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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

Long Haul to recovery! - Alpha Edge, May 2020

The month of April has been thus far the worst since the pandemic has started but has turned out to be one of the best for the stock markets. Markets saw a sharp and swift bounce back due to the unprecedented liquidity available. It has neglected the damage this pandemic and the ongoing lockdowns have brought to the global economies, corporates, and consumers.

Our Prime Minister has announced an impressive stimulus package ‘Aatmanirbhar Bharat Abhiyan’ to give our economy the much needed impetus. But unlike the most relief packages announced globally, Rs.20 lakh crore is not entirely in new spending and includes Rs.1.7 lakh crore package the government had announced in March as well as the steps taken by the Reserve Bank of India (RBI) such as liquidity enhancing measures and interest rate cuts.

The reforms and the package are definitely a positive step, but we believe the benefits of the same will be enjoyed in the long term. The need of the hour is to boost consumption demand and the fiscal part of the package is a mixed bag in that direction.

The demand and supply disruptions have been significant and is highlighted by the lead indicators such as weak Oil prices and declining Baltic dry Index (indicator to assess global economic activity). With the incremental active cases increasing day by day and the exodus of migrant workers to their native place surely make the case stronger for a longer W/U shape recovery and hence we believe that though the market has run up from its March lows, we see a Long Haul to recovery for global economies, corporate earnings, and consumer demand.

Hence, we had utilised the bounce-back rally, as an opportunity to take a 50% cash call from a) equity allocations within our model portfolios and b) Direct equity strategies, the same was published in our communication via “ Flash: Partial Exit from Equities : up to 50% “and the tweet shared on 30th April. The backdrop was the certainty of near-zero earnings growth for FY21, current high valuations - both on PE multiples and the Yield Gap models (attractiveness of Equity Vs Debt) amongst others which did not justify allocations to 100% equity with any degree of confidence. Going ahead, as the fundamentals improve or valuations become truly cheaper, we will re-evaluate the current cash call and update you proactively.

On the Global front, the GDP growth was not only negative for the US and Europe but was way below expectations. Without any clarity on the end of the lockdown period in the US and Europe, the global GDP forecasts may lower further.

On the Fixed Income front, RBI on its part has been aggressive in policy response so far. Yet it has only met with partial success in achieving the desired outcomes. The yield curve has continued to steepen and corporate spreads stay elevated. As a result, 2yr AAA credit spreads (yield difference between 2yr government Bond yields and 2Yr AAA bonds) still hover at ~220 bps as 2yr government Bond yields have touched 4.3% and most of 3Y AAA PSU bonds still at 6.4-6.5%.

Investors should welcome this spread retracement as yet another opportunity to allocate to quality fixed income and duration plays. Hence, 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. The corporate earnings are expected to be subdued amid the lockdown period and its aftermath. Hence we continue to avoid credit risk even if the spreads are higher.

Click here to read the report

Flash - Partial Exit from Equities : upto 50%

In our monthly newsletter ‘Alpha Edge’ released on the 13th of April, we had outlined our strategy of taking a cash call in the range of 30%-50% once the Nifty crosses the 9500 levels and comes closer to the ~50% retracement of the fall witnessed from the onset of the pandemic. 


Our observations:

(i). With the rally from March 2020 lows of Nifty 7500, the markets have rallied nearly 30%. The current valuations levels are at 22+ which do not seem to be pricing the earning deceleration ahead and look over valued. 2020 is clearly likely to be a year of flat to negative earnings growth. As the extent of such de-growth in earnings becomes visible, markets will keep adjusting lower, reflecting the incremental reality of economic downtrend. This process of adjustment could continue till an extreme where the index PE valuations possibly reach sub 15 levels, an area that typically marked the end of past bear markets. At such points markets tend to look forward rather than backward and a recovery in markets ahead of the economy begins once again. We are not there yet.

(ii). For instance, markets bottomed out at sub 15 PE multiples, towards the end of the bear markets of 2000-2002 and 2008 where prevailing growth was comfortable unlike the 2016 to 2019 period. The adjustment patterns and trends could repeat, as the world economy comes to a grinding halt with only a slow or gradual recovery likely owing to the severe unpredictability of how the health crisis will resolve and when full-fledged economic activity can resume. The structural dislocations that are unfolding currently will result in both demand and supply shocks alternatively and may take time to stabilise in a few quarters from now.

(iii). To summarise...with the prospects of near zero earnings growth for FY21, current high valuations - both on PE multiples and the Yield Gap models (attractiveness of equity Vs Debt), do not justify allocations to 100% equity with any degree of confidence.

Hence, further to our communication via Alpha Edge- April 2020 and the tweet shared yesterday by our founder, we would like to initiate a 50% partial exit from equities as per your risk profile (Nifty 50 at 9850).

As fundamentals improve or valuations become truly cheaper, we will re-evaluate the current cash call and update you proactively.

The cash call is being applied to equity allocations across all our model portfolios and the same will be available in our newsletter on our blog shortly. 

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