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On Our Toes! - Alpha Edge, January 2021

Wish you a very Happy New Year!

2020 was a year of surprises. There was the speed at which the pandemic escalated, the severity of the lockdowns, the size of the government stimulus measures and the magnitude of the equity market rebounds. Benchmark indices have had a tumultuous year but managed to post stupendous gains despite the record fall in March. The Nifty 50 index, ended the year up 14.9% while the Nifty Midcap and Small Cap rose 21.9% and 21.5% respectively.

The Indian stock market witnessed unprecedented inflows from FIIs and FPIs as surplus liquidity was available attributable to stimulus measures by Central Banks worldwide. Companies such as Reliance Industries set the ball rolling as they announced a plethora of stake sales to international organizations. FIIs collectively poured in Rs.1,71,507 crs into the Indian equity markets in 2020, starkly in contrast with MF investors who have pulled out Rs. 48,031 crs.

Indian stocks were also aided by better than expected corporate earnings as margin expansion resulted in double-digit profit growth on better cost controls by corporates, comfortably offsetting the decline in revenues. Also, providing support was earnings upgrades that continue at an unprecedented pace as activity continues to normalize.

Moving into 2021, the low interest rate scenario coupled with a weak dollar will be supportive of foreign fund inflows. However, the slow pace of recovery, high inflation and extreme valuations pose downside risk. Hence 2021, is likely to keep us ‘On Our Toes’ with a couple of unexpected surprises. 

On the Global front, a new strain of the virus found in the UK has brought with it a threat of fresh lockdowns due to its higher transmission rate. A smooth and quick roll-out of the vaccine coupled with continuing stimulus measures is imperative to keep the global economy on the upward track.

In India, given the flattish economic recovery post the festive season, it will likely take a much stronger growth and secular revival in earnings cycle for further upsides. Additionally, without any further stimulus measures from the Central Bank we might see some of the surplus liquidity dry up. Current equity valuations are exorbitant at 38.5x on a TTM basis and 24.3x on 1yr forward basis. This discounts significant and continuous expectations of earnings and hardly provides any margin of safety. Hence, extreme caution is advised to investors.

We believe that the equity markets may remain highly volatile, and we continue with our cash call due mismatch between long term economic evidence and forward valuations which discount even the rosiest picture.

On the Fixed Income front, inflation has remained consistently above its upper target of 6% accompanied with lockdown induced growth shock. The RBI current stance of a passive yield curve control with targeted tactical OMOs and Twist Operations may remain the preferred market intervention strategy for a while.

Given the excess liquidity on the shorter end of the yield curve, the government bond yield curve is likely to remain steep.

Given the crash in yields for ultra-short term, we believe any investment for a period of 1-2 years should be made in Arbitrage funds due to the pickup of spreads in the category. Banking and PSU debt funds can be considered for more than 2-year investment period.

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On the road to Recovery! - Alpha Edge, December 2020

Based on positive data concerning vaccine development, the Nifty and the Sensex gained over 11% each, aided by record FPI inflows of around USD 8 bn, even as local institutions were heavy sellers during the month. Market breadth improved considerably as Mid caps (15.5%) and Small caps (12.96%) outperformed Large caps.

Indian stocks were also aided by better than expected corporate earnings as margin expansion resulted in double-digit profit growth on better cost controls by corporates, comfortably offsetting the decline in revenues. Also, providing support was earnings upgrades that continue at an unprecedented pace as activity continues to normalize.

Along with the earnings upgrades, India also experienced upgrades to GDP estimates. Q2 GDP saw a lesser contraction at 7.5% viz-a-viz 9-10% estimated levels. Indian economy and corporate earnings surely are on the road to Recovery. However, whether the trajectory continues to improve post festive season needs to be closely monitored.

On the Global front, a decisive Presidential election verdict in the US, and positive news flows concerning Covid vaccine development led to global risk assets rallying over the past month, pricing in an earlier resumption of normal economic activity.

