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Remember the Pendulum-again! - Alpha Edge, October 2020

The Equity Markets experienced turbulence in September and ended the month with a dip of 1.23% on fears of a second wave of Covid-19, muted demand revival, and high unemployment. However, Small and Midcap indices continued with their strong momentum with an up move of 1.8% and 4.2% respectively.

In the month of January 2018, sighting markets to its extreme euphoric phase, we released our Alpha Edge report titled ‘Remember the pendulum’, where we highlighted the prospects of change in the market direction and correlated it to the movement of a pendulum. We believe that we are back to this extreme euphoric phase where all positives are priced in but the divergence between reality and expectations is completely ignored buttressed by the huge liquidity in the system.

On the global front, Global equity markets fell during September as the old ghost of COVID-19 pandemic once again made market participants wary which fueled concerns of muted demand and slowdown in global growth.

On the domestic front, Low interest rates, high liquidity in the system, a strong recovery in auto sales are some good signs of recovery but experts remain skeptical on a comprehensive economic recovery amid low credit offtake, high inflation driven by supply disruption, and a distressed MSME sector.

Further, structural reforms like agriculture and labor bill may have a long term benefit, but if not implemented well, may create disruption, as was the case with ‘Demonetization’ and ‘GST’. The timing of such reforms in the middle of a recovery phase for a pandemic-devastated economy may not be best suited.

The upcoming Corporate results season and the great Indian festive season will be critical to determine the trajectory and durability of the economic recovery. With most of the positives already priced in, any disappointment may lead to huge volatility as we experienced last month.

And hence extreme caution is advised to investors as the current valuations at 33.9x are not in sync with the distressed corporate earnings and hardly provide any margin of safety.

Hence we believe that the equity markets may remain highly volatile and we continue with our cash call due to lack of concrete evidence of a strong recovery.

On the fixed income front, The RBI should be able to continue its support, even as things have got a little complicated recently. A combination of high inflation, appreciating rupee, high Government borrowing program, and deficit slippage scenario has made the task of keeping yields low more challenging.

However, RBI will try its best to control volatility in yields with measures such as OMOs, OMOs with operation twists, and LTROs. Having said that, the longer tenure bonds may face some pressure due to the high Government borrowing program.

For investments, we believe that exposure to debt markets should be taken through short term funds and floater funds for a 1-2 year investment period and Banking and PSU debt funds for more than 2 year investment period.

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Fasten your seat belts! - Alpha Edge, September 2020

Equity markets had yet another month of strong gains in August, though it ended on a sour note with a sharp sell-off due to the China standoff. Small and Midcap indices led the market optimism for the month with a jump of more than 10% and 6% respectively attributing to a more broad-based rally.

However, the extent of the contraction in Q1 GDP (-23.9%), a first in more than 40 years was a wake-up call to the exuberant market participants. Now, their focus shifts to the next round of stimulus. But, with the current fiscal situation seeming to be already stressed, the resources for the economic impetus would be found wanting by the government.

Rising Covid cases are pushing the country-wide ‘Unlock’ further, prolonging the full-fledged economic activities and the skirmishes on the Chinese border are adding to the uncertainties. Going forward, these uncertainties should keep the financial market volatility high. So expect a bumpy ride ahead and Fasten your seat belts!

On the global front, China is showing some signs of plateauing after the early recovery backed by the pent up demand. The mobility data continues to indicate flattening of economic activity in the US, Europe, and the UK. Acknowledging the concerns, the US has changed its stance from ‘inflation targeting’ to ‘average inflation targeting’ which augurs well for Emerging markets like India, as it keeps interest rates at bay and boosts liquidity.

On the domestic front, a strong rebound in auto sales, expansion in agriculture/rural economy, high liquidity in the system, and low interest rates are some of the positives, but a subdued service economy, geopolitical tensions, low credit offtake, distressed MSME sector and lower capacity utilization does not augur well for corporate earnings.

With current valuations at 32.5x lingering near its all-time high, a further up-move can only come when strong earnings growth supports the market. The corporate earnings currently are in distress and do not justify the exorbitant valuations. The strong momentum experienced in the last few months indicates that market participants are entirely ignoring the subdued earning prospects for FY21 EPS and are already discounting a robust rebound in corporate earnings for FY22. (FY22 Nifty EPS growth is estimated at 46% as per Bloomberg consensus data)

Such steep corporate earnings recovery has never been seen before and the probability of achieving the same is highly questionable, which poses a massive risk towards current market momentum.

