A perspective on smallcaps & momentum based investing
We have seen the destruction of the Covid-19 second wave in India on our healthcare system. The new strains of the virus have led to a much higher number of cases & deaths and the loss is grave. To support ourselves in these trying times we need to look at the robustness of our investments and evaluate how this crisis impacts the financial markets. In our case by case webinar we showcased the impact of Covid’19 second wave on the market. We talk about some of the key points here.
Before we evaluate the impact of the second wave, let’s see how pandemic impacts the business environment:
- Mobility goes down due to lockdowns
- Consumer spending goes down, especially in discretionary products
- Medium, Small businesses face severe challenges
- Bank credit might get impacted
- Travel, tourism sectors suffer
- Lockdowns hit retail & wholesale businesses
- Manufacturing & Services sectors face challenges
- Healthcare system is burdened
- Sentiment weakens
First wave vs Second Wave
In the first wave of covid we saw a very adverse market reaction in the beginning of the wave. Vix shot up 500% in March 2020 and markets crashed almost 40%. This time we haven’t seen such a reaction in the Vix.
How is this wave different from the first wave?
- The number of cases & deaths is much higher
- New variants of Covid have come up
- Lockdown has been limited
- Vaccination drive has started
- Business impact is muted
In fact, Nomura Business Resumption Index shows a much less impact than last time and the power demand has also not had a drawdown like 2020.
Many analysts have commented that this wave shall have a much muted impact on business impact than last time.
Bigger Concerns for the Economy
While the covid impact could be muted on the economy, there are certain other important factors that can have a larger impact on the market & the economy.
- GDP Growth – IMF projected Indian Economy to grow at 12.5% in FY22 prior to the second wave and many analysts believe that there might either be a short term impact or no impact on this projection
- Cyclical Recovery – Cyclicals were projected to take over defensives prior to the second wave and even now majority of asset managers are betting on cyclicals
- Emerging markets – Emerging market equities are a very attractive investment opportunity and many global funds are betting on India
- Taper Tantrum – with recovery coming in the developed world with mass vaccination, we can see the stimulus from the Fed stopping which could be a concern
- Inflation – there could be resurgence of inflation in the country and the central bank could raise rates to mitigate that.
Wright Momentum is one of our best performing portfolios. This portfolio has given more than 50% returns in the 6 months that it has been live! Momentum is the best performing factor in the markets & we expect the factor to stay strong in the present environment.
This portfolio has a risk similar to the market but the risk adjusted returns are much higher. In historical drawdowns, this portfolio has gone down similarly to the market but come up faster. We also have a deallocation rule where we deallocate away from the portfolio if it goes down more than 10% in a short span of time.
We are betting on cyclical sectors in this portfolio and have recently increased our allocation to technology over financials.
Smallcaps rise higher when the market is in a bull phase. Wright smallcaps uses momentum & other fundamental factors to choose the right smallcap stocks to ride the rally. We expect smallcaps to outperform large caps in the foreseeable future and are betting on this portfolio.
This portfolio has a risk similar to the smallcase index but the risk adjusted returns are much higher. In historical drawdowns, this portfolio has gone down lower than the smallcap index but has come up faster. We also have a deallocation rule where we deallocate away from the portfolio if it goes down more than 10% in a short span of time.
Some key questions about the second wave answered
Q.1 The second wave of the Coronavirus is taking place at different timings around the world. What does this mean for the Indian financial markets? Is this worrisome or a blessing in disguise?
What’s happening with the second wave of covid is terrible, to say the least, but having seen the toll that the first wave took, we are better prepared. The focus has shifted from lockdowns to vaccines which makes sense. Looking at the markets though, I have mixed feelings. Just before the second wave we were assuming that the recovery is done and dusted and the rate hikes could come sooner and derail equities, but the second wave sort of eases the fear of rate hikes. On the other hand, the second wave would dampen earnings & sentiment for the short term atleast and we will see the market lose some strength.
Q.2 It seems that lockdowns cause the markets to fail. But at the same time lockdowns can reduce the number of cases and deaths. Are we in a loop here? What should we do with our money?
There’s no models that seem to work in a covid wave. There is going to be short term pain in the market and being conservative might be reasonable. The way the virus is spreading, lockdowns seem like an urgent solution, but for a healthy economy, increased vaccination is the only long term solution. At Wright we deallocated a little bit away from cyclical stocks to gold, liquid ETFs and increased our nasdaq exposure for the short term. We haven’t shifted from cyclical to defensive stocks yet as we believe in the long term growth story of the Indian economy, but the volatility in the immediate term is real!
Q.3 Let’s move to a sector wise analysis. With the coronavirus pandemic throttling closer, what does it look like for the infrastructure sector? And its impact on metals which seemed to have a good run last year. What does the pharmaceutical industry currently look like? We noticed that it had a certain dip but now with the Second Wave approaching, how would it impact the industry?
Defensive sectors like Pharma & IT have made a comeback in the past few weeks while Banks, Auto, Infra is in a downtrend since March. Metal stocks are still going strong riding the commodity wave. In the fear based decline of the covid second wave Pharma has been the strongest and defensive sectors have had a lower decline than the cyclicals. Pharma did well in the last covid wave and it also falls right into the value and defensive bucket which is showing a recovery.
Q.4 And finally what would your smallcase strategy be to ride this wave? Any specific stock/stocks exist in your smallcase that helps you achieve this? Or a rebalance that you’re planning to do for this?
We did rebalance our multi factor portfolio in the middle of April, we deallocated a little bit away from cyclical stocks to gold, liquid ETFs and increased our nasdaq exposure for the short term. We might look at increasing allocation to value stocks and defensive names if the situation does not improve for the cyclical growth story, but given the projections of growth by IMF and good performance in the last quarter, we are optimistic in the long term. We hope that the second wave of the pandemic has only a short term impact but you never know.