Make sure your portfolio has these 3 types of Covid-proof stocks: ICICI Securities

Top quality expensive stocks, high quality beta cyclicals and high yield utilities or telecom stocks are must-haves in your portfolio, says Vinod Karki, VP- Equities, Strategy.

Let us talk about the momentum in the markets. Whether it is attributed to a liquidity driven rally or the fact that we are riding on what is going on across the globe, the momentum is intact. Are we staging ourselves for some sort of a solid crack as the fundamentals play catch up or do you think that there will be no stopping this solid rally?
The way the market is set up, two things are happening. One, the stimulus that we had from central banks and governments globally although India did not come from the fiscal side. We did not have a big stimulus but the RBI did its bit. The stimulus is kind of unprecedented in terms of the timing and the sheer magnitude. The way this was being played out, there was this fear that the economies will take a long time to open up and the second wave will be very lethal, as we had seen in the case of the Spanish flu. That is the only real, empirical evidence we have in the past of such a pandemic.

But the high frequency data for June shows China is on an expansion mode in terms of PMI. Lot of countries, however, are still contracting. The reading is still below 50, but the contraction is reducing. Lot of data on global mobility and other things -- even some of the banks have given their initial results -- seem to suggest that things are not as bad as they were made out to be earlier. So this combination of a mother of all stimulus and the high frequency indicators showing that things are probably not as bad as originally thought to be, is allowing this market to be quite resilient.

The story would have been very different if the second wave was very lethal and these high frequency numbers were not as supportive as they are right. So even for India, the PMI is still contracting but there was improvement in toll collection, the highway e-way bill filing etc. GST was also showing some improvement although it has a backlog coming in. The big worry the market had was on the financial pack. But the early indicators for Q1 on some of the banks seem to suggest that when the GDP is contracting, maybe by double digit in Q1, the growth is not as bad as originally thought to be.

So a combination of these two things and plus the fact that risk appetite is rising globally, does not seem to suggest that a big crack is around the corner right now from the trend that we have been seeing.

How have you read into the March quarter numbers? There has been a decline owing to the lockdown and the kind of constraints that a lot of these companies have had to face. Going forward, your note suggested that the Nifty earnings could grow at 16% CAGR over FY20 to FY22. What is the rationale behind that?
So it will not be 16%. The note is saying it would be around 13-14% and lot of it is due to base effect. Most analysts and economists are forecasting a 4% to 5% real GDP decline in 2021 which effectively means the inflation is going to be around 4% -- largely flat to slightly 1% kind of decline for the nominal GDP. The 2022 number is largely 6% to 7% and you had another 4%, adding up to 10-11%. So the nominal GDP will be around 4% to 5% over 21-22 going by current estimates.

Typically what happens is corporates have operating and financial leverage which accentuates these movements. If the GDP falls by 1%, fall in corporate profitability can be even higher. So, in FY21 we could see a dip in profitability after a long time. The profit growth may be around 10% but in FY22 due to low base and improvement in the demand, to some extent at the aggregate level and due to kicking in of this leverage effect, the profit jump can be high.

Overall, we see that it is possible that the 13-14% compounding can happen over FY21-22 which has downside risks to it, given how a second wave of Covid can be very lethal. But there is nothing to prove it right now, given that the high frequency indicators are suggesting that recovery is reasonably okay. Yesterday, the US services data was quite robust but then at the same time, virus cases are also rising in the US. So, it is a mix of hope and despair. I would say but the jury is still out/

One cannot bet big time either way. But all said and done, the incoming data seems to suggest that things are not as bad as originally thought to be.. At least, it is kind of confirmed right now and as the stimulus continues, the Fed, for the first time, has embarked on buying corporate bonds. They have been buying junk ETF bonds and so the risk appetite is high right now so yes.

In terms of strategy, going forward, what would you suggest sectorally?
In fact, when the market was even below the 10,000 level, we have been advocating in our research that as it is one of the most unprecedented times, there can be a scenario where things can go out of hand and the cases can rise and there could be a second lockdown. In that case, there could be a flight to quality again.

So, in a portfolio, you cannot completely wish away the expensive quality stocks. You have to have such stocks in sufficient numbers even if they are expensive. But on the other side, we have been constantly saying that high quality beta cyclical stocks, which are typically banks and some of the consumer discretionary stocks, also need to be in the portfolio. Thirdly, given the market crash, we have an opportunity of including stable businesses like utilities or telecom where the cash flow yields or the dividend yield or the earnings yield are high because globally we are moving in an environment where yields are rock bottom and typically robust businesses with high yields should outperform in this environment. These are the three types of stocks we have been recommending right through this Covid crisis.

If I look at the updates coming in from HDFC Bank for their Q1 or for that matter from Bajaj Finance or Bandhan Bank, it is mighty impressive and clearly a show of resilience. All corners of financials are covered and strong commentaries are coming in. What does it tell you about investment opportunities within the larger financial group and not just the top five?
There are two, three things. One, even without this data, the thought process was that, first of all, this fear of NPA is not similar to what was in the earlier cycle. The NPA cycle was largely driven by the core sector, highly capital intensive sectors and it was lumpy and there was evidence of wilful default. But in the current scenario, the fear of NPAs is largely focussed around the MSME segment and unsecured retail lending.

Maximum government effort has been towards the agri sector and the MSME segment in terms of providing refinance. I would say that some mitigation of that risk happened and the rural space and agriculture will be the only space which will grow in FY21. The outlook is looking good with the monsoon coming in.

From that perspective, for someone who is in microfinance maybe in the rural segment, at least from the income perspective, I do not see a big loss over there. That is because rural is the only good spot. In terms of the unsecured retail loans, one has to bear in mind that unless a person is completely bankrupt, one does not expect wilful default happening here. In this digital environment, your credit score is all that matters when you make all the statements and ecommerce and all.

Obviously, there will be people who have completely lost their income and will default because of the loss of income but wilful default is unlikely. You have to remember that there is a moratorium and going by the data, it seems, two things are happening; one that the jobs are coming back strongly in the unorganised segment and second, there is a sign of reverse migration.

There is a moratorium of three months which allows a lot of these people who are in the unorganised segment to at least recoup some of their income. I see very little chance of wilful default happening in the granular loans which are under stress right now.

I am not saying there will not be any increase in NPA. There will be and when overall things go down, you have to remember it is not like the earlier cycle where there were lumpy NPAs from infrastructure, power, and metal sectors which are difficult to resolve. Those kinds of things get prolonged. So an unsecured retail loan NPA cycle will be written off quickly. You cannot prolong that. You have to keep that in mind as well.