We write this note in the context of strong momentum in the Indian stock market. We discuss our perspective on running a performing portfolio and deploying capital at these times.
PART A: Why are the markets trading higher, in our view.
The market momentum is driven by a strong flow of funds from domestic retail investors (via SIPs), and domestic institutions. This flow is more and more structural and will continue over the coming years. There is also an inflow of funds from foreign institutions, though a part of it is from passive funds driven by bullish momentum. If the US cuts rates, more money will pour into India.
The India macro story is strong and stands out. The markets are pricing in a stable, strong political outcome in India post the 2024 general elections, and the US Fed lowering rates sometime in 2024. There have been signs of weakness in China, with foreign funds moving out. Some of the outflows from global allocations other than India are finding their way to the Indian markets.
The market’s positive view on key assumptions and strong liquidity are the driving forces behind the strong market momentum in CY2023.
PART B: Why is important to know where we are in the market cycle.
The Indian markets are trading at trailing earnings multiple of 25 times, which in historical context has indicated very high levels. There are clear signs of excesses in the mid and small cap equities. The large oversubscription of IPOs shows up as “buying panic” amongst primary market investors.
Periods following market highs have been periods of moderate performance. It is not clear to us which exact event may cause the cycle to reverse, but then cycle reversal does not necessarily require a trigger. Cycles are self-correcting. We need to remain cautious.
PART C: How does our process to assess existing portfolio and find new opportunities, hold up.
We have an intrinsic value estimate and a core set of variables that we track on all our investments. At this time, we are asking only one question on each investment in the portfolio: How much optimism is factored into the current price? For our core portfolio, the answer has been acceptable – the best-case scenario is not priced in yet. For the others, the price has begun to reflect close to the best set of underlying variables. We are exiting those and investing cash in T-Bills / AAA bonds.
While we add to our cash position. We remain focused on preparatory work – building fundamental theses, and getting ready to act as one gets to invest at target entry prices. However, we are finding fewer and fewer opportunities to deploy meaningfully in the current market momentum.
Our process does not deviate from its core. We remain patient investors.
PART D: Outlook – as far ahead as we can see.
India as an economy is well positioned for a nominal growth rate of about 12% in the next few years. While the current valuations seem to be in a zone of discomfort, the possibility of contraction in PE multiples will likely be balanced by the structural flow of liquidity. It will be difficult to stay aside and not participate in the India story.
We continue to work to identify well-run businesses with strong earnings and an ability to grow without requiring fresh equity, driving growth in earnings per share. We think careful selection can bring meaningful returns to the long-term investor in the Indian markets.
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