Take the Barbell approach for a safety net in volatile markets

We have taken the Barbell approach, with defensive sectors like pharma, IT and FMCG on one side and also economic recovery type sectors like banking, consumer discretionary, industrials and energy on the other side, says Andrew Holland, CEO, Avendus Capital.

What is your view on the largecap valuations?
There is an earnings surprise on the upside for the market due to some factors including the cost-cutting that the companies have done. Prior to the Covid outbreak, the economy was weakening. The companies were doing a lot of cost cutting even prior to Covid and post Covid, it is forcing companies to continue to cut costs and that is a big element because interest costs depend on debt.

As India exits lockdown, increase in sales would be much more significant than the average expected at this point. Valuations on certain sectors still look rich but if you look at a price to book valuation, then we are still reasonably valued and I expect earnings to catch up. It will probably shoot up and already we are seeing the first signs of analysts’ forecasts being upgraded as we go through this result season and that is the good news.

How are you gauging the FIIs’ sentiment? It is just a trickle of flows right now. How do you see it pan out over the next 24 months?
The Chinese economy has seen a V-shaped recovery. Unlike other countries which have rebounded, China has been really growing. The dollar will depreciate but Asia will be seen as the new growth area going forward and therefore flows will come to Asia and India because of its weightage within the emerging market and Asia will get a fair share. In the next three to five years, an Asia centric view will start to emerge as we come through this.

Even if we get a vaccine, with a lower number of cases in Asia, that would obviously open up borders a lot quicker than in the rest of the world and flows are going to come to Asia. India will capture a lot of new interest because of many different factors that we will see as the economic recovery comes through. I believe that we will see strong flows into Asia and particularly India.

What kind of themes are you playing? What is your long short right now?
There are a lot of concerns globally, many moving parts which could still come and test markets and global economic recovery as well. We have taken the Barbell approach, which is on one side you have your defensive sectors such as pharma, IT and FMCG but you also have economic recovery type sectors in particular, banking, consumer discretionary, industrials and energy.

Once that market turns and the full blown growth in the economy comes, then everyone’s going to try and switch across from defensives to economic recovery types of sectors. Since we can’t know the timing, a Barbell approach gives us a safety net if things get a bit more choppy. When the economy starts to recover, then you have got on the other side of the Barbell, those economic recovery stocks as well. That is how we are playing through over the last six months and we will continue to do that until we have real evidence that the economy is on the right path.

All the signals look good, the high frequency indicators are good, we are all excited about the festival season. The question is what happens after the festival season and that is why the Barbell approach is probably the right way to be at the moment.

How big is the risk of a second wave of Covid-19 spread which seems to be rearing its head once again in Europe and many parts of the world? Is the market factoring in that risk?
The markets are well aware of these risks. But what they are banking on this time around is the circuit-breaker kind of approach that we are seeing in the UK, shutting down certain parts of the country. The finance minister is saying they are going to extend the furlough, the benefits and fiscal packages to companies that are infected in that area.

I am sure that is what is going to happen globally. In the US, the fiscal package may come before or after elections. The markets are expecting the fiscal push by governments to continue along with the backing of the central banks. There is less concern because everyone expected a second wave or a pickup in cases because of winter in Europe. The markets now know what the governments will do about it and how quick the response will be. That gives some comfort until a vaccine comes through.

Pfizer has said they expect something in the first part of November, maybe just after the elections and some better news from Oxford vaccine trials that they have been doing. Whilst we are not going to see a vaccine till next year, obviously the optimism around the vaccine is continuing. That makes markets more comfortable until they know the response and the triggers that the government and central banks will put in place to tide through a second wave.

So if one were to make a portfolio of a clutch of stocks with the themes you are talking about, what kind of returns or earnings growth can that portfolio get over the next three years?
If you look at FMCG, you are probably looking at 10% to 15% earnings growth. If you are looking at banking, if the economy starts to recover, then the growth could be 20-30% plus. So it depends on the sector you are looking at.

As a group if you take the whole index, I will be looking anywhere from next year to start seeing a big rebound of well over 15% in earnings and gathering speed thereafter as the economy starts to recover. The point I am trying to make is that even though we might rebound next year, it might not be real GDP growth. That will accelerate in 2022. You got to look at it in a little bit more staggered manner but earnings growth should accelerate next year and into 2022.