Nobody knows now but let’s try to find what is essential to know!
Writing a blog after few years! Today there are serious legitimate concerns & ambiguity in minds of people invested in market to know where we stand, where we may go from here and how long will it take.
First is an admission. Like you, I also don’t know with clarity and I feel none has. We are at a “never seen before… never experienced before” type historic juncture where not human greed and fear which drive economic or market boom and bust in all earlier cycles is playing the spoilsport, but a health hazard created the crisis after almost 100+ years when globe is much more interconnected, when people, information and analysis travel must faster than anytime in human history. Pretending knowledge in midst of chaos is more dangerous than admitting ignorance. Ability to have a curious and open mind with willingness to take prompt action when opportunity arise should ideally be our pursuit (doesn’t mean correctness in action or in timing, both can go wrong in spite of all efforts).
We all are inundated with more information and data than we can process so I would like to split my thought process in different silos and then try to connect those:
Supply Side issues: When the Covid 19 started in China, almost all took it as a Supply Side issue as China is global supply source of most key raw material and electronic goods in the world. Most expected a 3 – 6 months’ supply disruption before normalcy is restored. Now China is limping back to normalcy but the global major ‘Consumption Centres’ of those supplies are unable to absorb those supplies. We can safely assume, right now, 60% to 80% of GDP of most countries are not functioning in Developed World and major Economies. The rest of the functions which are working are Essential Commodities, Banking, Power, Water, Medical Services etc which may constitute 20% to 40% of the economy, roughly. In this scenario, China is forced to cut back labour, closing factory temporarily.
Similarly, there would be domestic supply shock at local level and it may vary depending on how complex are the supply chain of different countries, geographies and localities. For example, in India, labour dislocation from business centres and ‘productive activity areas can create supply shock in almost any labour-intensive sector from Harvesting to Transportation. I expect supply shock can be felt much longer after the lock-down is lifted because — a) Presently we are getting supplies from past inventory; b) Govt machinery is working in emergency mode; c) Effect of migrant labour shortage would be felt once new set of supplies are expected in the market as farm or warehouse or logistic sectors are highly labour intensive. This can possibly affect “Farm to Fork” supply chain and distort Agri commodity price and price of non-perishable resulting fall in income in hands of farmers. Also, if finance, demand or liquidity become a “choke point” then revival of Supply from MSME / SME sector may become longer than desired.
However, the Supply Side issues would be significantly less or zero in sectors which work in “Start & Stop mode” like Cinema Halls, Hospitality, Airlines, Travel & Aviation, Online Retail of non-Essentials, Availability of Credit etc.
Demand Side issues: It is function of earning power, predictability of cash flows. demographic profile, availability of quality jobs, skill level, wealth effect and “animal spirit”. These issues have varied effect on different countries. In India, these are constraining our growth for many years as we faced quite a few economic shocks which are known to everyone like Demonetization, Lack of Private Capital expenditure, Complex GST system, Stretched Fiscal Position (combined and real Fiscal Deficit is almost 8%+), Poor growth in Tax collection and almost zero job growth.
This Lock Down has only exacerbated the issue significantly. Now we face situation when many people who are employed in SME / MSME may find problem in retaining their existing jobs, there may be salary cut or deferment in well-paying jobs, poor increase in salary / wage across sectors. Add to that, as discussed above, if farm to fork supply chain get affected then income in hands of farmers can be affected too. This in turn, may bring “demand side” problem in rural economy. Also, migrant labour remitting money to rural home and augmenting consumption there – If their income gets impacted, it may further depress rural demand. Demand side problem is hard to solve in short term, in my limited understanding especially in India.
Why I think demand side problem is tougher to solve in short term: Our Banking, NBFC, MFI sector which fuelled the demand in Industry, Business and Individual sectors respectively have passed through different phases of crises in past 6 – 7 years. In spite of high liquidity and low borrowing cost, banks would be cagey to extend liquidity to disbursing intermediaries like NBFC or MFI in uncertain situation especially when they just passed through the worst NPA crises from which it is just about to recover. Unfortunately, this Covid 19 crises have come at a very critical moment for Indian economy as banks now would be very unwilling or are unable to extend credit to weaker borrowers. For them, a new set of NPA crises would be too tough to withstand within such short time gap. Also, the bond market in India is not that well developed to supply entire credit demand at right cost to larger entities.
In this situation, Fiscal measures like direct cash transfer and very liberal credit is essential for a major section to survive (at least 40% – 50% of the population) … It would be surely done by Govt irrespective of tight fiscal but it would only help “Sustenance” but not a “Stimulus” to consume. To me. this distinction is critical and important when we model rural demand related investment thesis of consumption (FMCG, Apparel etc). The rest 30% to 40% of population would be cagey to spend because of obvious consequences of lack of clear visibility of cash flow / job security / salary growth especially in areas of large value discretionary items (Foreign Travel to High Value Consumer Durable depending on sub segment of the middle class).
This demand reduction leading to supply reduction is a negative feedback loop — Large Govt spending can break the vicious cycle. I am unsure how much ability Indian govt has to spend and inflate away the crises given fiscal profligacy can reduce our global credit rating to non-investment category and can create a different set of problem in attracting global fund especially in our bond market. But possibly, fear of sustained high inflation may be misplaced in low demand environment even if Govt resorts to fiscal expansion except may be spike in food prices in short term.
