A bottom-up approach to investing

The phased end of lockdown and the rebooting of the economy has started. But it’s going to be a long process and there could well be more lockdowns. India has largely wasted the time bought by a long, harsh lockdown since it hasn’t built healthcare capacity. As the economy opens up, the number of cases is growing, and that is inevitable. Nobody knows when numbers will peak and if herd immunity will occur, or a new cure or vaccine will be found.

The economy has several obvious problems. One is massive unemployment. 

Unemployment was already an issue pre-lockdown. It’s never been as bad as it got by May. Reverse migration with millions headed back to their villages also means that people have effectively left the workforce.

The lockdown itself triggered supply-side crisis. As industries stopped functioning, supply chains broke down and many goods and services became scarce. We don’t yet know how badly the agri-economy has been affected. Just as bad, the unemployment and fear has also led to a demand crisis. Everyone is spending less. Incomes have taken a hit and people are afraid to eat out, travel, buy new cars, and spend on other goods.

It’s unusual to face big demand-side and supply-side issues at the same time. As the lockdown ends, the supply-side problems should ease and some of the unemployment will be addressed. Will demand respond with a sharp rebound or will there be a slow recovery?

The government has little or no resources to spare to address economic issues. A big fiscal deficit makes it hard for the government to put serious resources into pump-priming. This is a situation when putting money into pockets by Direct Benefit Transfers would have helped.

The Reserve Bank of India (RBI) is doing what it can in the shape of Quantitative Easing by buying bonds off the market to ensure that the government borrowing programme is funded as cheaply as possible. Liquidity will be high with other central banks also printing cash. This could help kick-start activity and keep asset prices from collapsing.

So should you be buying equity? The normal modes of valuation via changes in earnings and other financial parameters will not be easy. Year-on-Year results will be bad for the next 12 months since the 2019-20 base will be high. If you see Quarter on Quarter sequential results, the bases will be low!

There are bound to be huge swings in sentiment. There will be good news (rumours of vaccines or cures, slowdown in case rates), bad news (a rise in cases, civil unrest, etc.) and fake news (much of the official data and political messaging). There are political and geo political upheavals in store, with the US elections and difficult situations for India visavis China (and Nepal). Global commodity prices and currencies will swing too.

There are two ways to see this. One is broad brush: Will the economy (India and the world) be in better shape two or three years down the line? If you think so, equity makes sense. The other way is bottom-up: Can you identify businesses which will weather this storm and come out stronger?  If so, buy those companies.

In both approaches, you will have to ignore wild fluctuations caused by sentiment swings. You will have to set a valuation band and buy whenever your targets seem attractively priced. This will be tough since you will have to “adjust” mentally to weird near-term numbers when you try to value businesses.

While most indices have lost ground since the pandemic started in January, one has done well. That’s the Nasdaq-100, which hit a record high last week. This has 103 shares issued by the 100 largest companies listed on the USA’s tech-heavy Nasdaq exchange.

The big Nasdaq-100 winners include Amazon, AMD, Alphabet, Apple, Autodesk, Citrix, Ebay, Facebook, Gilead, Intel, JD Com, Mercadol , Microsoft, Netflix, Nvidia, PayPal, Regeneron Pharma, Tesla, etc. A couple of these are pharma companies, working on Covid solutions.

The rest of the winners are tech household names. It is worth looking at the Nasdaq-100 itself, since you can buy it although you must account for currency swings for rupee versus the dollar. Or, if you think those specific companies are over-valued, identify the reasons why investors expect these businesses to do well. Then, try and find cheaper businesses with similar characteristics.