Monthly Digest – March 2025

Back to writing the monthly newsletter after a short hiatus. Compliance setup effort post the SEBI RA license approval and the launch of the new Emerging Business Portfolio kept us on a tight leash for the past 45-50 days. We also have our first smallcase launched for the new Emerging Business Portfolio

As they say, there are times when the market does nothing and there are other times when the market does a lot. CY2025 clearly falls into the latter category as of now, broader market indices are down > 20% from their 2024 peak, most stocks are down > 30% from their recent peak & many counters are now looking reasonably priced, if not cheap. Some of the things we expected to play out in H1 CY25 (covered in this session) have already played out, a tad quicker than expected. Portfolios and investor confidence have been beaten black and blue within a short span of time. Most of us are well aware of the many issues plaguing the Indian market now – USD strength till recently, Trump tariffs, slowing GDP growth in India, FPI selling for many months now and many more.

But now is not the time to focus on the headwinds and look for reasons to not do anything. Now is the time to start wearing the optimist hat every now and then and think of the positives that have been happening –

1. Reversal of the DXY Index trend and moderation of crude oil price
2. Resumption of Govt spending from December 2024, channel checks indicate orders picking up
3. Union Budget finally focusing on reviving domestic consumption through personal Income tax regime change
4. New RBI regime easing liquidity and starting to relax lending norms
5. Inflation starting to ease, giving RBI more ammunition to shore up growth
6. Equity valuation now back to a reasonable range, a good chunk of the froth has gone out
7. SIP inflows continuing to show strength, retail inflows have been more resilient than expected so far

While the near term pain needs to managed prudently, there are enough factors at play that can get India out of cyclical growth low it has gotten into. We may finally be past the point where the risk/reward ratio for looking one year out and thinking positively is significantly high. This isn’t to say that the current correction is done, just that we are at a phase where allocating incremental money to the equity market offers a good probability of a good outcome. We must also keep reminding ourselves that corporate India balance sheet is very healthy and that whatever growth is happening now is on the back of below average credit growth. India domestic macro risk is clearly not high, the market is worried more about the fallout of global macro developments than about domestic developments now.

The thing with FPI flows is that they are cyclical. Sometimes FPI outflows persist for 7-8 months (as seen in 2022) but they eventually mean revert. We keep going back to this observation of ours again and again – the benchmark Indian index is most sensitive to a delta change in FPI flows. It reacts significantly in pivot & trend reversal months, the first month of positive (and negative) months move the needle for the NIFTY 50. As has been the case in the past, whenever FPI flows turn positive the first 5% of the NIFTY 50 will surprise many investors. However, there is no magic wand that allows one to predict when this could happen. As a medium term investor, one can only build positions during bad times and wait it out for the eventual mean reversion to happen.

Coming to stocks and sectors from the din of macro news and FPI inflows. The IT Services index has taken a solid beating after the relative outperformance starting June 2024. This should drill home an important point – defensives cannot operate as defensives unless earnings growth holds up at normal rates. IT Services & FMCG have traditionally been defensive bets during times of volatility because investors would bet on earnings growth of 8-10% YoY while the rest of the market slowed down. We are no longer in a regime where investors can make those bets with confidence on these indices. Everything is a function of time and place in investing, there are no everlasting Gospels that can work 100% of the time.

We have always believed that betting based on Relative Strength is useless in the early phases of a market correction. For what is strong today will eventually fold. Till December 2024 small caps were holding up better than the benchmark index, but when the eventual crack came it got ugly. Relative Strength as a tool should ideally be used after all pockets have reacted and the mood turns pessimistic. In our opinion, the week of February 17-21 was the first indication that value buying has started to emerge. Today, we are back to using Relative Strength as a screening tool. Fundamental investors take time to discover the next potential set of winners. Once they identify a stock that is likely to deliver good (and disproportionate to expectations) numbers over the next 2-3 quarters, they broad base their research within adjacent pockets to see if there is a trend. This buying is what creates the “bottom formation patterns in some stocks “Relative Strength” that shows up in chart scans. Every good technical analyst understands this intuitively.

For this knowledge to percolate down to the broader investing community, it takes a few months at the very least. For this reason, there is no incentive to rush into buy when a bear run is underway. Strong stocks and themes will reveal themselves with time, and then often given you multiple opportunities to buy at reasonable price. Investors often end up deploying entire cash before this market pivot has fully matured, only to be forced to reverse their positions later. Patience is a virtue during most deep corrections. Sometimes we just need to be right, we don’t need to be very early. Pulling the trigger quickly is a bull market induced mistake that one needs to consciously steer clear of once a market correction begins.

For the first time in many years (almost a decade), consumer stories are trading below lofty valuation multiples. Today we have market leaders trading at ~45x trailing PE, some emerging businesses here are trading at ~32x trailing PE. While these aren’t yet cheap in an absolute sense, this is the cheapest they have traded in more than 7 years now. Investors willing to do detailed fundamental work today have a plethora of options to choose from across sectors. While prices may get worse before they eventually get better, the time to get busy with research is now.

We are working with simple rules when it comes to building incremental positions –

1. Does the business offer visibility of good earnings growth over the next 12-18 months?
2. Do we need to go beyond FY27E earnings to justify the current market cap of the business?
3. Do we have a good breadth of ideas or are we funneling money into the same limited set of stocks?
4. Are we operating with first principles and prioritizing concepts like balance sheet risk, cash flows & capital efficiency or not?
5. Do we have enough conviction in our work to be able to buy stocks when we feel like idiots for buying?
6. Are we evaluating relative attractiveness of ideas before buying or not?

We reckon that if we continue to do these basics right, we should come out of this correction with a portfolio that can get the job done over the next 2-3 years. We obviously won’t be the first set of buyers in many stocks but we have enough confidence in our ability to calibrate and navigate into the right pockets over time, once the market reveals its hand.

The next 2-3 months could be a constructive time to build medium term equity portfolios, especially in the small cap segment. For all the gyan we see in the traditional media, we still don’t see too many large caps that are cheap. The bulk of the opportunities are still emerging from the small cap segment for us. So long as India doesn’t go to a low GDP regime, some businesses can continue to hit a home run in India.

Are we good enough and focused enough to identify some of these and stay the course for the next 3-5 years?

That’s the question every alpha generation driven active investor needs to ask oneself today.