---
title: "Light At The End Of The Tunnel: Reading The Cycle Through Howard Marks | Quarterly Newsletter - December 2019 / Q3 FY20"
period: "Q3 FY20"
published: 2020-01-31
modified: 2020-01-31
url: https://equitreecapital.com/insights/newsletters/december-2019
markdown: https://equitreecapital.com/insights/newsletters/december-2019.md
authors: ["Pawan Bharaddia", "Ssuneet Kabra"]
publisher: "Equitree Capital Advisors Private Limited"
language: en-IN
---

# Light At The End Of The Tunnel: Reading The Cycle Through Howard Marks

Quarterly Newsletter, December 2019 / Q3 FY20. Published 31 January 2020 by Equitree Capital. About 11 minutes to read. Web version: https://equitreecapital.com/insights/newsletters/december-2019

> Quarterly Newsletter published 31 January 2020. Figures are as of the dates stated in the letter and are not updated after publication.
> Performance data has not been verified by SEBI. Past performance is not indicative of future returns.
> Current performance, with its as-of date and benchmark: https://equitreecapital.com/pms
> Performance relative to other portfolio managers in the same strategy: APMI, https://www.apmiindia.org/apmi/IaInsight.htm?IAID=407
> Not investment advice, an offer or a solicitation.

> History provides a crucial insight regarding market crises: they are inevitable, painful and ultimately surmountable.
>
> Shelby M. C. Davis

Dear Investors,

The early weeks of 2020 are starting to feel different from the two years that preceded them. After a long stretch in which the market polarised into a narrow band of "safe haven" stocks while the broader universe was left for dead, **the mean-reversion we have written about for the last several quarters is finally playing out**. Credit is flowing again at the margin, the government is signalling resolve on tax and capital-gains policy, and our portfolio has begun to reflect the underlying business quality we have always believed it carried.

Below we share three things: a read of the early-2020 sentiment shift; what we expect from Budget 2020; and Howard Marks's market-cycle checklist applied to India today. We close with on-the-ground anecdotes from banking, autos, small-caps, and GST.

## Our Performance

|  | YTD as of 27-Jan-2020 |
| --- | :---: |
| Equitree Capital | ~12% |
| NSE Small Cap | ~8% |
| Nifty | -0.41% |

Year-to-date returns as on 27th January 2020. The Equitree portfolio has far exceeded the NSE Small Cap index over the same window.  
Source: Equitree Capital internal performance records; NSE; Bloomberg[1].

## 01. Is It Light At The End Of The Tunnel? Or So It Seems!

**The early-2020 setup is one of the most interesting we have seen in two years.** The portfolio is up roughly **12% year-to-date** as of 27 January 2020, well ahead of the NSE Small Cap index at about **8%**, and against a Nifty that is fractionally negative at **-0.41%**. That outperformance is not a function of a single sector trade — it is the reflection of a broader-market thaw after twenty-four months of frozen valuations.

The shift is showing up in soft signals before it shows up in earnings:

• The **Prime Minister, at a global platform**, signalled that India's capital-gains tax regime would be brought in line with global markets, and called on wealth creators to shrug off fears.  
• The **Home Minister** stated that 90% of the political agenda has been delivered; the PM is actively inviting public budget comments and meeting corporate chieftains and regulators.  
• The **market regulator** is softening on derivatives margin requirements and broker funding for clients from proprietary funds.  
• **Leading industrialists** at the recently concluded global economic forum agreed that the worst seems behind us.  
• The mean-reversion theme between "safe havens" and the oversold broader market is finally playing out — exactly as we wrote about in our last several quarterly updates, including the **September 2019** edition.

> **In Focus:** **A note of caution.** Q3 corporate earnings are unlikely to show meaningful growth, and the hard macro is still weak. The thaw is in sentiment first, fundamentals second.

## 02. Budget 2020 — Will The FM Bite The Bullet?

The FM is walking a trapeze: a **tax-collection shortfall** on one side, **fiscal-deficit discipline** on the other. Both can't hold simultaneously, and the budget is where the trade-off becomes explicit.

