Market free fall: Market selloff indicating start of an earnings downgrade cycle: Kotak AMC

Would you attribute today’s market fall to the global sentiment or would you attribute it to lack of fiscal stimulus back home? What exactly is spooking the market?

I would call this a Ram aur Shyam market. Ram is the son who stays with the parents which are the largecaps in the markets and Shyam is the son who got separated in Kumbh Mela, which is the smallcap and midcap segment of the market. The smallcap and midcap segment has been going through its bout of pain over the last two years while the largecaps have been holding on in that period. But in the month of March, we saw that the largecaps also gave away its gains and that was the culmination of a two-year bear market and, of course, in the month of April, we saw some ebullience about the markets and both Ram and Shyam did well. But then again, we are seeing what we are seeing today.

Clearly, this is a start of an earnings downgrade cycle. What has happened because of the lockdown will have ramifications on earnings going forward and those segments of the markets which were doing well till now will see the impact of this earnings downgrade as a result of the lockdown going forward and we will see both their earnings come down as also the multiple contract which will have, of course, an impact on their prices.

What we saw today is that in fact the small and midcap indices are outperforming the largecap index and particularly in the largecap index, the Bank Nifty is underperforming, which tells you that those segments which were highly bought into or where investor interest was the maximum is what is giving way today while those segments which were sold over the last two years are holding up better.

You have many aspects which are playing just now. You had three heavyweights which came out with results over the weekend and all those results were below expectations and that led to some anxiety on those individual stocks and that spilling over into the broader markets. You have, of course, global markets weakening today and on Thursday, India outperformed the global markets. So some of that outperformance is also being given away. But net-net this is a period to be cautious, not a period to be over excited and look to be a hero. It is a time to be cautious in the market.

I heard you say the word cautious. I was waiting for a day when fund managers would say it is time to remain cautious.

Do not get me wrong. Crises are periods where you make the maximum money. But then that depends on your time horizon. If your time horizon is the next three to six months when markets are on downswing, then definitely this is a time to be cautious because numbers are just going to start coming out. They are not going to be pretty and if you are expecting that stocks will rally despite numbers not being pretty, that is not happening.

So in that context, over the next three to six months, it is the time to be cautious. I do not know if we have already bottomed or if we are three-six months away from the bottom, but whenever this bottoms, this will be an opportunity of a lifetime. So it is important to be liquid at the time that it bottoms. It is important till then to be a little cautious and hold your horses. Have cash in your bank to invest at that time and then you will make a lot of money thereafter.

What does the current market remind you of? When did we see this kind of a market because we both know that in markets, the same things keep on repeating itself again and again; perhaps the winner is the one who is able to identify the patterns again?

2008 was a very sharp correction and it rebounded also quite fast. What this period reminds me of is 2000 to 2003 where you had one segment of the market just going through the floor; there was really no bottom. You had PSU stocks, auto stocks, commodity stocks just really going to the floor and as I said, there was no bottom for those pockets of the market. And on the other hand, there were certain growth pockets in the market which held up well.

FMCG and something similar has played out just now. What happened then also was that by the end of that phase of downswing, you had fund managers and investors in the markets completely tired out and thereafter in the year 2003 when we got hit by SARS which happened sometime in January and March of 2003, markets in that period were down about 10-15%. But March onwards, the year after, markets were up 83%. I think that we are in that phase where investors are tiring out. They have gone through two years of extreme pain on the broader markets. You could name quality stocks doing well in their businesses contracting a price to earnings multiples by half and that has an impact of course on the prices. So there has been a lot of pain over the last two years. To my knowledge, having gone through three or four cycles, this period has a parallel to the 2000 to 2003 period.

Talk us through how you are looking at things right now. Where are you focussing on and what are you completely staying away from?
We would segregate the markets into three pockets. One is the pocket where you will not see material demand destruction in the short term; these are sectors like pharmaceuticals, consumer staples, small value items which will be bought and needed by consumers. So those pockets are where you would not see material demand destruction.

The second pocket is where you will see in the near term demand destruction but that will kind of bounce back in a period of two to four quarters; say two wheelers, small value discretionary items like electrical goods. And then there is that pocket which will take much longer to bounce back; take airlines, cinemas, etc where you will see demand destruction for at least four quarters and maybe even longer because those will be impacted by behavioural changes at the end of consumers which is semi-permanent. It may not be fully permanent but definitely semi-permanent for some time. Now it is in this context that one has to see where to invest in the markets.

In our judgement it is the first pocket which will probably hold out the best at this time. The second pocket is where you are getting value at this time where stocks have corrected but this is on account of temporary impact either on supplies or demand. So there you have value and that value may bounce back two to four quarters down the line. And the third pocket is where one would have to be quite cautious and stay away for the moment and look at that pocket at a later time when further value gets created or there is some clarity on demand patterns changing there again.

This is a horizontal or sectoral assessment that one has. This is something that holds in all markets but more so now; companies with leveraged balance sheets will lose market share and business because there will be scarcity of capital and these companies will find it difficult to raise capital. So weak balance sheets will give away markets to strong balance sheets. And secondly, companies which are leaders in their respective spaces will be gainers at the expense of those companies which are laggards. So a mix of this horizontal and vertical assessment of the markets is where one should be focussing on and taking decisions on entering or exiting the markets.