Is the Economy on a Great Rebound?
Is the Economy on a Great Rebound?
The ‘Great Rebound’ of the Economy offers a Great Investment Opportunity
- Economic data points indicate that economic activity has already rebounded and reached levels seen pre-Covid-19
- This ‘Great Rebound’ is supported by the fact that the outlook for the next several quarters and for the next 2 years is significantly higher
- Investors should be aware that certain sectors have been permanently impaired, and their past financials do not reflect their future. These might look cheap on their valuation multiples but are not
- Investors should also avoid sectors which are popularly identified to benefit from the rebound but are overvalued
- Investors should focus on bottom-up research to allocate to SuperNormal Companies at SuperNormal Prices in a staggered manner over October, November and December 2020 to benefit from any volatility
2022 India GDP real growth rate estimates are in 8-10% range
Economic Rebound Underway…
While the focus of most discussions is on the negative impact of Covid-19 on GDP in Calendar 2020 for US and FY 2021 for India, and the fact that the markets are overvalued, S&P 500 (PE=31.24) and Sensex (PE=27.82), the point that there is probably a Great Rebound underway is being missed.
A large number of economic data points indicate that post the Covid-19 related reduction in Apr-Jun 2020 quarter, economic activity has already rebounded to a significant percentage of the pre-Covid-19 levels in most cases, to even surpassing it. Further, the outlook for the next several quarters and for the next 2 years is significantly higher.
This rebound, which we term the Great Rebound, is already underway. Investors would do well to pay heed to this phenomenon in a calm, analytical manner and not be in panic mode.
Interestingly, this panic mode is also being manifested in two seemingly contradictory ways. On the one hand there is the panic of being in a “bubble” or at a “market top”. On the other hand, there is FOMO—the fear of missing out—on the market rally.
We suggest that investors try to understand the actual economic activities which are taking place, their direction, quantum and impact.
Indian Investors should stagger their allocation to US and Indian equities over the next three months
Further, the investors should do a bottom-up research to find out the stocks which are benefiting from this rebound in terms of increased sales, earnings and improved fundamentals, while being available at a significant discount to their conservatively estimated intrinsic value.
The companies where the intrinsic values based on conservative estimates of long-erm fundamentals are significantly higher than what the market is giving them credit for are the ones to be considered for investments.
The Scientific Investor takes the improved macro-economic data to be informed about the improved economic background in which the companies operate. Sectors, industries, or companies which might have a negative structural impact due to Covid-19 have to be identified based on the macro-economic information. The projections for the impacted companies must account for this structural change in their future. For example, airlines, travel, tourism, hospitality, entertainment, and commercial real estate might have been permanently impacted and structural changes in these industries must be accounted for.
Many other industries and companies might have significantly improved prospects and these, too, should be incorporated, though on a conservative basis. For example, pure ecommerce companies, retailers with significant online sales focus or ones which have pivoted quickly to adapt to the new reality and opportunity, video conferencing and collaborative tool providers etc.
In contrast to typical investment programs which focus on trying to predict which sectors etc. will benefit from this shift and try to go long on them, we at OmniScience, believe that the focus should be on a bottom-up analysis and searching for companies which might be at a discount to their intrinsic value. Where the information or insight about the change in prospects is handy for Scientific Investors is when projecting the financials of the companies. The companies which are negatively impacted will be projected with
significantly worse financials as compared to their pasts and the ones which are positively impacted will be projected with improved financial as compared to their past.
This also highlights why the typical, rules-based or Smart Beta strategies are unlikely to work in a disrupted macro-economic scenario. The Great Transformation was already underway worldwide with the Technology Transformation (recognized and captured in our AIoT (US)—Artificial Intelligence and Internet of Things—and DX (India)—Digital Transformation—thematic portfolios) and Global Supply Chain Rearchitecting away from China (probably helping India partly with our Omni Supreme India portfolio providing that exposure). The Covid-19 disruption just accelerated these transformations.
An illustrative set of data is presented which indicates that the Great Rebound is already underway in both US and India. This is followed by data supporting the continued growth momentum to continue in the medium term. Finally, a few risk factors which could delay or derail this scenario are also discussed.
Several economic parameters indicate that the economic activities have regained levels close to the pre covid-19 levels or in many cases surpassed those levels. The following exhibit lists down multiple such indicators.
Continued Growth Momentum
The growth momentum seen so far is expected to continue for the next multiple quarters to couple of years. For US and India this trajectory is expected to continue longer on back of tech transformation and large planned capital expenditure as discussed below.
