Nilesh Shah on how to invest in such a market

May 14, 2020

The spread of coronavirus has wreaked havoc across markets. The lockdown has negatively impacted most businesses while some sectors remained immune.

In a webinar conducted recently, Nilesh Shah, managing director of Kotak Mutual Fund tells investors how to navigate this market.

Impact of the pandemic on specific sectors

  • Real Estate

The real estate sector will go through a lot of pain. Buyers are likely to get a good deal if they negotiate with builders and are ready to pay quickly.

Tata Consultancy Services has announced that 75% (3 lakh) of its workforce will work from home permanently. Many more companies could follow suit. As a result, there will be a lot of inventory in commercial real estate, which means, prices of commercial real estate may stagnate for some time.

A similar story is being played out in residential real estate. Consumers are likely to defer their home buying decision. Prices are unlikely to go up when there are no buyers.

  • Chemicals

Great opportunity rests here. China’s market share in global chemical market has slipped from 43% to 39% over the last few years. On the other hand, India has increased its market share from 2.5% to 4%. Chemical firms have started getting multi-million dollar contracts.

  • Luxury

Companies in the luxury segment will find it very difficult to survive. They have to create value for money without compromising their mother luxury brand.

  • Insurance

The sector looks fairly attractive. In general insurance, there will be much lesser claims due to the lockdown. We will also see huge penetration of health insurance as fear psychosis sets in about health.

Common investor questions

  • Should one switch from balanced funds to pure equity funds?

It is time to move from balanced to large-cap funds. Don’t switch at one go at this juncture. Stagger them through systematic transfer plan, or STP.

Alternatively, one can switch some amount now and the balance once a cure for the virus is found.

  • Should one avoid investing through a systematic investment plan, or SIP, when market PE is high?

The PE of Hindustan Unilever has moved from 25 to 70. Stocks such as Nestle and Asian Paints have high PEs but delivered good returns. Stocks which have low PE (metal companies, some PSU banks, some value stocks) haven’t delivered good returns.

The notion of markets not delivering good returns above PE of 25 comes with the benefit of hindsight. But it is not proven if you look at the performance of individual stocks.

By the way, index PE is also calculated based on the constituents of individual underlying stocks.

  • Non-Banking Finance Companies are trading at low PEs. Is this a good sign to buy into these companies?

A low PE is not a reason to buy a stock. You have to look at the management and quality of earnings. The microfinance industry will suffer because people may not be able to repay their loans. Gold finance NBFCs don’t have to worry about non-performing assets. Gold prices have moved up. Borrowers can sell gold at a higher price if they are unable to pay the loan. Thus, there is a lot of difference between these two types of NBFCs.

  • Should one invest in passive funds at this juncture?

Invest in actively managed funds this year. Index managers will deliver index returns while active managers could outperform the index. While SIP returns are not looking good right now, they have done better than their benchmarks.

  • Should one buy at every fall?

We should buy as long as the fall is below the historic average market capitalisation to GDP ratio. You should be a buyer in the current market but in multiple tranches because we don’t know the bottom of the market. The bottom will be at the intersection of a medical solution for virus and a fiscal and monetary stimulus.

Impact of the pandemic on a macro level

  • The cost of lockdown

The exact estimate is difficult to calculate since the pandemic is not over. A back of the envelope calculation shows that India’s GDP is roughly $3,000 billion. If we shut for one month with 100% lockdown, assuming all months contribute equally to GDP, which is a wrong assumption, the cost is around $250 billion. The economy is not like power that we switch on or switch off when we desire. It takes money to restart the economy. If 50% activities remain shut down during these 47 days lockdown, rounded off cost will be $130 billion plus the cost of restarting the economy.

One benefit of this lockdown is that India benefits from lower crude oil prices.

  • Impact of the weakening rupee

The rupee could continue to weaken because of India’s high inflation and lower productivity in comparison to other economies. If it is trading at fair value, both importers and exporters are fine and the economy benefits. If it depreciates beyond its fair value, exporters benefit but importers suffer and eventually it hurts the economy. If it is overvalued, importers benefit, and exporters lose and the economy suffers. If the rupee is at fair value, it neither hurts nor benefits the economy.

  • Will businesses move out of China?

India has not done a great job in the past but we can do better in future. We need to allow businesses to set up their factories in India by creating a good environment. It is up to us how we capture the opportunity.

  • Will the inflation rise due to the fiscal stimulus?

The central bank will be worried about inflation due to the money being printed. Inflation will also increase due to supply shocks. This has happened in the past when the inflation was in double digit.  If we manage this transition well and provide appropriate fiscal and monetary stimulus then the supply side will not be impacted because demand is also subdued. Hence, inflation will remain within the central banks comfort zone. A lot depends on how we manage supply chain.

In western economies, they have taken a call that whenever there is a crisis it is better to pump liquidity and cut interest rates so that supply chain is not disrupted. In India, we raise interest rates when inflation is high so that it hurts demand and keeps inflation in check. We need to balance between demand and supply side inflation.

  • Will helicopter money work in India given the high inflation scenario?

If you inject helicopter money beyond a limit, then it leads to inflation in a supply stretched economy like India.  In countries where there are no supply side issues, helicopter money does work.

In Lords of Finance, you can read how Depression was converted into Great Depression by central bankers who withdrew monetary measures and support to economy from 1930 to 1933. Most central bankers will be now averse to that. They don’t want to repeat the mistake committed by central bankers of 1930 era. They will provide liquidity, support consumption and take some risk of inflation. We have to do everything in equilibrium. We have to manage money supply with supply chain in a reasonable manner.

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