Liquidity: Presently the biggest problem faced by companies globally is liquidity. On global level there is huge shortage of US$ as global trade is stalled, which is predominantly denominated in US$ and hence velocity of US$ reduced substantially. The massive fiscal stimulus announced by US of US$ 2 trillion may reduce the crisis gradually. But effect of this would be felt by emerging market currencies and depreciation of INR may be highly likely.
In India, the liquidity problem is high for similar reasons of trade stalling, certain fixed cost continuing and stringent regulations & credit concerns making funding institutions very selective. RBI actions are more than expected but how much effect it would have is something solely depend on risk appetite of banking channels.
In stock market also the present fall is primarily due to liquidity issues faced by ETF and global funds due to redemption pressures and flight to safety of global capital. Whether this issue would continue, exacerbate or slowdown is a matter of pure conjecture at present moment as we have no clarity of when the virus spread and related fear would subside. At present it is very tough to guess.
Businesses: It is relatively easier to identify.
Business has 5 sources of expense – Vendors (for RM, Utilities, Rental etc), Salary, Interest, Taxes & Dividends. Out of these dividends are last and discretionary. Taxes and Vendors are function of sales and profit, Salary and Interest are almost fixed in nature. If we take only debt free, cash rich companies then they may be better placed to survive longer duration than others unless demand of their end product is drastically less needed by market. But here also I can visualize a scenario where this assumption may not work. For example, take NTPC, which produce power but if industrial demand (which pays) is low for long time then consumer & agri demand (which is subsidized) would force Discoms to delay payment or resort to load shedding to save money. So, without demand from remunerative customers, very few businesses except FMCG & Select Private Banks can remain unaffected in their business economics (nothing to do with valuation).
Some businesses are avoidable in short to medium term in present context — Travel, Tourism, Airline, Hospitality, High Value Capital Goods, High Value Consumer Durable, Theme Parks, Construction, Commodities like Metal and Minerals, Real Estate, Corporate Lenders, NBFC etc. Please note, it doesn’t take into account valuation (Imagine valuation has no meaning for this part of discussion, will discuss separately).
Market: The unprecedented fall has created a situation where everything may be looking attractive if one has cash. And conversely, may look very unjust, wrong, disgusting to anyone who is already invested and wounded. Present market gives no consideration to past history of the business, terminal value of the business, incremental improvements in business or quality of earnings. It is panic all around! Panic & fear has its own justification and evolutionary logic and I personally don’t feel anything negative about being panicked (mistaking rope as snake 10 times may be socially shameful and humiliating but mistaking snake as rope just once is recipe for death and destruction) —- Most global investors are selling today simply out of fiduciary responsibility of risk mitigation which if one likes can call “fear” but I am more charitable to their reasoning. Since ‘No Body Knows Anything” about when and how fast better days would come, taking some money out by investors can’t really be called “fear”. Investors are in risk mitigation mode so either raising or preserving cash. Here lies the opportunity for the prepared!
Valuation: I feel, even if two years of earning get impacted, the terminal values of robust businesses are not substantially impacted. But since the present selling is not due to market excess, the valuation-based investment has no meaning unless one has very long-term view as price in the interim may fall to any absurd level if concerted sell and short sell continue. It can have definite reversal only when virus related concerns are abated by concrete data or some cure or vaccine is discovered, all of these are not going to happen in very short term as we know today.
Here, for short to medium term, let market give signals about where to invest and from where to withdraw (if invested).
But during these periods of great uncertainty, unless humanity perishes and markets disappear, opportunities for long term investment comes at an unbelievable cheap valuation slowly but surely. In both bear and bull market extremes, market acts as if there will be no tomorrow. But rushing to market is foolhardiness at this time. We will get enough time to pick and choose. Hard work to prepare is more important than actually playing the game. Also, it is excellent time to review if one feels portfolio rejig is desired.
Positives: For India there are few positives. Firstly, we are younger country and possibly due to our better immunity (left-handed compliments to our poor social hygiene!) we may withstand it better than many countries where median age is much higher and immunity is compromised due to high social hygiene standards. Secondly, 60% of our population is dependent directly or indirectly to agriculture, essential services and govt jobs, which would be relatively immune to the vagaries of economic cycle to some extent (not fully) & high resilience of Indian common mass due to its adaptation to living with uncertain environment like flood, drought, cyclone, vagaries of monsoon, localized epidemic and some such negatives throughout history. Thirdly, we have huge food grain reserve which can withstand extreme existential issues without much stress even if the problem become acute and lingers for almost a year. I always feel, in a crisis, we, on most occasions, underestimate human ability to find solution for its survival and overestimate the extent of negative which can befall on humanity.
This time, unlike war or environmental calamity (flood, earthquake etc), this particular emergency like situation doesn’t need rebuilding of infrastructure but needs huge investment in public health, creation of more medical, nursing and healthcare facilities apart from giving income support to poor and vulnerable, we may also expect major change in focus of Govt expenditure and private sector CSR initiatives. Also, the lock down may change certain priorities of human behaviour and consumption in medium term … I am yet to fully build a scenario about those changes as yet as in these extreme scenarios we all are victim of recency bias.
Stay calm, stay safe, be vigilant for opportunities and seek suggestion if you need.