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The benchmark index made a high in September, took a dip and is now back to a new ATH (all time high). It is a good time to look at how portfolios have behaved during this brief reset phase. If the portfolio has gone onto make a new ATH, it means that it is aligned with the current market narrative. Else, it is an indication that we need to take a fresh look at things and see what has changed in the meanwhile.
Our reading is that the texture of the market is still the same, pockets that did well in H1 continue to lead the market higher. Pockets that were struggling with hazy earnings outlook and high absolute valuation continue to drag. Earnings momentum is being by driven the fixed capital formation theme after more than a decade while the consumption continues to struggle with a high base and muted earnings outlook. In the long term, India will need both engines to fire if we need to get onto a secular trend of higher GDP and higher equity markets.
The NIFTY 50 is interestingly poised right now, our analysis tells us that whenever the 3 year return of the benchmark NIFTY 50 crosses 15% p.a., future returns have dipped closer to the 10% p.a. mark. What is notably different this time is that the usual sectors that have led the market higher are underperforming this time. The best performing stocks in the NIFTY 50 right now have much lesser weightage than the so called “secular businesses”. For this reason, we believe that we are in a stock pickers market that is conducive to alpha generation.
Post the reset of H2 FY22, the market has reinforced a few important lessons –
- Most things (stocks, sectors, market) are cyclical; there are no evergreen animals that “always” perform
- One needs to have a framework that enables you to detect and calibrate to the changing market texture
- Themes that come back into vogue after a long time do not go away in a hurry
- Themes that have stopped working (after working for a long time) don’t come back into vogue immediately
- Steadily reduce exposure to the investing style of the fund managers who hog the current media limelight
One of the underappreciated aspects of investing in the previous decade was the misallocation of capital in the developed world. Growth capital chased new economy businesses that had questionable unit economics while starving core sectors like conventional energy, infra & power. Some day case studies will be written about how private funds lost their marbles funding businesses that not only had questionable unit economics but also had questionable ethics and business practices.
We believe that the investing playbook of the previous cycle (peak of it being 2016-21) is no longer something one should rely on. Unless one believes that interest rates will fall a lot and quickly at that, chasing the angels of the previous run isn’t a prudent bet. Core sector businesses that were shunned for a decade because they were “sub 15% ROCE” businesses have delivered the best return in the Indian market since 2022. The thing with ROCE is that it is cyclical too, in a good cycle many of these businesses will deliver 20% ROCE at 20% growth. A large chunk of the smart money in public markets is managed by fund managers who were investing much before the GFC forced central banks into ultra low interest rates and QE. A combination of wisdom and experience beats smartness hands down across cycles.
We revisited a blog post of ours from June 2021 when the previous cycle was close to its peak (with the benefit of hindsight). We take comfort from the fact we were able to think of a few scenarios well before they actually played out in the real world. The perspective of “common knowledge” did not help us predict anything in advance but it did help us recognize the shift in the market mood once it started. We have no qualms in admitting that had we stuck to the same portfolio construct we had through CY21, we would have underperformed big time in this run. The pivot we made in Q1 FY23 has made all the difference, we could make that pivot because we were open to possibilities. Doubling down on the bets we had at that point of time would have been irresponsible.
As an investor one should always be a forward thinking, inferential reasoning driven animal who is always scanning the horizon and making mental notes all the time. Else we run the risk of missing the forest for the trees.