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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.

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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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Coronage! - Alpha Edge, March 2020

Is the significant fall of the 10 Year US G-sec to an all-time low of 0.34 bps and crude oil collapsing to $ 30 signaling to a US/Global recession? What seemed to be a normal correction due to the Coronavirus scare has been accelerating with the contagion effect across interest rates, currencies and all asset classes. Historically, we have seen that central bank policy actions have been able to halt the market downfall. However, the recent market fall, post the US fed cut seems to signal probable loss of control of Central banks. We shall await for a next leg of policy action and the market reaction thereafter to assess a structural shift in the direction of markets.

In February, equity markets have been on free fall with Nifty 50, Nifty Midcap 100 and Nifty Small cap 100 index falling 6.4%, 6.8% and 8.8% respectively. Markets all over the world have turned ‘risk-off’, as investors struggle with the economic ‘Coronage’ that is happening. With the advent of the novel virus spreading over to new territories with each passing day, global economic and corporate earnings forecasts are being revised sharply downwards.

On the global front, as an emergency response to any economic fallout from the epidemic, the Fed has announced a 50 bps rate cut on 3rd March. If the impact of the virus is not contained, central banks world over may follow suit. With the US elections not far away, a tax cut is also expected from the Trump government if the impact of the Coronavirus aggravates. Our allocation to Gold for many portfolios since 2016 has started to pay-off. The time may not be far away when we see US rates at near Zero and Gold crossing its previous highs and reach 2500 USD.

On the domestic front, the juggernaut has been hit hard, though with a delay. With the global interlinkages increasing and getting more substantial, we have no choice but to adapt to outside shocks affecting us. The current virus epidemic is yet another shock that will at a minimum have a temporary impact if managed well. And at a maximum, we tread into the unknown.

Certain industries such as auto manufacturing, and auto component industry may see tough times as raw materials inventory depletes in the next couple of months. On the other hand, due to the disruption in production of the chemical industry in China, Indian specialty and agrochemical players with global export footprints may benefit from a hike in international prices. Cool off in commodity prices will help improve margins for Industrial manufacturers, but the adverse impact of the virus on global demand might offset the benefit.

Markets may continue to experience volatility in the near term in such uncertain times.  Historically, whenever US Fed had to cut rates out of turn, i.e, inter-meeting, the year went on to be mostly turbulent. As we have highlighted earlier, this may provide mid & small caps better entry points than their larger counterparts for medium to long term investments, short term pain notwithstanding.

On the fixed-income front, the bonds have rallied, partially influenced by global softening of bond yields. Benchmark 10-year bond yield is at 6.18%, partially helped by the recent fall of US Treasury 10-year yield to 0.34% post a 50 bps Fed rate cut. RBI's stance on policy rate action remains accommodative, but action depends on the easing of inflation.

With less expectation from duration funds and credit space still being a cause of worry, any exposure to debt markets should be taken through short term to medium term debt funds with a non-negotiable high-quality portfolio.

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A longer pit-stop? - Alpha Edge, December 2019

Rallying on the record breaking FII flows, Indian markets have scaled new highs in the month of November even as Indian macro data continues to disappoint, both IIP & GDP numbers.

We sense that the stronger FII flows and catch up in corporate earnings that is underway, could probably give the markets a longer pit-stop than anticipated earlier. And we are closely watching.

While global economic data has not been deteriorating further, policy stance stays more than accommodating thus leading to a congenial situation for financial markets. Our medium-term expectations are based on continuation of policy support with a significant number of central banks turning dovish and cutting rates, prospects of fiscal support in select economies, cyclical uptick in manufacturing, and forward movement in US-China trade discussions.

On the domestic front, some sectors that have been contributing to large pools of losses appear to be on the mend now with corporate banks and telecom being two of the largest. However, a delay in the revival of domestic demand, a further slowdown in global economic activity and geopolitical tensions are downside risks.

On the markets front, the recent run-up has been very strong, but has also taken valuations closer to +2 standard deviation mark. With valuations once again hovering near its peak, we may see profit booking soon.

We believe that any declines hereon shall be seen as opportunities to invest for better returns in the next 2-3 years. As we have highlighted earlier, we continue to believe that mid and small cap provide relatively better entry points than their larger counterparts for medium to long term investments.

On the Fixed income front, RBI decided to keep the policy repo rate unchanged and continue with the accommodative stance 'as long as it is necessary to revive growth’, while ensuring that inflation remains within the targeted range. Given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture.

The bond yields have strengthened post corporate tax cut and have remained range-bound with a steepening bias. Government fiscal is under stress with tax revenues falling short, even as government tries to meet budget expenditure targets to support growth. This kind of coordinated response has increased uncertainty in the bond duration space.

We continue to believe that the term premium may remain elevated in the near term and any exposure to debt markets should be taken through short term to medium term debt funds with a high-quality portfolio.

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Halt in the March! - Alpha Edge, November 2019

In the last couple of years, we have experienced a significant polarization in price performance as a shrinking profit pool has led to investors herding into the safety of the select few companies that continue to grow at a reasonable pace.

Last Diwali to this, while the Nifty is up over 9.7%, the Nifty Midcap 100 and the Nifty Smallcap 100 indices are down over -6.5% and -9.5% respectively. The market breadth should improve as investment cycle revives and profit growth becomes more broad-based.

We have seen green shoots in the recent earnings season, and with the i) benefit of corporate tax cut to support earnings from next quarter onwards, ii) a lower base effect and iii) a reasonably better monsoon boosting rural demand, we may finally expect a revival in corporate earnings.

Globally, central banks are pumping liquidity to boost their economy, Fed has cut interests by another 25 bps, China and the US are inching closer towards an agreement on trade talks in a phased manner and the ‘Brexit’ is deferred until 31st January 2020. All these events have provided an adequate amount of tailwinds for emerging markets such as India.

However, the recent run-up has also taken valuations way above +1 standard deviation mark and markets may take a ‘Halt in the march’ from hereon, this pause will help participants to evaluate the changing trade dynamics and likely perception of investors, domestically and globally.

We believe that any declines hereon shall be seen as opportunities to invest for better returns in the next 1-2 years. As we have highlighted earlier, we continue to believe that mid and small cap provide relatively better entry points than their larger counterparts for medium to long term investments.

For Fixed Income, the near term growth-inflation dynamic along with an elevated term premium (premium of long-term bonds over short term bonds) should keep a ceiling on bond yields. Within corporate debt, polarization in favor of top quality continues as many others struggle to borrow. This may be a cause of concern, for now, however, an economic revival can change this eventually.

We continue to believe that the term premium may remain elevated in the near term and any exposure to debt markets should be taken through the short term to medium term debt funds with a high-quality portfolio.

Click here to read the report

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