What we expect the FM to attempt:

• **Lower personal income-tax rates** via slab rationalisation or a higher exemption limit.  
• **Long-Term Capital Gains relief** to align with the PM's Davos signalling.  
• **Sector-specific import-duty tweaks** to push domestic manufacturing.  
• **Policies for agriculture and infrastructure** to revive rural demand and the capex cycle.

### 2A. The True Fiscal Deficit Could Be 5.5% — Not 3.3%

The headline budgeted fiscal deficit for FY20 is **3.3% of GDP**. Strip out off-budget liabilities and the picture changes materially. **Including off-budget liabilities, the true number is closer to 5.5%**[2] — bank recapitalisation bonds excluded. The total FY20 revenue shortfall is estimated at roughly **₹1.6 trillion**.

[Chart: Government's True Fiscal Deficit Could Be As High As 5.5% In FY20. Reported fiscal deficit vs the deficit including off-budget liabilities, FY02–FY20. Drawn on the web page: https://equitreecapital.com/insights/newsletters/december-2019#budget-2020]

Series: Reported, Incl. off-budget.

Union government fiscal deficit, % of GDP, FY02 (2001–02) to FY20 (2019–20), digitised from the original chart (±0.1). FY19 reported is the 3.4% revised estimate. FY20 dots: 3.3% budgeted (reported), 4.2% estimated excluding off-budget liabilities, 5.5% estimated including them. Off-budget liabilities for FY02–FY09 include oil, fertilizer and FCI bonds; from FY17 they include NSSF loans and government-serviced bonds; bank-recapitalisation bonds are excluded.  
Source: Mint Graphiti; Union Budget documents; CGA; ICICI Securities Primary Dealership[2].

### 2B. Tax Collection: 45% Of Target By November — Lowest In Five Years

Tax revenue collected as a share of the full-year budget estimate, **as of November**, sits at **45.5% in 2019-20** — the lowest in five years. Non-tax revenue at 74.3% has held up better, but the tax-revenue line is the one that matters for the deficit math.

| Year | Non-tax revenue (%) | Tax revenue (%) |
| --- | :---: | :---: |
| 2014-15 | 60.4 | 42.3 |
| 2015-16 | 78.1 | 50.5 |
| 2016-17 | 54.2 | 58.9 |
| 2017-18 | 36.5 | 57.0 |
| 2018-19 | 56.6 | 49.4 |
| 2019-20 | 74.3 | 45.5 |

Collections as of November as % of full-year budget estimates.  
Source: Mint Graphiti; Union Budget documents; CGA[2].

### 2C. FCI Subsidy Carryover: Liabilities Are Compounding

Carryover liabilities of unpaid subsidy bills to **FCI** have become structurally larger over the cycle. The carryover line is approaching **₹2,00,000 crore** in 2019-20; subsidy deferred during the year is around **₹1,50,000 crore**[2].

[Chart: FCI Subsidy Carryover Has Become Structurally Larger. Carryover liability to FCI vs subsidy deferred during the year, ₹ crore, 2001-02 to 2019-20. Drawn on the web page: https://equitreecapital.com/insights/newsletters/december-2019#budget-2020]

Series: Carryover liability to FCI, Subsidy deferred during the year.

Yearly readings digitised from the original chart (±2,000 crore). The deferred-subsidy line sits behind the carryover line before 2009-10 and cannot be read there, so it is plotted from 2009-10 only. Source: Mint Graphiti; Union budget documents; CGA; Food Corporation of India; Mint calculations[2].

### 2D. GST Compensation Cess: The Gap Will Widen

The gap between estimated GST compensation cess collections and the compensation needs of states is set to **widen sharply** over the next three years[2]. The compensation requirement assumes 5% growth in revenues.

| Year | Estimated collection (₹ Cr) | Compensation requirement (₹ Cr) |
| --- | :---: | :---: |
| 2019-20 | 96,800 | 1,60,000 |
| 2020-21 | 1,01,640 | 2,28,400 |
| 2021-22 | 1,06,720 | 3,08,670 |

Estimated GST compensation cess collection vs compensation requirement, ₹ crore.  
Source: Mint Graphiti; GST Council meeting note; Mint calculations[2].