Hence, we believe that equity markets may remain volatile in the near term and upside if any is likely to be capped from current levels. We do continue with our cash call until we see reasonable valuations or earnings prospects improving.

On the Fixed Income front, going forward Inflation trajectory will be key for yields to stay down sustainably. As economies gradually reopen, in the wake of supply chain disruptions, stable supply may take time to return and this may lead to inflation uptick and volatility. As a savings grace, a stronger monsoon season bodes well for easing food inflation which is the biggest component (~48%) of CPI.

A steep yield curve and the RBI’s strong intent to keep a lid on yields, may provide tactical opportunities. Meanwhile, we believe that exposure to debt markets should be taken through short term funds for 1-2 year investment period and Banking and PSU debt funds for more than 2 year investment period.

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Keep your powder dry! - Alpha Edge, August 2020

Nifty continued its euphoric rally and crossed the psychological level of 11,000 with a jump of 7.5% in the month of July. The rally was largely attributed to Defensives like IT and Healthcare along with Reliance, supported by steady Foreign flows. In contrast, we experienced a flattening of economic activity in July as the gradual improvement of April lows, appears to have plateaued.

The worldwide liquidity has already led the markets to a spectacular recovery, but a lackluster earnings season coupled with FY21 and FY22 earnings downgrades and subdued economic activity do not justify the alarming valuations of ~30.7x as we speak. We believe that markets will eventually recognize and respond to the yawning gap between perception and reality and we strongly recommend to keep your powder dry for such eventuality.

On the global front, GDP numbers for the US and Germany have seen a record drop. China’s economic activity has bounced back, as strong overseas demand for health products fuelled exports notwithstanding the global lockdown. However, the local consumption demand is yet to show signs of recovery. Elsewhere, the recent mobility data indicates flattening of economic activity in the US, Europe and UK, due to the change in consumption patterns and deferred expansion plans by corporates.

On the domestic front, while GST collections, positive tractor and 2 wheeler sales are positive indicators, lackluster earnings season, slowing mobility trends due to fading-off of pent-up demand, continued surge in virus infections and cautious consumers & businesses, are cause of concern.

With Nifty FY20 EPS contracting closer to FY18 level and FY21 & FY22 forward estimates facing downgrades amid cautious narratives from corporates, a valuation of 30.7x on TTM basis looks way too expensive and unprecedented in 20 Yrs. The prevailing narrative that markets are looking at FY22 numbers instead of FY21 seems far-fetched yet again with the medium-term activity unlikely to go back to pre-Covid FY22 projections so fast.

Hence, we believe that the equity markets may remain range-bound and logical upside is likely to be capped from current levels but for irrational momentum. We do re-iterate with our cash call of 50% for the medium term and are closely keeping a tab on the ongoing developments. Were there to be any evidence of sustainable recovery or fair valuations or both, we look forward to becoming fully invested.

On the Fixed Income front, RBI has kept rates unchanged in its August policy meet. The status quo in the RBI policy was primarily driven by sustained cost-push inflation in Q1 FY21 coupled with comfortable liquidity conditions.

We expect an adverse impact on long term yields due to near term inflationary pressure. Hence we believe that exposure to debt markets should be taken through short term funds for 1-2 years investment period and Banking and PSU debt funds for more than 2 year investment period.

While structural view remains unchanged, we will take the advantage of tactical opportunities as and when possible in the duration space.

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Hopium! - Alpha Edge, July 2020

Nifty Index had a strong month with ~7.5% and the best quarter in 11 years, since June 2009. The rise has been as swift and steep as was the crash. The Nifty has surged over 35% from March lows even as the number of Covid-19 cases in the country have jumped from 500 to over 6 lacs during the period. Probably the fastest crash and recovery on record globally.

Indian equity market valuations have again reached a disconcerting level of 28.30 x as we speak. It seems to be supported by a narrative of falling yields in India and globally. However, the real reason for the rise is unprecedented liquidity. That has directly helped financial markets to price in an anticipated V-shaped economic recovery and / or discounting too far into the future – FY22. Over the last two decades we have seen consensus estimates underpricing growth only once, in 2005-2006. Every year before and after, the analysts estimates of Nifty EPS have mostly overstated and have been needlessly optimistic, creating ‘Hopium’ – hope induced by opium.

