A new government and a new Momentum Portfolio from Capitalmind Wealth

Finally, elections are done, and we were unnecessarily scared of the consequence, it turns out. With a stable government, the next five years will, at the very least, not have a fear of one party arm-twisting the other with the threat of bringing it down. This is good news for the overall economy perhaps, but there is a lot of work to be done.

But before we continue, a few notes:

• Please do connect with us at support@capitalmindwealth.com or +91 6361 531 722 if you have any questions or queries, including allocation, goals or changing funds.
• Please check Progress for your portfolio details and current status.

Now, to the commentary.

Horrendous Economic Data

GDP growth came in at a dismal 5.8% for the March quarter, which brought India down to the lowest growth in over five years. This data comes just after the election results, and is eerily low. However, the March quarters of election years tend to be rough - because companies restrict spending or capex until there is clarity on who’s in power. Things can change suddenly when a new regime comes aboard - such as in Andhra Pradesh, where the new government has cancelled all un-commenced orders given by the outgoing older one.

This GDP number accompanies a jobs report that shows unemployment at an extreme high - with nearly 10% for males and 15%+ for women. Youth (under 30) unemployment is at 17%+ with urban women seeing 27% unemployment. This is a cause for concern and there is a quick need for action.

We anticipate that the first set of actions will be by the RBI - in the coming week. The fact is that inflation is low at sub-4%. The fact is that interest rates, in general, are too high with even fixed deposits making 7%. We believe that this differential is hurting India in many ways:

a) When inflation is low - say 3%- your costs go up by 3% and you can increases your prices by 3% so revenues go up similarly.

c) If your margins on your capital fall to 8% or so, then you might as well invest in a fixed deposit instead of running a business. b) But interest rates are at 9%+ if you borrow. Which means the cost of borrowing money to fund your business will eat into your profit margin substantially.

This structure causes two things: people won’t start a new business because the returns are relatively low due to the high interest rates (cost of capital). And people running existing businesses either don’t expand, or cut down their business.

We did a podcast on this concept: Do have a look by clicking here for the High Cost of Capital in India.

That is a big factor for unemployment. But there’s a ray of hope.

Foreign Investors Looking Hungrily

If inflation is low, our currency should not depreciate much. And indeed, in the last five years, we have seen less than 2% a year of actual depreciation of the rupee. This is a good sign, but also an interesting thought.

If you can borrow abroad at 3% and park it in India at 8%+, with inflation becoming structurally low (as in, it’s not a temporary thing) - you can make a very decent return even if there’s a 2% depreciation per year. The spread is wide.

And that’s what’s happening already. A number of foreign participants have started to look at Indian assets hungrily, and also the desperate sales that seem to be coming with IL&FS and other NBFC resolutions. Canada’s pension fund CDPQ is looking to buy a bunch of highway assets. The troubled DHFL is looking to sell its home loan portfolios and even a mortage company associate to US investors Blackstone and Oaktree. Cube, a PE fund, has already been buying road highways from Reliance Infra and our portfolio company, KNR constructions.

The interest in India is, in our view, purely commercial - not a political statement. There’s a good reason why, and that concerns our high real interest rates. Meaning: what is unattractive to Indians because of the fact that we get extremely high rates of return through our fixed deposits, is attractive to foreign investors who get capital cheaply and are enthused because of our control over inflation.

Oncoming Stimulus

RBI is likely to change this equation slightly by cutting rates. After all, low inflation, a slowing economy and rising unemployment don’t call for keeping rates higher. A big beneficiary of this is in the banking system initially, but over time this will spread to the rest of the economy.

Another big area will be in infrastructure and capital goods. RBI surveys show that capacity utilisation remains at a high - so to grow further, new capex needs to be made. And the government, once settled, will spend on infra (roads, public infra etc) which is likely to help both employment and spending, especially in the rural sector.

What’s hurt the most has been the auto sector, but we don’t believe that hit is permanent - with a rate cut and further stimulus, we expect a strong revival in the coming years.

Other headwinds exist - from Trump’s eccentricities, to a Chinese trade war, to the sudden moves in Crude (currently in our favour) we get impacted substantially when things happen abroad that are not in our control.

The statistics show that in the last 15 years, we have always seen stock markets go positive after elections. But in the previous three elections (2004, 2009 and 2014) stock markets weren’t very expensive to begin with. This time it’s the other way around - the consolidated earnings multiple of the Nifty is over 25 times earnings. This is at the high end of the curve, and we are seeing extremely high multiples for a few companies that comprise a substantial part of the index. The Nifty’s at all time highs, but if you look at the Midcap indexes, they have corrected more than 15% from their highs, and even the Next 50 (stocks 51-100 in the top 100) is down over 12% from its peak. This incongruence can sustain longer, but generally it reverts back to normal over a few years.

Still, the market remains expensive. We have expected a correction, which might still be ahead of us, and we are concerned about the valuations of the market.

Capitalmind Wealth: The Momentum Portfolio

We have commissioned two main portfolios - the Long Term Multicap and the Index portfolio.

We now bring you another equity portfolio that is much higher in terms of risk: The Momentum Portfolio. We have a post describing it at the Capitalmind Wealth Blog. (Click here)

Essentially this is a strategy that: a) Invests in stocks accelerating up b) Gets out of stocks that have lost stream c) Adjustments once a month d) 30 stocks, filtered for liquidity and sanity and momentum through our proprietary algorithms.

If you’re interested, do get in touch, and we’ll help you allocate part of your funds to this strategy. Note: This strategy is more volatile and active than others, and will have short term transactions that may impact taxation, so it’s not suitable for everyone.

The Other Portfolios: Changes

In the Long Term Multicap portfolio we have sold parts or all of various stocks as a rebalancing exercise, and raised cash to deploy into other stocks. We find the capital goods and capex related stocks interesting, and as a start have allocated to L&T and Ultratech - players that we believe will benefit from the up-cycle. L&T also has become a consolidated entity that owns entities in Finance, IT, Engineering technology and has also bid for a Mindtree. The company is in various sectors and most will benefit from a revival in infrastructure, lower interest rates and a resurgence of capex.

Ultratech is a bet on their aggressive expansion through acquisitions in the distressed cement sector (Jaypee and Binani) and through its own growth. This is a small allocation that will increase as the position plays out its part.

In the Index portfolio, there are no real changes, and allocations continue as usual.

There will be more changes in the coming months, as the government and RBI set out their path.

Do get in touch with us if you have any questions or suggestions. We would love to hear from you, and help you get closer to your goals!

Cheeringly, Deepak