Globally, equity markets are seeing a massive sell-off due to the covid-19 outbreak.
Two major reasons possibly are
- Growth slowdown, fear of a recession and lower corporate earnings expectations in the near term, led to a market downturn as valuations looked stretched, mainly in the U.S.
- Panic selling by investors due to high risk (uncertainty) around the covid-19 outbreak and its likely impact on the world economy.
What we see now is money moving to debt, gold, and safe-haven currencies, all of which have seen significant capital appreciation in the last few weeks. This investor behavior is not alarming as in past market downturns; money moved to bonds and other safe-haven assets.
The first point is not new for the markets, as markets have gone through different cycles in the past – upswings & downswings and each being followed by the next. The second point is mainly driven by an exogenous event, which, to an extent, is also part of the market cycle. Panic selling is one common factor across all market downturns, driven by short-term investor behaviour.
Cycles are self - correcting, and their reversal is not necessarily dependent on exogenous events. The reason they reverse (rather than going on forever) is that trends create the reasons for their own reversal. Thus I like to say success carries within itself the seeds of failure, and failure the seeds of succ ess. During panics, people spend 100% of their time making sure there can be no losses, at just the time that they should be worrying instead about missing out on great opportunities.
- Howard Marks in Mastering the Market Cycle
The strong U.S. bull market over the last decade and a strong run-up in Indian equities between 2014-2017, led to market valuations look stretched as price/earnings multiples rose. Being valuation-driven investors – the ongoing downturn, to our sense provides a valuation opportunity to add equities from a long-term perspective. As a group, we aim to build portfolios that deliver returns through the cycle in a much steadier way and with less drawdowns than a broad composite benchmark. This is designed to help investors with risk-adjusted returns equal to or above benchmarks and dilute the negative impact of human emotion at times of market drawdown, such as the last couple of weeks.
How we were positioned early February
In our multi-asset managed portfolios, we were conservatively positioned to minimize drawdown before the sell-off, which acted as expected to cushion the impact somewhat of a vicious recent sell-off.
We were overweight domestic bonds, particularly short & medium term, and cash and underweight equities, particularly India and U.S., relative to the benchmarks or neutral allocations.
How we are positioned now
In times of extreme negativism, exaggerated risk aversion is likely to cause prices to already be as low as they can go; further losses to be highly unlikely; and thus the risk of loss to be minimal. Thus, the safest time to buy usually comes when everyone is convinced there’s no hope. – Howard Marks
As the virus inevitably spreads, the extent of its impact on the global and domestic economy remains to be seen. We expect the investor fear quotient to reduce from markets, and instead, prices to focus on earnings impacts. When that attention turns there, we would expect very different results from those companies that have been able to keep their supply chains intact versus those who have not. Our estimated 10-year valuation implied return for Indian equities is driven by a suitably strong trend growth and improving valuations with the recent downturn.
Now we are focused on rebalancing portfolios back to target (selling bonds and buying equities) in order to respond prudently to recent market actions. Return expectations from fixed income have come off relative to what they were a couple of months ago as yields fell across the curve. With the return profile improving for Indian equities, we have increased allocation to equities (thereby reducing our underweight positions) by utilizing extra cash and debt allocations. Within Indian equities we have added exposure to Large-caps and Small-caps. We continue to retain our underweight (albeit marginal) stance on Indian equities and marginal overweight positions in debt as compared to neutral or benchmark allocation.
We continue to monitor the portfolios closely and stay focused on helping investors achieve their goals over the long term. As it has in the last few weeks, going ahead as well, our overweight position in cash (vis-à-vis neutral position) and debt should provide ammunition when attractive investment opportunities arise and protect ourselves on the downside.
The trade war, corporate tax cut in India, and now the pandemic outbreak in major Asian exporters are likely to cause shifts in manufacturing (concentration) away from China/South Korea. India could benefit from this, if policies are attuned to requirements of global manufacturers. As such, we have penciled real growth of 4.3% over a rolling 10-year period. We endeavor to identify and select managers who actively lookout for companies where the growth potential is higher than what the broad market index would offer.
The global growth slowdown amid covid-19 outbreak casts doubt on the Indian growth story in the near term, and stocks have declined sharply on expectations of low earnings growth for the coming quarters. Earnings expectations for FY21 could see a significant re-rating due to a slowdown in consumption and investments. Although, over the long-term, we believe that India would benefit from a cut in bureaucracy, increase in exports, additional reform measures, pick-up in government expenditures & consumer spending, superior demographics and improving penetration for banking and financial services.