Globally, all Central banks have continued their expansionary stance. China has shown a very strong recovery. The economic activity and mobility data in the US, UK and Europe has improved in the last two months, but is flattening now indicating the recovery might be a more of a bumpy ride than a smooth one.

On the Domestic front, good recovery in 2 wheeler sales, GST collection of 90% of pre Covid levels are positive indicators. But the Nifty earnings have de-grown by ~23% YoY and Nifty Mid Cap Index has reported a loss at an aggregate level in Q4 FY20. The weakness in corporate earnings in the March quarter, when the impact of the lockdown was insignificant, clearly indicates the sluggishness in the economy even before the Pandemic.

FY21 Nifty earnings growth consensus estimates have already been downgraded to -10%, with a recovery expected in FY22. The reasons for the earnings downgrade has been subdued consumer demand, low capacity utilisation, and a stressed financial sector with likely NPA pressure after extension in the moratorium period is over. With valuations looking expensive again, we believe that the equity markets may remain range-bound and upside is likely to be capped from current levels. We do continue with our cash call of 50% and are closely keeping a tab on the ongoing developments. Were there to be evidence of sustainable earnings recovery and fair valuations or both, we look forward to becoming fully invested.

On the Fixed Income Front, RBI has been aggressive through its bond purchase program and has led to a contraction in Credit spreads within high quality (AAA and PSU) bonds. But the spreads remain high for bonds rated AA and below attributable to economic uncertainty and risk aversion.

We believe that there is some more room left for yields to fall, however, the juiciest period for government bonds seems likely behind. While the curve stays very steep, continued fiscal pressures provide resistance. Hence we believe that exposure to debt markets should be taken through short term funds for 1-2 years investment period and Banking and PSU debt funds for more than 2 year investment period. Credit spreads are elevated, but they also reflect the economic uncertainty and constraints in the financial system. Hence we continue to avoid credit risk even if the spreads are higher.

While structural view remains unchanged, we will take the advantage of tactical opportunities as and when possible.

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Unlock 1.0! - Alpha Edge, June 2020

India has completed two months of the nationwide lockdown, meant to curb the spread of the novel coronavirus pandemic. So far, essential services, some industries, railways, and more recently, domestic aviation was allowed to resume.

Further, the Government has announced its “Unlock 1.0” plan to open religious places, offices, shopping malls, restaurants, and hotels from June 8 in non-containment zones across the country. It will be a good start to begin with as the economic activities came to a grinding halt amid the lockdown period.

The Indian government has issued clear guidelines required to be followed for each type of establishment. A failure to follow these social distancing guidelines can increase the risk of a rise in containment zones as economic activity resumes delaying further recovery.

On the global front, Global GDP growth estimates for CY20 continue to be downgraded further due to the pandemic. However, the slowdown in incremental cases, progress towards medical solutions, and re-opening of economies have been some positives. Central banks also expected to further expand their balance sheets. However, the Civil unrest in US and flaring of US-China tension are new risks.

On the local front, India is playing catch-up with global markets ignoring the ongoing pandemic, the country-wide migrant crisis, cyclones, earthquakes, locust attacks, border tensions with neighbours and a ratings downgrade.

We believe that the near term upside is expected to be limited due to the continuing earnings downgrades amidst the COVID-19 uncertainty, poor consumer demand, low corporate earnings growth, and a stressed financial sector with likely NPA pressure after extension in the moratorium period. Hence, we do continue with our cash call and are closely keeping a tab on the ongoing developments.

On the debt front, the RBI has been aggressive in policy response so far whether it may be rates, liquidity, and transmission. Yet it has only met with partial success in achieving the desired outcomes. Given the sharp jump in the quantum of bond supply (both G-sec and State Development Loans), the absence of any announcements for managing the supply such as Open Market Operations(OMOs) or any other similar measures will lead to steepening of the yield curve.

Hence we believe that exposure to debt markets should be taken through short term funds for 1-2 years investment period and Banking and PSU debt funds for more than 2 year investment period.

While structural view remains unchanged, we will take the advantage of tactical opportunities as and when possible.

Credit spreads are elevated, but they also reflect the economic uncertainty and distress in the financial system. Hence we continue to avoid credit risk even if the spreads are higher.

 Click here to read the report

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