"In investing, what is comfortable is rarely profitable.” – Robert Arnott

Markets in the last six to nine months have been very narrow in terms of sector performance as well as stocks. The BSE100, in the last 6 months (ended 31st August, 2018), rose 10.6% with 86% of the index performance concentrated in 10 stocks. In the same period, the Consumer(+26%), IT(+23%), and Pharma(+16%) sector names in the same index have had a stellar run leaving other sectors far behind. In the light of the same, we take stock of two of our preferred market propositions, namely the twin phenomena of the Investment Cycle and Rural Resurgence. Clearly, the sectors favored by the market mentioned above, sit outside these themes, while sectors such as Industrials, Construction, Fertiliser, which closely fit into these themes have actively lagged the market.[Refer Table 1 below]

The Business Cycle thesis: Using past cyclical trends−both global and local−as the baseline, it was evident even in 2016 that a revival of investment was on the cards. While timing these phenomena, in order to capture them fully in portfolio gains would always have been a challenge, the potential size of the move, we believe, left enough room for delays and even some reversals.

The private investment cycle was expected to ramp up after initial setbacks given the dramatic election results of 2014. However, a series of events, starting with lending inertia on the back of rising Non-performing Assets, followed by demonetization hurting informal businesses and the Goods & Services Tax(GST) shift a year later, have all clearly been impediments to investment revival. Fortunately, in the last one year, large capital goods players have seen some clear signs of pick-up. According to RBI data capacity utilization in was 75.2 %(Q4FY18), the highest since the 75.5% seen in Q4FY16. [Refer Chart 1 below].

We expect ‘make in India’ to get greater policy impetus spurred by a weak current Account Deficit (CAD)which should drive up demand for production equipment. There appears to be a marked increase in the commissioning of project reports in the areas of auto ancillary, consumer durables, rail, ports, and airports versus say a year ago. The Indian banking system now seems closer to clearing up its balance sheet, even in the much-pained power sector. US demand for production capacity could see production partly shift from China to other countries including India. Further, China pollution norms should see a shift of production and capacity of chemicals currently being imported into India. While the domestic focus on pollution, control/efficiency improvement will relatively increase capex on powergen equipment.

The Rural Revival thesis: Based on structural changes in the economy, including factors such as farm economics, rural income trends and improving road and power connectivity, a strong case for rural revival was building up in late 2017. The theme has recently hit a bit of an unsteady patch with rising input prices in agrochemicals and fertilizers,given the reduced production in China. However, the ongoing US-China trade war should lead to freeing up of some capacity. We expect players to pass on increased input prices in a phased manner. Long term, we expect backward integration into raw materials to be the key to sustaining profitability. Rising import prices due to the steep INR fall augurs well for urea producers. The working capital burden of fertiliser subsidy on companies should begin to abate once government implements Direct Benefit Transfer (DBT) fully over the next few years. Fertiliser company balance sheets should strengthen once government clears its pre-DBT subsidies.[Refer Table 2 below].

Consumer durable companies, which have more feet on the ground, are focusing their efforts on rural markets. They expect penetration to increase due to improved road, power and water connectivity and expect these markets to grow much faster than their urban counterparts. Tailwinds in improved crop insurance implementation along with enhanced Minimum Support Price(MSP) coverage have just begun to enhance farm economics; momentum in the space should build as we near elections.

Overall based on anecdotal evidence, we remain optimistic. Active policy intervention and changes in global events are resolving the delays, as also sufficient time has elapsed for various mechanisms to take effect in both investment theses. The events of last week seem to have spelled a pause in the virtually one-sided match between growth-momentum stocks and value stocks and could well be the change in tide these themes have been waiting for. In conclusion, we see enough reason to be upbeat and expect fair rewards for investor patience with these propositions.

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