Developed economies have counter-cyclical industries such as auctioneers, placement agencies and ship-breakers. These do better business during recessions. Unfortunately, India doesn’t have listed companies in such spaces.
This is a pity. Most of the data suggest that India is into the third quarter of a recession, and it could get worse before it gets better. Gross Domestic Product (GDP) growth has slowed. The government, the Reserve Bank of India (RBI) and the IMF and World Bank have cut growth estimates, and all the high-speed indicators suggest a slowdown.
Corporate data for Q4, and before that for Q3, was disappointing. The latest bad news consists of a sharp drop in auto sales in May, coupled to lack-lustre Index of Industrial Production data for April, a rise in May inflation and a poor global outlook. The Trade war between US-China has impacted growth. It has also triggered dovish advisories and slowdown warnings from the Fed and the People’s Bank of China. Europe is also fearing recession, going by the last statement of the European Central Bank.
Global commodity markets have responded by selling down industrial metal prices. The major reason why crude has not dropped, is tensions in the Middle East between the US-Iran, leading to fears of conflict and potential supply disruptions.
One saving grace for investors could be accommodative stances and maybe, new QE programmes from central banks. That could create a risk-on attitude where FPIs continue to buy stocks. Also, if crude does fall, as the fundamentals suggest, that could ease the current pressure on imports, and on the Current Account.
Under the circumstances, the best an Indian investor can do is seek to identify strong efficient businesses, which may get beaten down in price, if there’s further earnings disappointment. One place to start looking is the auto sector itself.
The auto index is down 28 per cent in the last 12 months. History tells us that share prices in the sector tend to correct by 50 per cent or more during every cyclical recession. We’ve seen corrections to multi-year lows already occurring in several auto blue chips. So, there’s a case for starting to build auto sector exposure.
It’s anybody’s guess how long the sector will take to pull out of recession however. Lack of demand is the problem. Small changes in equated monthly instalments, which may be triggered by the RBI’s headline rate cuts, will not reverse the lack of demand. Auto-manufacturers are already desperate to clear inventory. They are offering large discounts and other incentives to potential buyers. If costs fall due to low commodity prices, they will surely pass on some benefits. So price isn’t the real issue here.
Low food prices and a weak monsoon outlook have dampened rural demand while urban demand has also stagnated as unemployment has increased and business confidence has dipped. There could be a bounce if the monsoon turns out to be normal. That hoped-for demand could come in during the festival season. If the 2019 festival window is missed, we might be looking at stagnation across the sector, even one year down the line. That would mean further earnings downgrades, and further price declines.
Taking those caveats into account, anybody who starts buying auto stocks now has to be braced to average down, if prices do fall further. Such a contrarian investor also has to be prepared to hold their positions for an indefinite period — maybe for three or four years.
The margin of safety lies in the fact that there have already been serious corrections across many stocks. If there’s a downturn across the broader market – and that’s quite likely –auto stocks are likely to hold their ground better than other sectors. In fundamental terms too, these are all big companies operating in a big market. Even though there’s pressure on margins and balance sheets, they are unlikely to go out of business. Of course, there would be strengths and weaknesses associated with specific stocks as well.
It’s a high-risk, long-term investment to go overweight in auto stocks before there’s any sign of an end to the current recession. The pay-off however, could be high for somebody who can hold for around three to four years. The move from a cyclical low to the next high tends to return 125-150 per cent. That’s much more than you could expect from the Nifty at current levels.