Greetings from Prosperity, hope you are all keeping well.
As I write the first quarterly letter for this financial year, it is imperative to reflect on the year gone by. The global economic sentiments continued to remain a challenge for most part of the year. Caught between adverse global sentiments and a strong domestic outlook, the Indian stock market remained highly volatile. Nifty corrected and recovered by over 10% on multiple occasions within a span of the year, and ended with negligible returns.
While volatility is certainly uncomfortable, the Indian stock markets have historically, copiously rewarded investors who have remained invested through the volatility. Hence a steadfast focus on long term investing is essential, especially at such occasions.
On the macroeconomic front, the US inflation now stands at 8.3% warranting further interest rate hikes by the Fed. This would continue to drive a recessionary environment in the US. Russian sanctions on Europe has made energy and gas prohibitively expensive for the European manufacturing sector. On the eastern side, China’s looming corporate and housing debt crisis may lead to adverse repercussions on the global supply chains. Amidst the above, the Indian economy looks fairly robust given a rise in consumption fuelled by rising disposable incomes and the aggressive import substitution capex being undertaken by the private sector. India’s Inflation too seems to be peaking out at over 7% given the timely hikes by the RBI.
In Q1 Fy23 (April - Jun), The benchmark’s performance was -13.18% and our portfolio outperformed the index by +2.66%.The focus remained on insulating the portfolio from global sentiments by investing in companies catering to the rising domestic demand.
We also witnessed an interesting phenomenon in the last two months of July and August (Q2), wherein, the benchmark seemed to have recovered sharply outperforming our fund which broadly remained flat. Upon further analysis of the same we pinned down the reason which can best be explained by the graph below.
From the graph it is evident that the recovery over the last couple of months was largely led by stocks in cyclical sectors such as Energy, Auto, PSUs and Media (Media was up 8.3% in July & August). Despite the stellar performance of cyclicals Nifty gained only 4.63% as sectors with secular growth such as IT, Pharmaceuticals (Proxy for Chemicals as well), Private banking and manufacturing were under performers.
Our exposure to cyclical sectors is limited as they are devoid of growth and do not create any real shareholder value in the long run. While cyclicals can deliver good returns if timed perfectly, holding them to outperform in the short run we feel is highly speculative. Cycles are mostly driven by factors outside the company’s control. Moreover, catching them on the wrong side of the cycle can result in significant wealth erosion too.
The table below depicts the 5 year revenue growth and PAT growth of the top 3 stocks in each of the cyclical Indices (Media, Energy, Auto & PSU). From the table it is clear that none of these stocks have delivered any real growth (except energy), and share price movement in such stocks is possibly due to a high degree of speculation than business fundamentals.
(Nil indicates loss making companies; ‘-’ indicates companies that made
losses in the preceding years and calculating growth% on a negative base is not accurate)
We hold Reliance in our portfolio to represent the energy sector, however, the growth in the energy index was largely delivered by the Adani stocks which trade at unsustainably high valuations (Adani Transmission P/E: 463 & P/B: 62.4; Adani Green Energy P/E: 749 & P/B: 309), A correction in such stocks could be sudden & drastic.
Our core belief at Prosperity is that sustainable long term shareholder value can only be created on the back of consistent growth in corporate earnings. The cyclical stocks will sooner than later revert back to their mean at which point only businesses with strong growth and reasonable valuations will drive the stock market.
Prosperity Discovery Fund is well diversified across multiple sectors. We have limited exposure to companies that may be significantly affected by a global recessionary environment.
Over a longer investment horizon we are confident that the broader market indices will revert back to their former growth trajectory and the fund will continue delivering returns over the benchmark, as the expansion expenditures undertaken by our companies begin to deliver robust growth in earnings.
MD, Prosperity Wealth Management.