Year in Review – 2022 from the Windmill Capital Desk

With its fair share of ups and downs amidst geopolitical tensions and unusual monetary policies – 2022 was an eventful year, to say the least. Just when you were thinking that the pandemic blues are behind, Russia had other plans to keep the world hooked onto news forums. Well, as far as equity markets are concerned, we’ve been lucky with its outperformance as an asset class over the last decade. One felt the heightened importance of equities, as it is the only asset class that could potentially beat inflation.

The idea here is to dissect the performance of our markets and provide insights into how things might shape up going forward. Let us start by taking a look at the performance of the Nifty 500 index, which represents ~95% of India’s total market capitalization.

If you wish to work with averages, then the Nifty 500 index has returned ~15% over the last decade. Since we’re aiming to look at what transpired in 2022, here are some factors that contributed to the rise and fall of our stock markets –

• Geopolitical Tensions – No prizes for guessing, the Russia-Ukraine war has been the most influential development behind the performance of equities in 2022, not just in India but across the world. Besides the obvious ramifications it has had on investor sentiments, this war has further defunct an already broken global supply chain. Countries dependent on imports for essential commodities found themselves amidst a huge crisis, as a sharp rise in prices of commodities (oil, wheat, corn,& so on) not only hurt businesses but also government coffers. As can be seen from the chart underneath, prices of major commodities exploded post the Ukraine invasion. Particularly for India, the problem exacerbated as 80% of our crude oil requirements are met by imports.

• Central Bank Policies – Quantitative tightening was the norm across all major central banks, as all hell broke loose on the inflation side. A mintgenie study indicates that central banks, across the world, have raised interest rates by a whopping 1570 basis points (15.7%) in 2022. The Reserve Bank of India (RBI) has raised the repo rate by 225 bps, from 4% to 6.25% in 2022. This is a testament to the pain caused by the accelerated inflation, especially on two key items – food and fuel. Attached below is a pictorial representation of rate hike trends across developed and emerging economies.

• US Dollar Strengthening – One of the major pain points for our markets was the incessant strengthening seen in USD. As a result, USD/INR rates kept trending upwards and we saw massive value erosion in our currency. To put forth some context, USD appreciated nearly 11% from the start of the year against INR. Needless to say, it is a bane for importers too, as imports get expensive. In other words, besides local factors contributing to our inflation, currency depreciation accelerated the inflation woes.

Now, let’s switch gears and shift our focus from the rear-view mirror to the path ahead. We step into 2023 with the fear of an impending recession in the US and other major economies. The World Bank, IMF, Fitch – these institutes have cut their global GDP growth forecast, including that of India’s, due to all the headwinds. And the downgrades have been sharp, take a look –

Having said that, not all is doom and gloom for us. India has displayed immense resilience in an extremely difficult macro environment and has been a rank outperformer to both its developed and emerging peers. Year to date, our markets have managed to be in the positive terrain with gains of ~3.5%. However, let’s compare that with the performance of other key market indices –

The divergence can also be witnessed below –

Now, you may ask what is the reason behind India’s outperformance? Broadly, they are –

• Proactive policy making – The Government of India has been extremely proactive with the way they’ve managed multiple crises, especially that of the Russia-Ukraine tussle. At a time when the world was busy levying embargo on Russian oil, our government saw it as an opportunity and started sourcing oil from Russia at a much cheaper rate.
• Pragmatic monetary policy – ‘We don’t want to rock the boat as we approach the shore’, some wise words that the RBI governor had said in Oct ’21 during the MPC announcement. And in all fairness, RBI has lived by those words. The policy normalization has been pretty gradual which has prevented the markets from a sudden shock. 
• Business resilience – India Inc. has displayed tremendous business resilience in such uncertain times, with overall profitability growing due to a cocktail of factors – PLI schemes incentivizing production, export-first mindset, and smart cost cutting.

Finally, to close this piece, let’s look at few sectors that we have a constructive view, going into the new year –

1. Specialty chemicals – The sector is set to benefit from China + 1 strategy and possibility of coverage under the PLI scheme. The Indian chemicals industry has the opportunity to present itself as an alternate destination for production of major chemical raw materials.
2. Electric mobility – The government’s push has moved the needle and a lot of incentives have been provided in order to nudge the common public folks to buy an EV. This is definitely an interesting space to look at, with major infrastructure development taking place.
3. Infra – A strong impetus from government policies is one of the main growth drivers for the infrastructure industry in India, coupled with a strong capex environment. 
4. Auto – The pain points around the supply side have been easing out for automotive manufacturers. On top of that the demand pipeline for auto companies is very strong, which is an additional factor to have confidence in this sector.
5. Banking – Strong credit off-take in tandem with rapid asset quality improvement is a deal maker for the sector. Deposit rates have also been healthy for major private players. It is expected that the banking sector will continue to ride on the tailwind of asset quality, less provisions, and strong credit offtake. 
6. Defense – India’s military spending is the 3rd largest in the world with the FY23 Budget pegging it at ~$54 billion. Until 5 years ago, we were largely importing our defense needs. However, things have begun to turn around. The government’s focus has shifted towards indigenisation, wherein domestic players are not only servicing domestic orders but also exporting overseas, which explains the surge in exports. 

Here’s wishing you and yours a very Happy New Year from the Windmill Capital family!

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Windmill Capital Team

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