## 03. The Best Time To Invest Is When Everything Appears To Be Gloomy

Howard Marks's *Mastering Market Cycles* offers a side-by-side checklist of indicators that read **"vibrant"** at a market top and **"sluggish"** at a market bottom. The exercise is not to call a bottom — it is to ask honestly which side of the table the current evidence sits on.

| Indicator | Vibrant | Sluggish |
| --- | --- | --- |
| Economy | Vibrant | Sluggish |
| Outlook | Positive | Negative |
| Lenders | Eager | Reticent |
| Capital Markets | Loose | Tight |
| Capital | Plentiful | Scarce |
| Terms | Easy | Restrictive |
| Interest Rates | Low | High |
| Yield Spreads | Narrow | Wide |
| Investors | Optimistic | Pessimistic |
|  | Sanguine | Distressed |
|  | Eager to buy | Un-interested in buying |
| Asset Owners | Happy to hold | Running for exits |
| Sellers | Few | Many |
| Markets | Crowded | Starved for attention |
| Funds | Hard to gain entry | Open to everyone |
|  | New ones daily | Only the best can raise money |
| Recent performance | Strong | Weak |
| Asset prices | High | Low |
| Prospective Returns | Low | High |
| Popular Qualities | Aggressiveness | Caution and discipline |

Howard Marks's market-cycle checklist — vibrant (bull / expensive) vs sluggish (bear / cheap) signals.  
Source: Howard Marks, *Mastering Market Cycles*, 2018[3].

### 3A. Where India Sits Today

Now overlay India's 2019 readings:

• **GDP at an 11-year low.** FY20 GDP is estimated at **5%**[4]; the IMF projects an even lower **4.8%**[4].  
• **Retail inflation at a five-year high of 7.35%** in December 2019 — well above the RBI's upper band of 6%[5]. **Food inflation hit 14.12%** in the same month[5].  
• **Unemployment rose to 7.5%** during September–December 2019 — the seventh wave of increase since the May–August 2017 trough of 3.8%[6].  
• **Broader market falling since January 2018**; investor caution is at a multi-year peak; **gold sits at all-time highs**, the classic distress signal.  
• **2019 IPO fundraising was the lowest since 2015**, with credit and liquidity constraints throughout the year.

> **Takeaway:** **Most indicators sit on the right column of the Marks checklist.** That, combined with our own bottom-up portfolio readings, is why we believe **this is the best time to add equity exposure on a 3–4 year horizon** — not because the bottom is in, but because the prospective-return math has rarely been more favourable.

## 04. Anecdotal Evidence Suggests Things Picking Up On Ground

### 4A. Banking — The Deposit-Credit Mismatch

**Incremental deposit accretion in the Indian banking system was about ₹5.3 lakh crore higher than credit growth as of November 2019**[7]. ICRA expects FY20 year-on-year deposit growth of **8.4–9%** to outpace credit growth. That gap forces banks to lend — the cheapest way to fix a deposit-credit mismatch is to put money to work.

### 4B. Auto — The Worst Is Behind Us

Passenger-vehicle inventory is back to normal levels post the festive-season discount push. **Maruti and M&M reported slight growth**. The **BS-VI transition** and the upcoming **scrappage policy** are the next demand triggers; market leaders are openly signalling that the worst is behind them.

### 4C. Small / Mid Caps — The Reversal Begins

**S. Naren and Prashant Jain** — two of the most disciplined large-cap voices in the industry — are now publicly endorsing the small-cap thesis. The valuation mismatch between safe havens and the broader market has been amplified to the point that even traditionally cautious houses are calling it.

### 4D. GST — A New All-Time High

**Both November and December 2019 GST collections cleared ₹1 lakh crore**. **January 2020 collections are expected at ₹1.15 lakh crore against the prior all-time high of ₹1.13 lakh crore**[8]. Compliance is improving and the formalisation curve is bending.

