A Counter-Intuitive Rally

I interact with a plethora of investors - Retail, HNIs, Family offices & Institutions. A common question each one is grappling with is the sanctity of this rally. The disconnect between the economy & the market is perplexing. In India a common perception prevails with regards to markets that it is irrational, volatile & beyond comprehension. Thus most have drawn the conclusion that the market is liquidity driven or being manipulated. The data we look at suggests - Market are intelligent & they are right in creating this disconnect. Let me explain this in as simple a ways as can be.

This rally has been led by Reliance & the fundraising done by its telecom business - Has data consumption increased in this lockdown, has phone usage increased, has digital adoption increased - Yes. Business outlook for Jio has improved thus Reliance has rallied. 

The next participant of the rally is pharma. Has US FDA taken a more benign view, Has business grown for the industry, have companies given a better outlook, have acquisitions/ IPOs taken place - Yes. This sector again has benefited in the environment & market has been right in pricing the same. 

The next sector that rallied was Agro-Chemicals. Has agriculture activity increased, have monsoons been on track, has rural India been active - Yes. 

By now you get the the drift - one should not be investing based on macro. Macro plays a very small & transient role in driving markets. How a business handles these macro challenges play a larger role. The other beneficiaries IT/ Specialty Chemicals/ Power all have a fundamental rationale for outperforming. 

Even now the economic stress points have hardly recovered in the markets too - Textiles, Financials, Retailers, Multiplexes, Hospitality, Tourism, Alcoholic Beverages etc. 

The market is presenting opportunities in both spaces but one has to be very selective. Both good & bad results are being extrapolated on excel sheets. The important aspect for companies seeing a significant fall in business is the balance sheet. 

The long term enterprise value is not changing materially because of one year/ one quarter miss thus those sitting on substantial cash will see this as a one off & a marginal adjustment in market cap is sufficient. While others might see significant debt built up which means even though enterprise value is constant the value might move from equity to debt. Some others will raise equity(rights, QIP etc) which means the same value is shared by an expanded equity base. At this juncture I am trying to stay with companies where capital structures are not getting modified even if business has been dented. The dent is temporary, the change in capital structure is a medium/long term issue.