Equity View by Mr. Atul Kumar Head- Equity Funds, Quantum AMC

‘I opened the Times newspaper and the news appeared red. Then I opened the Express paper, news there was deeper red. After that I looked at the stock market screen and it was bright green .’

This joke well sums up the economy and financial markets for the month of April. Covid-19 has held most economic activity at ransom while stock markets are on a roll. Many participants are probably looking at a sharp recovery (called V-shaped in financial jargon).

Speculators and investors are banking on a government stimulus and ultra-low interest rates which could pull the Indian economy from this unprecedented crisis. In addition, the Reserve Bank of India is providing a backstop, i.e. even junk bonds have no worry of default. The RBI will rescue them. Traditional theory of risk and return has been turned on its head by such policies.

For the 4 months of calendar 2020, S&P BSE Sensex return is negative 18%. Despite the fact that the S&P BSE Sensex surged 14.4% during the month of April (14.6% in USD). This follows a 22.8% decline in the previous month when India went into a stringent lockdown from March 24th. The performance of the S&P BSE Sensex was slightly better than the developed market indices such as S&P 500 (12.8%) and Dow Jones (11.2%) (Both in USD terms).

Midcap and small cap indices had gains similar to that of the Sensex during April. S&P BSE Midcap index rose 13.7% while S&P BSE Smallcap leapt 15.5% in the month.

Healthcare, auto and oil & gas were some of the sectors which did extremely well in the month of April. Positive news flow in terms of new drug approvals and plant approval from FDA helped pharma stocks.

Non-cyclical sectors such as FMCG and consumer durables were among the least gainers in April. Real estate and PSUs rounded up the laggard sectors. The Indian rupee appreciated 0.7% during the month v/s US dollar.

FPIs had a quiet month during April. They were net sellers of USD 31 Mn. So far, in the current year, the FPIs have sold stocks worth USD 6.6 Bn. Domestic institutions (DIIs) were also net sellers to the tune of USD 100 mn in April. However, since January 2020, the DFIs have cumulatively purchased USD 10 Bn worth of stocks.

The impact of the Covid-19 pandemic on the world economy has been higher than any previous event including the two World Wars. Developed countries are looking at contraction of between 8-16% in their GDP. For some countries, like the UK, this would be the biggest decline in economic output in the last 200 years. For many countries, it could take about 2 years to reach the same level of GDP that was recorded in 2019.

Since there doesn’t seem to be a cure or vaccine for the disease, the economic problems are likely to drag on and become more acute if the governments still insist on lockdowns. Many small businesses are on the verge of closure and unemployment rates will be at a historic high. World over, there is going to be higher corporate bankruptcy than any time in recent history.

The lockdown has been particularly strict in India. All economic activity - except for farm and few essential goods – have been suspended. Given the severe impact on livelihoods and incomes, the wait for fiscal stimulus has gotten longer. So far the size of the stimulus has been only 0.8% of GDP. Even by conservative estimates, the country needs a stimulus of at least Rs 10 trillion (5% of GDP).

The lockdown was supposed to end on 14 April but was extended till 3 May. After that, the country was divided into 3 zones and some relaxation was given in green and orange zones. Estimates suggest that approx. 48% of economic activity lies in the red zones where stringent measures continue. Manufacturing output, as measured by PMI or the Purchasing Managers’ Index, stood at 27.4 in April. It is normally above 50 - the current level is a 15 year low. Unemployment levels, as measured by CMIE, have touched levels closer to 25% from 7% before lockdown.

An absence of a stimulus can lead to a significant social and economic problem. This would make economic recovery even more difficult in the successive years. The rising NPAs of the financial system, closure of critical industries, and the massive rise in unemployment are some of the collateral damage in the absence of a significant government economic revival package

Many listed companies are declaring their results for the last quarter and for the full year of fiscal 2020. Given the prevailing situation, the demand revival and normalization of operations could take 6-12 months from levels pre Covid-19. We understand it could be even longer given uncertainty of economy opening. All companies are looking at drastic cost cutting measures to compensate for lost sales.

The current economic scenario is challenging for many companies. Many companies may not survive and some will emerge weaker after the current crisis. Few other companies, however, will emerge stronger and benefit from consolidation in respective industries. The Scheme has chosen stocks which we believe be winners in the long term.

India is likely to grow faster than many nations. The economy is dependent on domestic consumption and insulated from any global problems over the long term. While economic growth faces pressure in the near term, a better monsoon and measures to ease liquidity are likely to stimulate growth. While economic activity has halted in urban areas, things are much better in rural areas. Rural India is likely to bounce back sooner after the lockdown is lifted.

India could also be a gainer from the Covid crisis if it positions itself well. Many companies are looking to restructure supply chain away from China. Manufacturing sector can capitalize on this opportunity with the support of government policies.

April witnessed 6 debt schemes of a mutual fund house unable to pay money to its investors and deciding to wind up. These schemes had approx. Rs 250 Bn in AUM. Severe market dislocation, the illiquidity due to Covid-19, and high credit risks were the reasons for the closure as per media reports. Such events can test the financial system which is already fragile.

QLTEVF saw a 15.4% appreciation in its NAV. In comparison its benchmark BSE 200 had 14.7% return in April. Refer page no. 8 of the combined factsheets for complete performance of the scheme. The Scheme’s holdings in healthcare and auto stocks contributed positively to its performance. Some IT stocks and a PSU bank dragged overall performance for the month.

For the 4 months of 2020, the Scheme’s performance is -20.6% as compared to -18.1% for the benchmark. Cash level in the Scheme was 8% at month end. Many stocks were re-jigged during the month. Given the challenges to discretionary spending in current scenario, we cut our position in 2-wheeler stocks. On the heightened risk to banking, a PSU stock was also trimmed. The Scheme also reduced position in an IT stock where upside appeared limited.

We remain positive on equities in the long run even as a sharp rally in April has reduced the very attractive upside potential. Investors should use this opportunity to deploy capital in equity mutual funds if they don’t have enough exposure to the asset class. Investors should continue with SIPs to take advantage of better valuations and volatility.