Portfolio in the time of COVID 19 Vol1

(1) This is to provide you a summary of the corona virus, its spread, and our best response to the challenge of managing the portfolio in such times.

(2) First a summary of facts: After remaining largely contained to China till mid-February, where it has caused ~3000 deaths and over 80,000 infections, the virus has spread to over 80 countries, and the total number of infections ex-China now number 20,000+, and rising at a significant rate. The most affected countries ex-China are: South Korea, Italy, and Iran. All other countries have an infection count of less than 1,000.

(3) As of now, China is claiming (some sort of) a victory over corona virus, as death count has fallen drastically from over 100 per day to 20s/30s over the past few days. The number of fresh infections in China has also reduced.

(4) After remaining unaffected through February, India saw a sudden burst of infections reported last week, mostly from tourists/ travelers to Italy/ Iran and their relatives. Even so, total number of infections are less than 40, as of now. Several hundred test results are awaited, and it is possible that the numbers may rise, but several hundred suspected cases have been negative also.

(5) The rise in probability of a worldwide epidemic has begun to get factored into global equity markets, beginning the last week of February. While India has a relatively smaller number of cases, India’s indices have also seen a sharp fall over the last fortnight. The benchmark indices have declined 11% from recent peaks, while the small cap indices have declined about 17% from recent peaks.

(6) The geographical spread of the virus in various countries suggests that warmer environments are less hospitable to the novel corona virus; also there is some comfort in the idea that past corona viruses (SARS, MERS) have also been less severe in warmer environments. As such, there is a possibility (suggested by experts, although not as an assurance) that India may see relatively modest impact.

(7) Now, coming to the question of: what is the best that one can do with his equity investments in such a time? I believe that the answer depends on what stage of corona virus does the world see itself in, and what stage of the virus does India find itself in.

(8) The spread of virus in China alone had raised fears that global supply chains shall be impacted severely: as China limps back to normalcy, these fears shall reduce. However, the spread of the virus in Western countries has further led to fears of demand decline.

(9) Advice on how to position yourself in the market shall be dependent on scenarios. I am in no position to provide an expert opinion on viruses, but this is my best guess (I admit, largely based on prevailing trends, and likely to change rapidly as situation evolves). In that spirit, I make the following assumptions:
a. India, along with other warm nations, shall witness only sporadic incidents of the virus. However, given the vast spread of the virus, these sporadic incidents are bound to occur from time to time. We can be sure there will be fear and concern among people for an extended period of time.
b. The development of a vaccine/ cure may take a few quarters at least, considering all the testing required. SARS died its own death in about eight months, but this virus is more infectious, and thus it appeals to common sense that it will survive longer than that, absent a vaccine/ cure.
c. India may be relatively less affected in the immediate term, but firstly, there will be scares from time to time, and secondly, if the virus survives long enough: north/ central India does have a pretty cold winter. As long as the virus survives in some nations, there is a possibility of it coming to India, even if that possibility can be delayed.
d. (following from c above) There may be little point in expecting an immediate recovery in earnings of those (Indian) companies whose revenues/ profits stand disrupted. One should be prepared for an extended disruption, lasting more than a year, perhaps.
e. European countries/ Iran are likely to see continued rise in incidents/ deaths, possibly leading to temporary shutdowns in economic activities,
f. USA is in a danger zone, where the number of cases reported is 450 so far, but there is a likelihood of cases swelling up (as per media reports, there may be some under-reporting on account of insufficient testing).
g. Due to weakness that should be expected in major economies, most commodity prices, including crude oil, are likely to remain soft for a few months, at least. Crude price is also expected to be low in expectations of a price war among producing countries. Gold demand, on account of safe haven status, is likely to be strong, and gold prices may stay strong/ rise significantly in the coming months.
h. We are likely to see concerted central bank action/ fiscal policy action to tide over the crisis, which will probably devalue money further and make bond yields even less rewarding
i. Indian companies which have significant exports to the US/ Europe, or basic intermediate goods being supplied from China, or other affected countries, are likely to see some earnings disruption in the coming quarters
j. We see the following as areas where there will be a rather low level of earnings disruption: consumer staples, select white goods companies, utilities, cement companies, telecom companies. Further, some consumer staples shall see the benefits of lower crude, lower palm oil prices on their earnings. Cement companies are likely to see benefits of lower raw material prices as well.
k. It is possible that there will be some financial pressures on account of trade disruptions, that may spill over to the financial sector; this possibility, shall continue to get factored in
l. The cuts in interest rates across the world could potentially spur buying of high dividend yield companies with stable business models. In this context, certain PSU entities with stable earnings and high dividend yield are likely to attract investor attention (more so as valuations have been driven down sharply in the past few quarters)
m. Flows are likely to be maintained to mutual funds, and if India stays significantly insulated, the flows from FIIs shall see significant but not back-breaking withdrawals
n. The rebound from weakness could take up to three-six months, in as much as we can guess from the case of China. The rebound in equity markets could take a few weeks more or less than that. But the depth of the correction we could see, or the timing of the rebound, is extremely difficult to predict.

(10) What should an investor do with his portfolio in such times? We think the following may be areas where there is potential for improving portfolio performance/ staying liquid:

• The market is likely to be volatile, and thus not dependable, over the next few months. Your investing decisions (add/ reduce) should depend entirely on your assessment of how much excess cash you have/ will generate from income for precautionary purposes over the next one year. That done, the market is likely to offer good bargains on quality companies over the next few months, so it will be a good idea to start deploying excess cash in such opportunities.
  
  
• Safeguard your portfolio against extreme volatility by sticking with names that are less likely to face disruption. There is a case to weed out those that have potential for earnings disruption in the medium-term and add to those that have fallen but are likely to be relatively insulated in terms of final demand.
  
  
• The market has offered/ shall offer relatively lower risk ideas at significant discounts to recent averages. Look actively to deploy incremental money in three kinds of stocks: i/ those that will see very little disruption in revenues and will benefit from lower commodity prices (consumer staples, paints, possibly cement companies), ii/ those that have potential to actually benefit from corona virus by selling products that are meant for prevention/ cure of the virus (pharma companies, and you know who manufactures masks/ sanitizers), iii/ those that are likely to be have stable topline/ bottom line and have a healthy dividend yield (say, over 3%)
  
  
• I would not point to any stocks (unless necessary), but the following sectors stand out, in the framework that I have described, as attractive: i/ consumer facing companies with high crude/ palm oil composition of raw materials, ii/ select cement companies (moderate), iii/ power utilities, iv/ select PSU companies, and v/ pharma companies. Telecom is a space which will stay undisrupted, but really, that sector sees sufficient disruption without a virus, so we would be selective and deploy only moderately, vi/ there are ways to play gold strength, and expectations of the same, which could include gold ETFs, and also some equities such as jewellery stocks, the one listed commodity exchange (MCX), and perhaps gold finance companies. Potential beneficiaries of an extended China weakness (but please note that China is recovering) could include textile companies, companies engaged in electronics, and capital goods.

Disclaimer: This is a letter written primarily for clients, whose risk profile is well known to us. The same may not apply to a general reader. Further, the advice given here has significantly followed by me in personal capacity, as well as by my clients. I/ my clients shall benefit if certain stocks in sectors described as attractive perform well. Further, I may change my opinion (and take actions accordingly, for myself or for my clients) on any of the matters discussed above without any alert to the general reader about the same. Readers are advised, therefore, to view this as a matter of discussion rather than investment advice, and may take investment actions as per their individual assessments of risk/ as advised by professionals in the space.