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Opportunity Amidst Turmoil Monday, Mar 16, 2020

For long term observers of equity markets, the wild gyrations observed in the past two weeks, is once in a decade event. The last time we witnessed such deep, globally synchronised sell offs was in 2008, when the global financial system essentially went in a freeze after large financial institutions in the western world including Lehman brothers went insolvent due to problems emerging in the US subprime markets.

The major difference between the correction 2008 and 2020 is, the correction in 2008 was on the back of very strong earnings growth and essentially took market participants by surprise. The correction in 2020 especially in India was not totally unexpected given that markets have been rising devoid of any earnings growth. What has surprised many, however, is the pace of fall, as most indices have lost ~20% from their respective peaks, in just over a month.

The Covid 19 impact

As governments race around the world to stop the spread of the novel coronavirus, we are seeing an increasing trend to impose restrictions on public gatherings as well as shutting malls, movie theatres, sporting events etc. One expects companies' dependent on discretionary spend to be the first to get impacted. How long this will last is any one's guess, but given that the countries who were the early epicentres of the new virus are reporting lower cases, one expects the economic impact to be limited and transitory.

Matters in India have been further complicated by problems in the banking systems with the blow up of Yes Bank and one expects an increasing period of risk aversion in credit markets like one saw after IL&FS default. This may act a bigger near term drag, as savers and lenders both prioritise safety over higher returns, making credit availability to businesses lower down the rating ladder scarce.

Some positives on the horizon

The extended monsoon has ensured reservoir levels are at a multi decade high, driving expectations of yet another record farm output. Rising food and dairy inflation also suggests higher farm output combined with higher realisations which may in turn trigger a revival in demand from rural India. While food inflation may see some tempering after the record output, it still could see a higher trend than what has been seen over the last few years.

The other big positive remains the falling international crude prices. It not only improves India's current account position (It is estimated that $1 fall in crude prices lowers India's current account deficit by ~$1.5 bln dollars) but also improves the government's fiscal situation as traditionally the government has used the fall to shore up revenues by increasing taxes than to pass on full benefits to end consumers.

Outlook

It is difficult to predict how much the markets could correct if this virus spread becomes uncontrollable. Our interaction with our portfolio companies suggest that so far, they have not seen any major disruption in their supply chain and the managements believe they would not be significantly impacted by shutdowns in China. We believe most of our portfolio companies have robust balance sheets and should be able to last out the near-term decline in consumption in their consumer markets including India.

The correction in the markets has allowed us to deploy our cash allocation giving us an opportunity to buy quality stocks at attractive valuations. The correction offers a great opportunity for investors looking to allocate to equity markets for the long term. At current valuations, Investors sitting on the side-lines looking to deploy may start doing so in a staggered manner. Investors running their SIPS can continue to do so, and are advised to stay invested.


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