2022 – Year of the Tiger and what it means for India!
Is the market overvalued and can I wait for a correction?
Entering a new calendar year brings in new aspirations and a wish list for everyone. However, markets are not a place for excitement and euphoria. It has always been a weighing machine that rewards processes and tests an investors patience.
As we enter the new year, the investor is faced with two seemingly hard decisions, depending on the kind of individual we speak about:
A) An investor who has seen a good return profile in their portfolio over the last few years as the market has reached new highs.
B) A new investor who is looking at allocating capital into the markets for the first time.
Interestingly, it’s the same question that continues to be on top of the mind for both classes of investors above – Is the market overvalued and can I wait for a correction?
An investor in the real world wants to own and continues to buy assets which they believe has value and this would fall in the category of – valuable, rare, cannot be easily found, has limited supply. According to most, this would be the traditional definition of value to assets or goods investors want to own for the long term.
However, the same category of investors, the moment they come to equities, change their definition of value – they would rather own a cigarette company which is known to cause cancer (where the number of smoking population globally and in India is reducing) rather than to buy a business which is winning the largest and highest orders in its history, has pricing power and has significant headwinds for growth in the IT services industry. The latter to an investor would be rejected based on valuation and deemed to be expensive.
It is this categorization and anomaly that creates extremely interesting opportunities in the equity markets. As we enter the new year, it is important for an investor to focus on the micro and the individual growth stories, and to continue to focus on businesses that are generating cash-flow growth. These businesses have two tailwinds that 90 per cent of businesses in India do not – a) the promoters of such businesses can reinvest this capital into the business for future growth b) pricing power which helps them grow their market share during inflationary times.
When the above is combined with an exceedingly good return on capital profile (say 1.5x cost of capital), you are looking at a business with a significant compounding effect on your portfolio. These businesses should be a part of one’s portfolio as we enter the next phase of growth in the markets.
I have continued to believe that we will look back at Covid (the first wave of global lockdown) as the biggest tailwind for Indian markets for the decade. Global supply chains came under stress and manufacturing across industries have begun to diversify from a geographical perspective. While China, will continue to dominate scale in Asia, the year of the tiger in the Chinese calendar will have benefits to India across specific industries where manufacturing and supply chain moves to India. This is coming alongside a period where wage inflation on the ground is rising. Digitization and IT services have become a significant tailwind for the country and the new calendar year should continue to see the value of IT exports grow at a 20 per cent CAGR over the next 5 years.
Corporate India is currently de-levered to the extent that it’s the lowest debt across balance sheets that we have seen over the last 15 years. This sets the base for the credit cycle to expand through private capex, which should see banks and financials see a 20 per cent growth in their lending book. I continue to believe that well-run banks will continue to gain market share through this cycle.
As the demand cycle picks up with wage inflation, this will have ramifications on the real estate cycle too. While there has been significant consolidation in the industry over the last 3 years, this has set the pace for the larger developers to garner more market share as the demand cycle picks up across Tier I and Tier II cities. This will have implications for the growth of the real estate ancillary businesses, many of which have debt-free balance sheets and have seen longer than normal periods of slow growth.
While we will continue to have discussions on Fed rate hikes, liquidity reducing from the system as the purchase of bonds taper off, the focus in 2022, will be back to micro growth stories which will continue to drive returns in portfolios. Focussing on the number of rate hikes, when the liquidity taper will take shape and at what pace, are beyond a point not fruitful as these are events that are bound to happen in the year. Instead, a stronger focus on the portfolio companies one owns will ensure robustness in the process, which is where I believe investor returns will come from.
The author (Naveen Chandramohan) is the Founder and fund manager at ITUS Capital, a PMS firm running a growth oriented multi-cap fund (www.ituscapital.com).