It is important to invest wisely, after all

It is important to invest wisely, after all

Rahul Shah, VP, Equity Advisory, MOFSL

Greed and fear are the best emotions due to which one gets an opportunity in uptick and downtick economic cycles. There is always an opportunity lurking in the equity market -- one just needs to invest wisely.

Indices of all major economies end lower in August. Morgan Stanley Capital International Emerging Markets (MSCI EM) was down  5%, the UK (-5%), Japan (-4%), Korea (-3%), Taiwan (-2%), Russia (-2%), the US (-2%) China (-2%), Indonesia (-1), India (-1%) and Brazil (-1%) were the key global markets to close lower in local currency terms.  Over the last 12 months, MSCI India and MSCI EM are also down by 8/7%. 

A protracted economic slowdown, as manifested in the recent GDP growth numbers, clearly points at a challenging grind ahead for the long-awaited recovery in earnings. Nifty trades at a 12-month-forward RoE of 13.8%, below its long-term average of 14.6%.  The market cap-to-GDP ratio is at 67% (FY20E GDP), below its long-term average of 76%.

Multi-year-low 8% nominal GDP growth in the first quarter underscores several challenges ahead: government missing its FY20 tax collection targets and continued moderation in top-line and earnings growth momentum for the corporate sector. Nevertheless, given the underlying weak economic momentum and our view of earnings downgrade ahead, portfolio strategy remains premised on earnings visibility and defensive orientation.

You can be sure that your portfolio not just weathers a recession, but will be the first to recover and outperform as well -- by its very nature do not go out of fashion.

The form of consumption of food and detergent changes but the essential consumption hardly changes.

In fact theses product only see increased demand as the income level in economy increases. Due to their stable demand structure, they tend to be less volatile and also manage to protect price and returns during tough times.

Good things are always expensive. Consumer sector Price-Equity (P/E) of 39.8x in August 2019 (up from 38.4x in July 2019) is at a premium of 18% to its 10-year average of 33.8x.

On a P/B basis, the sector trades at 11.5x, a premium of 12% to its 10-year average multiple of 10.2x.  In first-quarter commentaries, companies were hopeful of a recovery post in the second quarter in anticipation of normal monsoon and improving consumer sentiment.

Commodity costs are largely benign. While this is good for margins, companies with strong established are able to leverage their brands to maintain a higher level of ROE and sustain higher valuations compared to other sectors.

Companies such as Asian paints, Britannia, Proctor and Gamble are capable of leveraging their brands as much as their business models. It is always advisable to prefer defensive stocks with a strong brand impact, which makes the differences in difficult times 

If we just look at the way the performance of large-cap, fast-moving consumer goods (FMCG) stocks have delivered phenomenal returns in the last 20 years. In a country like India with a large consumer base, it will always succeed in the long term. The sector will continue to grow with a slower pace during a slowdown. For perspective, Nestle has doubled after the Maggie crisis hit in July 2015.

This has been true of companies such as Hindustan Unilever (HUL), Colgate, Dabur, Marico among others.

After all, markets respect the consistency and visibility of earnings.

Finally, it is very important to understand an important aspect pertaining to defensive stocks: you should not add defensive stocks on a broad sectorial basis.

Just to conclude, by including some good defensive stocks in your long term investment portfolio, you could help your long term investment portfolio beat a bear market.