expense ratio is 2.70%.

Aditya Birla Sun Life seems a better option.

5) Again keeping stability in mind I would look at utility Companies which have stable earnings, mostly which are part of essential services, virtually recession proof and offers very good dividend yield. They are laggards in a galloping market but offers great comfort in times like these. Companies to look for: Tata Power, CESC, Power Grid.

6) Additionally we can look at companies with large dividend yields but minimum retail customer sales, courier being an exception.

7) Also typically we are looking at companies where input cost being a key commodity whose price has dropped sharply causing windfall gains, e.g. BPCL, Pidilite.

a) Microfinance and small finance banks have been badly beaten down. I am still of the view that for organized finance to reach hinterlands of India it is one of the best routes. I would not recommend to increase holdings but to hold on to the sector.

b) Insurance is another sector where some money must be invested. I would look at companies with strong investment pedigree e.g. HDFC Life & SBI Life. With the ongoing pandemic it might be negative for the sector but would offer great long term value.

Credit card companies would also hold great potential and SBI cards is a company which

comes to mind given strong OPM.

c) Pharmaceutical space is a sure shot investment in this kind of market but the valuations are already stretched. India can corner bulk of the bulk drugs market.

I wouldn’t want to generalize but Abbot Labs which makes medicines for recurring medication for Thyroid, PI Industries which has strong contract manufacturing and Granules India would be some of the stocks to look at.

d) Farming and farm related products / companies :

It is one of the sectors which got preference even within lockdown. Basically in these times we have to come back to basics. Some good fertilizer stocks , seeds stocks could do well in the portfolio. Also farm equipment companies like Mahindra & Mahindra, ACE, Sonalika Tractors etc. would be worth taking a bet on.

Companies like Bharat Rasayan, National Fertiliser, Coromondel International , Avanti feeds, Shankara Building Products etc. have to be looked into based on fundamentals.

e) Stock exchange: A surprise inclusion but it can be seen that they are clawing back and coming back on track. Also the NSE imbroglio not so long ago emphasizes the need for an alternative, which might give some good business to BSE. The dividend yield in BSE is impressive.

IMPORTANT NOTE:

One of the key factors while selecting stocks is to give a deflated EPS and make a comparison of PEs. The EPS deflator would be done using some of the proprietary tools in addition.

TECHNICAL OUTLOOK FOR EQUITY MARKET:

Running Elliot long term analysis with proprietary tools, there is an indication of under allocation TO Equity markets anywhere till end of 2020. My personal investment asset allocation I have done as per this view and allotted 50% into fixed income category with high exposure to Government securities. This however does not mean that a crash is imminent but just that long-term Quant System is indicating lesser allocation to equity based on broad market indices and it has been indicating that since October 2019. Nifty last close of 10383 on 26.06.2020, Friday is a technical bounce.