Where is the Bottom?

Dear Investor,

“Where the bottom of markets?” or “Is this the Bottom” are the question on minds of most of the investors in the equity markets. NIFTY 50 index has corrected by ~ 10% 1HCY22 and about ~ 15% from 52 week high seen in October 2021. The Fall is led by fears emanating from increasing interest rates, high inflation, lower liquidity leading to expectation of recession in Advanced Economies. The year 2022 started on a weak note with narrative on transitory inflation, however supply chain issues elongated the inflation cycle and the Geo-political issues stretched inflation further to unexpected levels. Higher inflation globally led to global central bankers taking actions by increasing rates at a rapid pace to arrest the running inflation expectations thereby captivating the sentiments towards recessionary

outlook. Consequently, Indices in the US and Europe have corrected much more than India - NASDAQ by ~30% Euro Stoxx by ~21% and S&P 500 by ~21% Vs India at 11% on a YTD basis. Bitcoin corrected by ~ 70% from its yearly high as expected capital moving away from the speculative assets (Refer our note 2022 – Year of consolidation ).

In Indian markets, Cyclical sectors like Metals and Realty have corrected by ~32% from their yearly highs. While Metals corrected on back of fall in global commodity prices and increase in interest rates impacted sentiments on real estate. NIFTY IT corrected by ~28% on a YTD basis in 2022 on back of high valuations and heightened recessionary expectation

in the US, however it must be noted that despite the correction IT Services remains the best performing major sector on a 5 year (CAGR ~22%) and a 10 year basis (CAGR 17%). Such a performance in IT services is on back of consistent growth, superior return on capital and high operating cash conversion.

Role of Cycles

Market Cycles and Economic cycles are dynamic rather than linear. Lower interest rates, increased money supply and changes in fiscal/monetary policy, as well as lending terms, can all contribute to periods of economic expansion. On the other hand, economic compression/moderation might be caused by increasing interest rates, low liquidity, rising

unemployment, fear of recession and so on.

The economic cycle goes through expansion, peak, recession and trough stages. While these stages may be demonstrated to have occurred throughout history, their frequency and amplitude are dependent on a wide range of economic variables such as interest rates, employment, trade imbalances, monetary policy, tax policy and so on.

While corrections of Dotcom Bubble, Global Financial Crisis and COVID-19 are widely known, there have been several corrections within the large market cycles due to Fiscal Crisis in 1986, BOP crisis in 1991, Harshad Mehta Scam, Political Uncertainty, European Debt Crisis, Twin Deficit, US China Trade wars, Demonetization, IL&FS Fall, however markets have emerged stronger post any such crisis and have continued to rise.

Market Outlook

Currently, Inflation is an impact of recovery, supply chain bottlenecks and Geo political issues, looking 12 months forward which is what markets look at - recovery would be in base, Supply chain given the moderation in demand would be resolved and Geo political issues hopefully be settled or the incremental impact is likely to be known. Already India has handled crude situation quite well by ensuring supply from Russia at discounted prices. Further Excise duty cut has ensured arresting second level impact of fuel price rise. Food inflation, with normal monsoon and cool off in global prices, must be manageable.

In a situation where inflation expectation are manageable, the RBI may sound lesser hawkish than the developed world. While Developed Market inflation – US is at ~40 yr high, India is at ~8 yr highs. Indian household balance sheets, given growth in income vs increase in household expenditure, would be in much healthier condition than the households in developed world.

A combination of manageable inflation as well as manageable hike in interest rates, impact on consumers wallet in India may not be as high as what developed world is likely to experience. While demand moderation is likely to take place but to an adaptable extent. With moderation in global commodity prices, raw material pressure is likely to subside. Liquidity is something that will dry going forward impacting speculative assets or assets not backed by earnings, Cash flows or assets. However, with recessionary expectation in developed world, liquidity squeeze may be short lived. With the current situation the market may not be too far from the bottom.

What to do:

Many quality stocks have corrected to reasonable valuations and offer an opportunity to build a portfolio that offers an attractive compounding opportunity. We re-iterate our view that India is likely to unleash Animal Spirits in the upcoming decade and every investor must take an advantage of such an opportunity. In such an environment we prefer companies with capable managements, strong cash flow generating companies and businesses backed by multi year themes of Techification, Financialisation, Consumerism, Formalisation, Globalisation, and Clean Energy. Our recommendation on the above theme would be available soon if you are interested to know more and stay tuned you may click here.

Given that the bottom may not be too far, we recommend investing in a staggered manner and ensure prudent asset allocation.

Happy investing in this wealth creation journey!

With Warm Regards, Logon to https://tikonacapital.smallcase.com/ to know more

Sumit Poddar

Chief Investment Officer & Smallcase Portfolio Manager

Tikona Capital

www.tikonacapital.com