### 4E. What We Are Watching

• **Budget 2020** — the trapeze between tax shortfall and fiscal discipline.  
• **Coronavirus** — early days, but a meaningful drag on global trade if it escalates.  
• **Brexit** — the actual impact is finally about to be measurable as the end-January deadline passes.  
• **Middle East** — Iran-related tensions remain a tail risk to oil and global risk appetite.

## 05. In Closing

The macro backdrop is still difficult, and Q3 corporate earnings will not be the print that turns the tape. But **the gap between price and value in the broader market has rarely been wider**, the soft signals are inflecting, and the Marks checklist places India squarely in the column that has historically rewarded patience. We continue to deploy our usual discipline — staggered entries, business quality first, valuation second — and we thank you, as always, for the trust that allows us to do that.

As always, please feel free to [reach out to us](https://equitreecapital.com/contact) with your comments, suggestions, and queries.

Warm regards,

Team Equitree

- Pawan Bharaddia, Co-Founder & CIO (pawan.b@equitreecapital.com)
- Ssuneet Kabra, Co-Founder & CEO (skabra@equitreecapital.com)

## Sources

1. Equitree Capital internal performance records, year-to-date as on 27th January 2020. NSE Small Cap and Nifty closes from NSE / Bloomberg. Individual portfolio performance may differ.
2. Mint Graphiti infographic, page 3 of the Q3 FY20 Equitree Quarterly Update. Underlying data: Union Budget documents; Controller General of Accounts (CGA); ICICI Securities Primary Dealership; GST Council meeting note; Food Corporation of India; Mint calculations. The fiscal deficit, tax-collection share, FCI carryover, and GST cess gap charts have been rebuilt natively: the fiscal-deficit and FCI lines are digitised from the source infographic (about ±0.1 percentage point and ±2,000 crore respectively), the other two are transcribed from its printed values.
3. Howard Marks, *Mastering Market Cycles: Getting the Odds on Your Side*, Houghton Mifflin Harcourt, 2018. The vibrant-vs-sluggish indicator checklist is reproduced verbatim from the book.
4. Ministry of Statistics and Programme Implementation (MOSPI) — First Advance Estimates of National Income, FY20: 5% GDP growth (11-year low). International Monetary Fund (IMF) — World Economic Outlook update, January 2020: 4.8% projection for India.
5. Central Statistics Office (CSO) — Consumer Price Index, December 2019. Headline retail inflation 7.35% (five-year high; above the RBI upper-band of 6%); food inflation 14.12%.
6. Centre for Monitoring Indian Economy (CMIE) — unemployment data for September–December 2019 at 7.5%, the seventh wave of increase since the May–August 2017 trough of 3.8%.
7. Reserve Bank of India (RBI) — banking-system deposit and credit data as of November 2019: incremental deposit accretion ₹5.3 lakh crore higher than credit growth. ICRA — FY20 deposit-growth forecast of 8.4–9%.
8. GST Network (GSTN) — monthly GST collections data: November and December 2019 both above ₹1 lakh crore; January 2020 expected at ₹1.15 lakh crore against the prior all-time high of ₹1.13 lakh crore.

## Disclaimer

This newsletter is prepared by Equitree Capital for informational purposes only and is directed at existing investors and prospective investors who have requested it. It does not constitute investment advice, an offer, or a solicitation to buy or sell any securities, and should not be construed as a recommendation of any security, sector, or strategy.

Past performance is not indicative of future results. Returns referenced are as of 27th January 2020 and may not be representative of any specific investor's portfolio. The macro and sectoral commentary reflects the views of Equitree Capital as of the date of writing and is subject to change without notice. Forward-looking statements are subject to risks and assumptions that may not materialise.

Investments in small- and micro-cap equities carry higher volatility, liquidity, and business-specific risks, including the possible loss of principal. References to third-party research (Howard Marks, Mint Graphiti, ICRA, IMF, CMIE, MOSPI, CSO, RBI, GSTN) are illustrative of macro context and are not endorsements of those providers. Recipients should consult their independent financial, legal, and tax advisors before making any investment decisions.

This document is private and confidential. It may not be reproduced, redistributed, or published, in whole or in part, without the prior written consent of Equitree Capital.