ABC Equity Portfolio - July '24 update

Investing in transformational trends core to India's transition from a low income to a middle income economy

Performance

Jul’24 saw a large variation across equity markets as US small caps, Dow and India were up, while the Nasdaq and China were weakest. A strong rally in the Yen had ripple effects across asset classes, pulling up exporter currencies like Yuan and Won, causing a sharp rally in bonds and Gold, while base metals, oil and agri commodities fell.

Indian equity markets were among the strongest globally with rallies across Large, Mid and Small Cap indices. Foreign institutions (FPI) were small buyers of INR 5.4k cr (~0.64 bln$) while domestic institutions (DII) were large buyers of INR 23.5k cr (2.8 bln$). At a sector level, IT services, Consumer and Pharma continued to be strong, energy PSU’s saw a rebound while Metals and Private banks were laggards. Indian bond saw a rally in line with global trends while the INR weakened contra to other Asian currencies.

Developments in trends we invest into in the ABC Portfolio

Manufacturing ecosystem – We capture this via input providers like energy, materials & automation. The government is developing an energy transition framework to balance our energy requirements for economic growth along with the shift to renewable sources. Building diverse energy sources, access to critical minerals and building grid connectivity are central to any policy. As China doubles down on manufacturing, its overcapacity can be deflationary for the global economy, and slow down the supply chain reset. Employment creation in the world of automation and robotics is another deep issue.

Organized agri-business – We capture this via the farm to fork supply chain & fertilizers. An emerging line of thinking has agriculture as the focal point of India’s development process, v/s the established model of industrialization. This would need serious policy initiatives on ways to increase crop yield, give access to quality inputs, research and technology, post harvest marketing infrastructure, value addition via processing and sustainable practices.

Supporting infrastructure – We capture this via infrastructure, logistics and real estate. Building infrastructure and logistics is core to India’s development path given its multiplier effect. A cluster based approach is the go-to strategy for industrial development in India and requires developing the cluster areas along with connectivity to centers of consumption or exports. Infrastructure asset monetization will be key to securing financing for developmental work given the need to keep a control on Total debt / GDP.

National Champions – We capture this by replicating the Chinese strategy of consolidating the state owned banking and oil & gas sectors, plus developing the life insurance sector. The oil & gas sector poses a unique conundrum for our policymakers wherein a fast pace of energy transition may reduce oil imports but in turn lead to loss of tax revenues. Also renewable sources lack the energy intensity of fossil fuels thus creating potential supply issues. In the midst of this, oil & gas companies continue to strive for vertical integration.

Digital platforms – We capture this via firms which use India’s digital public goods initiative as the foundation to offer products & services. This theme is shaping into three sub - sections involving public & private platforms which help in economic and financial inclusion; digitization of data across sectors and consolidating them for analysis; and physical nuts and bolts to support the digital world i.e. data centers, networks and energy.

Summary & Outlook

July was a pivotal month from a macro perspective with key developments across the realms of politics, policies and geopolitics.

• The attempt on Trump’s life changed US election dynamics and prompted a rotation from big tech to US domestic companies.

• China’s plenum (5 year economic plan) emphasized self sufficiency and leadership in strategic sectors (potentially EV’s and green tech).

• The Federal Reserve hinted at rate cuts while the Bank of Japan decided to raise its rates range. This prompted massive short covering in Yen.

• Geopolitics re-emerged as Israel ratcheted up the offence and setting up the possibility for a multi-front conflict in the Middle East

Rate increases by Japan, reversal of the Yen carry trade, and FED message on softening labor markets led to a sharp fall in US bond yields.

• This would be a source of relief for banks and institutions facing large MTM losses on their bond portfolios over the past 2 years.

• It is also a pre-emptive weakening of the USD v/s exporter currencies, which can reduce the deflationary impact from Chinese manufactured goods potentially flooding global markets.

Coming to India, the annual budget was highly anticipated given the hype of it being the platform for a development roadmap till 2047. The actual speech suggested that policy formulation is still WIP probably given the unexpected election results along with changing global dynamics. The Economic Survey suggested that a rethink of India’s developmental model, emphasis on labor over capital and focus on rural & MSME development may be needed.

In our note last month, we had talked about the need to see a narrative shift from sectors we focus on back towards the old favorites like private banks, IT services, Consumer and Healthcare before we start scaling into our positions. As we saw this happening by late June, hence we added to our positions while still keeping a cushion for potential volatility in the markets.

Global macro developments have re-ignited financial market volatility and the ability of Indian markets to damp it down, will suggest underlying strength. A rethink of India’s developmental model translating into actual policy action is still an unknown, but adjustments needed to re-align the portfolio composition with altered realities is already on our radar.