Global Growth recovery
The real GDP growth rate projection for 2021 by IMF is 5.2% for the global GDP growth, 5.2% for Euro Area and 3.1% for the US. Similarly, OECD real GDP growth estimates for 2021 for G20, Euro Area and US at 5.7%, 5.1% and 4.0% respectively. This means that the nominal GDP growth rate for US should range between 5-6% for 2021. Similar data is suggested by the US Fed dot plot for the next two years. This is clearly a strong growth momentum that we are expected to witness. The consumer spending, the biggest driver for the US economy, is up in Sep 20 as per the retail sales growth data. And more than half of the consumers expect to spend as much or more than the last holiday season.
Further, there are many US large technology firms that have done well throughout the pandemic which in some ways has helped them by speeding up the technology transformation that has been brought upon by these tech giants. This transformation is expected to continue for many years and help US and global economies to continue to grow.
Investment Flow and Global supply chain rearchitecting
The ZIRP or near zero interest rate policy is keeping the investment hurdle rates low for investments. This coupled with the Global supply chain rearchitecting away from China is creating opportunities for fresh long-term investments into various emerging markets including India.
AatmaNirbharBharat Abhiyan (Covid-19 Relief Plan ~20 lakh crore)
The stimulus package announced as Covid-19 relief plan has already achieved 2.33 lakh crore direct cash transfer, 320 lakh MT free food grains to 81 crore people and 13.78 crore free LPG cylinders. This will further help free up money to be spent on other consumption avenues and the uptick in the rural demand is an indication of this. Further, in Oct 20 the government announced additional package of 73,000 crore which includes 12,000 crore of interest free debt for states and 36,000 crore expected impact with LTC Cash Voucher scheme and INR 10,000 advances to govt. employees. These measures are expected to sustain the consumption demand for multiple future quarters.
National Infra Pipeline ~INR 100 lakh crore
National Infrastructure Pipeline (NIP) is infrastructure spending roadmap for the next five years for India. The government laid out the various segment wise spending details of this plan early this year. There is a plan to undertake infrastructure projects worth INR 102 lakh crore across key sectors such as railway, power, roads and ports over 5 years. There is also key focus on the defense indigenization under the self-reliance and Make in India efforts.
Strong growth forecast for India
14-15% Nominal GDP growth forecast for 2021
OECD estimate for Indian GDP growth stands high at 10.7% real growth rate. IMF estimate is at 8.8% real growth. As per our estimate this growth rate forecast can be sustained for 2022 as well on the back of various fiscal incentives and prevailing lower interest rates. This expected recovery could offer great investment opportunities in Indian equities space. However, one needs to be cautious as the broader market indices indicate that the markets may be overvalued. The exhibit below indicates the price multiple and the yields for India and US equities. Therefore, Large cap MFs and ETFs are not the optimal way to go about equity allocation. Rather, a selective portfolio is the need of the hour.
Risk to the hypothesis
There are certain risk factors to the expected economic rebound that have been discussed in this report. There is so far no confirmed news for a vaccine for covid-19, hence the impact of the pandemic can continue for a longer period. There is also the possibility of further lock downs if the number of infected cases start to rise steeply. Further lockdowns could push the economic rebound to later time periods. But the important point from a mid-term horizon is that the rebound is likely to happen within the next 3-year period even with further lockdowns.
There is also uncertainty to the capital flows, infrastructure spending and the timeline of the same.
Actionable for Investors
Future will always have uncertainties and any view of the future should be made with that awareness. As an investor what is important to understand is that during uncertain times one is likely to get good investment opportunities in businesses where Mr. Market is not happy with the uncertain cash flows and growth trajectories of certain businesses. These businesses might be available at a significant discount to their intrinsic values based on even their conservative cash flow projections. If the actual cash flows turn out to be better than that then the eventual discount to actual intrinsic values might be much higher. These are the kind of opportunities one should look for where even if things are not great one makes higher than the market discount rate and if things turn out to be much better, then the returns are significantly better.
If the portfolio is constructed carefully by focusing on companies with a high likelihood of doing better than Mr. Market is giving them credit for, due to sentimental reasons, the resulting portfolio should prove “quite rewarding”, as Benjamin Graham might have put.
Scientific Investors should focus on a portfolio of SuperNormal Companies available at SuperNormal Prices, such as, Omni Supreme US or Omni Supreme India and allocate capital to it, assuming they have capital available and risk appetite for equity allocations with the goal of long-term wealth creation. Ideally, they can do new lumpsum investments or top-ups spread out over October, November, and December.
It is likely that there could be some volatility in the market pre-and-post-US elections during October and November. December has been a tax-loss harvesting month for US markets and could see continued volatility if elections throw up mixed results. This staggered allocation will help benefit from this volatility. Of course, it is possible that the markets continue rising for all three months as well. But the staggered allocation approach looks more logical to us.
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