Bottoms up!

Sanjiv Chainani
Mr. Sanjiv Chainani is the Managing Director of Value Line Advisors Pvt Ltd.

Investors should follow the bottom-up strategy to generate alpha.

At the time when global markets are experiencing turbulence due to aggressive selling by foreign portfolio investors (FPIs),Indian investors would do well to follow the bottom-up approach instead of top-down approach
to generate alpha returns in the markets. The bottom-up approach assumes that individual stocks can do well even when the broader markets are not performing well. This strategy entails a close review of the company’s fundamentals instead of investing based on broad macro factors.

The global equity markets are undergoing sharp corrections due to worries over hard landing in China and heightened geo-political tensions. The price of crude oil has fallen to a multi-year low. FPIs are aggressively selling all emerging markets as a part of an ongoing risk-off trade, irrespective of their fundamentals. India too has experienced the brunt of this sell-off.

The Indian economy is going through an interesting phase. The investment climate and macro indicators are showing signs of revival, but this macro recovery is clouded by near term concerns such as a weakness in the rural economy due to back-to-back years of deficiency in monsoon and increasing stress in the banking sector.

In the near term the weakness in rural consumption is expected to have a negative impact on the growth of the FMCG and auto sectors. The private sector is still not incurring fresh capex as capacity utilisation is yet to pick up due to slower demand revival. Indian exports are being affected due to the sustained weakness in developed economies.

The banking sector is plagued with high NPAs in critical sectors such as power, iron & steel, infrastructure, construction, etc. The sharp fall in global commodity prices has taken its toll on metals, mining, upstream oil & gas, chemicals and industrial commodity companies. All these factors have resulted in a delay in the recovery of Indian companies’ earnings, leading to a further weakness in the markets.

These issues are temporary as any loss of demand from weak monsoon will be more than compensated by rising disposable income in the hands of government employees post implementation of the Seventh Pay Commission. Government finances have improved over the past one year.

The price of crude oil has fallen by over 70 per cent from over $100 per barrel to $30 per barrel since September 2014. This will result in over $70-80 billion in savings for India. The Indian government has smartly increased excise duties on the fuel instead of passing on the full benefit to consumers through reduced fuel prices. This has helped strengthen its fiscal position – the benefits of which will be visible in the form of higher government spending on revival of rural economy and fixed capital formation in the years to come. The government has made it clear that the coming budget, which will be presented on 29 February, will be focussed primarily on revival of the rural economy and increased allocation to the infrastructure sector.

The temporary rise in inflation due to the deficient monsoon and ongoing chaos in the global financial markets caused by the Yuan devaluation has kept the RBI in a ‘wait-and-watch’ mode, deferring further rate cuts. The benefits of previous interest rate cuts are yet to be reflected in corporate India’s earnings. There is at least 50-100 bps more space for cutting interest rates which will further boost earnings of the corporate sector in the times to come.

The NIFTY50 has corrected by over 5.2 per cent since the beginning of CY16. But the individual stocks, especially in the mid- and small-cap segment have seen precipitous fall. Domestic institutional investors (DIIs) have invested heavily during this correction showing that Indian investors have matured over the period and are keen to grab this opportunity from the ongoing risk-off trades.

While broader markets may keep languishing due to global developments in the near term, there is serious money to be made in the individual stocks which have corrected sharply despite strong fundamentals. Investors would do well to follow a stock-specific bottom-up approach instead of following a broad macro growth theme. Cherry picking stocks will help investors generate alpha in the otherwise languishing markets.

Remember, bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria. This ongoing pessimism will give legs to this structural bull market. The best times are yet to come for Indian equities.

This article was originally published in Business India Magazine.
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Disclaimer: The views expressed in this article are personal and the author is not responsible in any manner for the use which might be made of the above information. None of the contents make any recommendation to buy, sell or hold any security and should not be construed as offering investment advice.

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