Hope all of you are safe. The corona virus outbreak is likely to force a great reset of every assumption of human life and the equations amongst them - economic, financial and philosophical.
To begin with...we owe you an apology. Our market timing models did indicate an approaching possibility of correction which we shared with you vide our notes in Jan-March 2020. The underpinning of an impending correction was similar to those that prompted us to take a 30% cash call in 2015 March and Jan 2018. As we expected this round of correction to start from a higher Nifty level than at the time of communication, we had stopped at cautioning but not actioning. We deeply apologise for missing this particular opportunity to safeguard your portfolios.
Why did we miss by a whisker? Of the four factors that help us in our tactical asset allocations viz - earnings momentum, valuations, persistency and fund flows, we couldn’t anticipate the volte-face of FII fund-flows that abruptly halted, turned and bolted from the markets. The speed of FIIs and their algos that now run 70% of the world’s trading volumes is something we will learn to factor in due-course.
We have seen unprecedented level of volatility in global capital markets at the end of the FY 2020. In India, Nifty 50 was down by 23.2% MoM whereas Nifty Mid cap and Small cap bleed by 30.3% and 36.7% respectively.
Internationally, the US is all guns blazing through its 150 bps rate cut within a month and announcement of $ 2.3 trillion fiscal stimulus package to provide stability to economic activities during this period and ensure that the eventual recovery is as vigorous as possible. Once it is apparent that the global economy is headed for a severe downturn or recession, markets see the bulk of selling during the same periods when the Fed ramps up its policy response.
But as policy response globally achieves a critical mass and market valuations begin to reflect the new harsh reality of lost earnings, markets begin to form a bottom. During the 2008 crisis as well, particularly during Sept–Oct 2008, the market fell very sharply even in the face of a determined and coordinated global policy response. But, eventually, as the stimulus started to have an effect and market valuations became cheap, markets bottomed out.
In India, markets are reacting as much to the lockdown and its economic fallout as to the pandemic itself, with billions of people are being locked down in their homes.
A study on non-pharmaceutical interventions (NPI) such as lockdowns during the 1918 Flu pandemic across the US found that cities (such as San Francisco and Pittsburgh) that adopted lockdowns earlier and for longer not only had lower mortality, but also grew faster than others in the medium term. India therefore may have done the right thing by imposing a country wide lockdown earlier on but many head of states believe the period of lockdown need a further extension to ‘flatten the curve’ of incremental positive cases.
This has led to economic consequences such as supply and demand shock. Lock downs have not only bogged down the distribution of intermediate or final goods but have also changed the consumer preferences restricting it to basic essentials and the trend may continue in the near future. We believe that even post the lockdown, markets will have to navigate the pain of the crisis and its aftermath. Many industries will take longer to get back to normal production and distribution capacities, due to the exodus of migrant workers to their native places during the lock down.
With the country’s economic growth already on decline, the pandemic and the imposed lockdown will have a further impact on the economic activity and corporate earnings. The current TTM PE valuations at 20.5x on 9th April are still meandering near last 20 yr average of 20.2x and with near to medium term earnings visibility at risk, any extension to lockdown will call for further de-rating in valuations albeit the available liquidity due to quantitative easing.
With the ongoing rally, If Nifty reaches 9,500 levels which is the 50% retracement of the entire fall, we are likely to take a cash call of 30% to 50% proportionately across all equity investments.
For new allocations/surpluses, considering the extra-ordinary situation, asset allocation should reflect at least 2 years of liquidity requirements. For incremental investments in equities, we believe Nifty levels of 7,500 and below make equity investments very attractive on PE (@ -1 standard deviation) as well as yield gap (Earning yield – bond yield) basis.
We believe that sectors such as Pharma, FMCG and IT will be favoured over other sectors. Whereas, Industrial goods, Real Estate, Auto and auto ancilliary, Hotel and Hospitality will be less favourable due to the current lockdowns and change in consumer behavior hereon.
We would be closely monitoring the pandemic, corporate earnings, valuations and volatility in the equity markets for re-entry, if we experience stability/favourable conditions in any of the above factors.
For Fixed Income, Despite the policy intervention of RBI on 27th March, the yields across the curve continue to be at elevated levels due to recent state government borrowings of Rs. 1,60,000 Crores. Further, risk aversion and flight to liquidity have been prime reasons for investors to stay away from corporate bonds. This is in anticipation of continued lockdown and minimal economic activity in the near term. The 6 months to 3 year space on the yield curve looks very attractive with limited volatility.
Hence, we believe that exposure to the debt markets should be taken through short term funds for 1-2 years investment period and Banking & PSU debt funds for more than 2 years investment period. The corporate earnings are expected to be subdued amid the lockdown period and for the next couple of quarters. Hence, we continue to avoid credit risk even if the spreads are higher.
Stay Safe, Stay Healthy
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