Private Equity and Public markets are far-cry from each other when it comes to marking down valuation. For PE industry, protective masks in the form of “marked-to-myth” come handy during pandemic outbreaks. Without the access to that mythical protection, public market funds, where valuations are marked second to second, start dancing to the sound of every sneeze and wheeze. If one is marked-to-myth, the other is marked-to-madness. This note is not about myth versus madness, but to discuss more about the myth behind the ongoing mayhem.
No one can argue about the stress that is ahead for the economy on account of lock-downs across the globe. The stock prices need to adjust for the impending recessions across developed markets. Whether the recession will be shallow or deep is difficult to say at this point of time. The debate is not on whether the stock prices need to adjust, but on how orderly or disorderly it can be. No assets in financial markets adjust orderly for the new information or the new situation, be it equities, currencies or commodities. The nature of the beast is such that every adjustment, upwards or downwards, are brutally dis-orderly. It is no different this time. But the new fancy features of the beast, such as, algo trading, passive ETF bubble (more in US) etc. are adding fuel to the fire of familiar old time suspects like margin-calls, speculative unwinding etc., This fancy combo has conspired with other panic sellers to wreck a brutal bloodbath in markets, that too in a very short cycle time of few weeks, which would have normally happened over few months in the past crises. In such dis-orderly adjustments, deep under-shooting is inevitable. Though screen may look scary, investors shouldn’t resort to selling during under-shooting as it will make the pandemic losses (notional) permanent.
Going beyond the technical context for the correction, what about immediate fundamentals? Easy to see that there will be a washout for earnings in this and the next quarter for many businesses. In our view, no business will be spared because of second and third order impacts across the economy. For many businesses, it will be a survival issue, esp. if they carry any balance sheet related risks. Debt can become a great de-railer for many companies. Across the spectrum (large to mid to small caps), companies with higher gearing (high debt to equity) may face survival risks. On the flip side, companies with low debt and high cash surplus may come out stronger from this crisis as they equip themselves to gain market share from weaker ones that will battle for survival. This will be the case across the spectrum including quality small-caps. Portfolios built on conservative approach with stocks with low debt will have much less to worry.
But what about medium term?
Right now, market is in the mode of scoot and run. First sell and then think later. In such mayhem, it is easy to lose sight of anything that is not in the immediate vicinity. But when the dust settles, market may start looking at some of the India specific opportunities (listed below) that are arising out of this crisis.
- The Covid crisis is now expected to accelerate the china-hedging process that has already begun post US-China trade war in many of the global corporates. Reducing china dependency is no longer a cock-tail discussion for many companies worldwide. It is a serious issue facing many boards today. When it is translated into action, India is likely to be one of the potential beneficiaries, esp. in industries where India is globally competitive. This is likely to incrementally boost growth in the medium to long-term, esp. with the new concessionary corporate tax regime of 15% for the new investments in manufacturing.
- Amid the rising fears of global slowdown and recession, it is important to remember that the following factors that are likely to alleviate the impact on India.
- India is coming off from a deep deleveraging cycle and a decade low growth. Since impact from global recession is mainly fed thro’ credit crisis, given the deleveraging that has already happened in many of the balance sheets, impact from global recession is likely to be limited (on relative scale) on this aspect, though there will be a collateral damage.
- Being domestic and that too consumption driven economy, India will be relatively insulated. Since it is coming off from a low base, any incremental growth that can potentially come from low oil prices and from china hedging, will make it look respectable for global investors, esp. if the Indian Govt. contains the covid crisis successfully (initial signs do give hope on this). In such a scenario, out-performance of Indian markets (after the dust settles) can’t be ruled out, esp. when India has more headroom in both fiscal and monetary policies in comparison with global peers. Recent RBI bazooka is a case in point (75bps cut in repo and other large liquidity measures).
At the moment, the consensus view is to wait for clarity. But, as past cycles show, one has to pay a heavy price for clarity. When cloud clears, prices will be already up. For those who are already well invested, it is not the time to panic, but to add to the portfolio by taking advantage of the pandemic prices. For those lucky few who are sitting on high cash, no better time to start deploying than now.
Happy Value Investing!!!