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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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