On the domestic front, positive surprises on macro-economic revival and Corporate earnings coupled with lower incremental Covid cases has pumped up the equity markets. And with recent earnings upgrades, a weak dollar, and lower interest rates may keep foreign flows supportive.

Post March 2020, there were expectations of a significant earnings downgrade. However, corporate earnings have not been as bad as expected which has resulted in a lesser contraction in earnings from pre-Covid levels and subsequent upgrades.

But the current exorbitant valuations at 36.5x on a TTM basis and 24.2x on 1yr forward basis discount significant and continuous expectations of earnings of which we are not sure yet and hence, extreme caution is advised to investors. 

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

On the Fixed Income front, inflation remaining consistently above its upper target of 6%, the RBI has to find a way to balance between prioritizing economic growth and controlling inflation. In its last MPC meeting, the RBI kept the Repo rate unchanged at 4% while pledging to maintain an accommodative policy stance well into the next financial year to support economic recovery.

To control inflation, The RBI has to suck out the excess liquidity, which means it cannot buy the excess dollar inflows and allow the currency to appreciate.

Given the excess liquidity on the shorter end of the yield curve, the government bond yield curve is likely to remain steep. The RBI is committed to supporting the market, but as we are towards the fag end of the rate cut cycle, it will be prudent to be on the shorter end of the yield curve for lesser volatility risk than longer maturity exposures.

For investments, we believe that exposure to debt markets should be taken through short term 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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Out of the Woods, Yet? - Alpha Edge, November 2020

The Equity Markets experienced a swift recovery in the month of October backed by improvement in economic activities and ample liquidity in the system. Nifty was up by 3.51%, albeit, with high volatility, Midcap and Small cap indices inhibited caution due to increasing concerns of a second wave with returns of 0.49% and -0.07% respectively for the month.

At the onset of November, markets gained momentum due to the gradual moderation in incremental COVID-19 cases. Yet, it is too early to say whether the virus spread has been decisively controlled with the festive season and winters upon us. 

Further, the ‘Biden Win’ in the US has given further impetus to markets the world over, as Democrats are likely to follow a more expansionary fiscal policy. However, the balance of power in the Senate won’t be known until after dual runoff elections for Georgia’s two Senate seats, which would reduce the chances for a big fiscal stimulus package from Congress, even as the Covid-19 pandemic continues to threaten the economy. Markets have already priced in all the positives, and we believe that we are not out of the woods yet.

Globally, a potential double-dip in growth due to fresh lockdowns and fading fiscal support is a cause of concern.

On the domestic front, Corporate results have been better than expectations so far driven by cost control and positive surprise from banks. Of 50 companies in the Nifty 50 Index, 40 have reported their earnings so far with a fall in revenue of 12% mainly attributed to the poor show from Reliance, BPCL, and IOC, but cost control measures have led to operating profit growth of 1.72% and PAT growth of 9.1% over the same period last year.

The partial ‘K shaped recovery so far may have been due to the pent-up demand; however, going ahead, economic uncertainty at the global and domestic level is likely to weigh on consumers' discretionary spending behavior and will determine the further path of comprehensive recovery. At the beginning of FY21, analysts estimated 43% forward earnings growth for FY21 on a low base, such a growth on TTM basis has been witnessed once in June 2007 quarter only. Though, the recent earnings have improved on a sequential basis but fall short of these expectations, and this will warrant further earnings downgrades.  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 partial cash call due to lack of concrete evidence of a strong recovery.

On the Fixed Income Front, RBI has not only been aggressive but also unconventional in the current economic crisis. It continues to do whatever it takes to bring the economy on track through providing aggressive rate cuts and unorthodox measures like TLTROs, Operation Twists, OMOs for SDLs, etc.

The longer tenure bonds are expected to face pressure due to the high Government borrowing program. The RBI is very much committed to support the market, but as we are towards the fag end of the rate cut cycle, it will be prudent to be on the shorter end of the yield curve for lesser volatility risk than longer maturity exposures.

For investments, we believe that exposure to debt markets should be taken through short term 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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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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