As a follow up on the 2 scenarios we shared earlier on 18 March, the scenario likely to play out is perhaps something between Scenario 1 and Scenario 2 that we envisaged.   No one knows, “for sure”, the road map to normalization.   We are likely to see 2 steps forward and 1 step back approach based on “trial and error”.

While we are all looking for certainty, we are confronting the “fog of war” at present.   I have some thoughts for your consideration. 

Navigating with a compass, a knowledge of market history, and an understanding of your own self will be key

• In a rapidly evolving environment,  no analysis can help us take more intelligent Investment decisions.  One needs to navigate with a compass, a knowledge of market history (mean reversion is a truism) rather than by torturing spread sheets to estimate near term earnings.

• Understand yourself – your time horizons and ability to tolerate mark downs.  What works for 3-5 months may not be the same as what is right for 5 year time buckets.

• A ~ 20% IRR over 5 years from here is not an aggressive assumption for a well-run company.  15% compounded Earnings growth over 5 years and 25-50% multiple re-rating will get us there (remember valuations for the broader market are close to 2008 lows, and most companies in our portfolio are well-positioned to gain market share and have grown profits faster than 15% in the preceding 5 years)

• However, there is no guarantee we may not see further mark downs before these returns are delivered.  Fear dominates rational thinking during troubled times.  Thinking long term and acting long term are very different.

If not done already, one should “re calibrate” exposure to risk assets as needed – increase or decrease risk exposure per your personal situation

• The longer the delay to normalization of the economy, more the job losses, social tensions and fear.   And unlike the West,  the Govt. may not have as much room to stimulate the economy –  India’ s Credit Rating is just one notch above Investment grade.   Hence, the recovery will not be “V” shaped one but a slow grind

• No one knows the path the market will take in the short term.   So, cash needed to service liabilities for the next 18-24 months should not be in Equities.  If you are overexposed to Equity, perhaps reduce some positions, even if at a loss.  This ensures you don’t have to sell at the wrong time.    Note, this advice is not inconsistent with our positive view of markets over the next 5 years.   Nor does it imply we believe markets will stay depressed over the next 24 months.  One should be prepared for the worst so one has the courage to stay the course.

• Alternately, if you are under-weight in Equities, and have the ability to stomach volatility and markdowns, and believe in the 20%+ IRR hypothesis over 5 years, one should add to your exposure systematically.   Add systematically, because no one can time the bottom.   Should it matter if stock prices go down before they eventually give you a juicy return if you have planned your cash flow appropriately?

Beware how you interpret news flow.   The route to economic recovery and the path of the NIFTY need not be correlated. 

• Recognize that “optimists sound superficial while pessimism sounds profound”  https://www.fool.com/investing/general/2016/01/21/why-does-pessimism-sound-so-smart.aspx

• India has always been a Micro story.  Of individual companies who have done well despite adverse Macro.

• Certain sectors will recover faster than others.  For example, many Specialty Chemical plants serving Pharma, Food and FMCG supply chains have re-started (albeit not at peak utilizations)

• Companies within sectors will do better than others.  For example, many NBFCs will not be able to raise money at any price because their survival is questionable.  This will raise medium-term margins for survivors and stock prices should start reflecting expected market share and margin gains.

• As stock prices have dived well before Earnings, recovery in stock prices typically precede a recovery in Earnings.

Our portfolio construct is aligned with companies having strong tailwinds for growth, leadership positions in their sectors, strong Balance Sheets and run by good management teams.  We see no reason to change our portfolio construct at present, but will not hesitate to act as needed.