Vijay Kumar Gaba

2021 – Market Outlook and Investment Strategy

The 2020th year of Christ is ending on a mixed note. Economically, socially & politically - the environment is filled with a myriad of emotions.

There is hope and anticipation of victory over pandemic and life returning to normal in 2021. Each piece of improvement in the economic data and healthcare statistics brings relief and stokes optimism. The wealth effect created due to higher asset prices is comforting people in more than one ways. The technological advancement and digitalization has made tremendous progress in past 12 months. The global effort towards climate change appears more promising than ever.

There is fear of new variants of Covid-19 virus disrupting the recovery effort and bringing the life to a standstill gain. There is widespread distress caused by the health and economic shock of pandemic. The people in numerous countries are unrestful as they resist increased state surveillance and struggle to manage numerous uncertainties confronting them. A massive leap in socio-economic inequalities is threatening to undermine the poverty alleviation efforts made in past three decades (since end of the cold war, liberation of East Europe, and economic liberalization in India, China & many other populous countries).

There is great deal of uncertainty as to the shape of the global order that would emerge from the shadow of the pandemic. How will Brexit impact the Europe? What would be the impact of a prolonged Sino-US cold war? What will be the end game for the profligate monetary and fiscal policies adopted by most states? How the normalcy will be restored in global monetary system? Will the supremacy of USD be finally challenged? Will neutral currencies (crypto or something else) become universally acceptable, or we will have cold war like trade blocks with their own respective dominating currency (for example, USD & EUR for one block; CNY for another block; and gold for the non-aligned)? Will the international borders closed to check the pandemic ever open fully? How many of the present businesses and industries will become redundant in post Covid-19 era?

In my view, the year 2021 may not provide many answers. To the contrary, as the year progresses, we may be faced with numerous other questions.

Insofar as India is concerned, I feel 2021 may mostly be continuation of 2019, with some added complexities and challenges. The country may continue to witness protests and unrest. People may continue to remain anxious and divided. The consolidation of businesses may continue to progress, with most small and medium sized businesses facing existential challenge. Disintermediation may also continue to gather more pace.

The normal curve for the economy may continue to shift slightly lower, as we recover from the shock of pandemic. A large part of the population may continue to struggle with stagflationary conditions, with nil to negative change in real wages and consistent rise in cost of living. Geopolitical rhetoric may also remain at elevated levels.

The Indian financial markets have faced lot of turbulence in past three years that may not be adequately reflected by the benchmark indices at all-time high levels. In the past 3months returns on investment portfolios may have been promising for most investors. Nonetheless, the confidence level is low and investors are mostly edgy about committing fresh money to financial markets.

With this umbrella view, my outlook for Indian markets is as follows:

Market Outlook - 2021

In my view, the stock market outlook in India, in the short term of one year, is a function of the following factors:

(1)   Macroeconomic environment

(2)   Global markets and flows

(3)   Technical positioning

(4)   Corporate earnings and valuations

(5)   Return profile and prospects for alternative assets like gold, real estate, fixed income etc.

(6)   Greed and fear equilibrium

(7)   Perception about the political establishment

1.   Macroeconomic environment - Negative

My outlook for the likely macroeconomic environment in 2021 is as follows:

(a)   Inflation: The consumer inflation may average around 5%, after the seasonal spike subsides and logistic disruptions get removed. The core inflation may remain weak and ease further during the year as raw material prices ease and wage correction gets over.

(b)   Fiscal Deficit: We may see relaxation in FRBM targets for FY22, as the government continues with the higher social sector spending and revenue lags the target. No significant rise in government investment expenditure may be expected. The systemic liquidity may remain surplus for first quarter of 2021 and gradually return to normalcy in second half.

(c)    Rates: Expect benchmark yields to average below 6% for the year. The next move of RBI would likely be a hike in policy rates. Deposit and lending rates may ease slightly more, before stabilizing or even trending upwards in late second half of the year.

(d)   Current Account: Expect current account balance to stay negative for most part of the year as imports begin to pick up. The deficit may average around 1.5% to 2% for 2021.

(e)    Savings: Household saving may grow at even slower pace as real wage growth remains poor. Aggregate corporate savings though may be higher due to continued deleveraging and rise in free cash flows.

(f)    Investment: The government investment expenditure may remain low due to higher allocation to social sector. Private capex is unlikely to see any meaningful recovery in 2021. Overall, investment growth may see marginal improvement from a low base and government incentives.

(g)    Exchange Rate: USDINR may average close to INR74/USD and move in 73-79 range.

(h)   Growth: Indian may attain higher overall real GDP Growth rate of 11 to 13% in 2020, as benefits of low base, government incentives and policy reforms kick in.

To sum up, the domestic macroeconomic factors may not be materially supportive of stock market in 2021, despite lower rates.

2.   Global markets and flows

Unlike 2020, there is little divergence in the analysts' and economists' views about the global macroeconomic outlook for 2021. The consensus overwhelmingly supports superior growth with emerging markets leading the way.

In my view, the global markets are likely to see higher volatility, as they continue to adjust to the expectations of normalized monetary policies and prolonged period of lower growth. The export based economies of Asia and Latin America will continue to face challenges as demand growth in US and Europe remains slow and Sino-US trade relations remain far from normal. I shall not be worried about any hard landing or financial collapse in global markets, though the situation in Europe does require a closer watch. Expect emerging markets to fare better than their developed peers. Significant yield differential could encourage higher flows into emerging markets in first half of the year.

3.   Technical Positioning

Technically, in my view, the benchmark indices are ripe for a major correction. We may see the volatility spiking in first half of the year as the correction sets in. The second half might see a slow grind down.

Like 2020, Nifty may move in a very large range this year also. On the downside, it may trade in 9365-10140 range. The upside though appears limited to 14117-14700 range. The risk reward balance therefore is clearly negative at present.

4.   Corporate earnings and valuations

The 68%+ gain in benchmark indices during 2017-2020, is mostly a function of PE re-rating; for corporate earnings have shown little growth in this period. Moreover, whatever improvement in earnings is seen, it could be mostly attributed to cost savings (especially financing cost and raw material advantage) and capital reduction (buy backs). There is little evidence of improvement in pricing power or significantly higher productivity of capital. RoEs have in fact declined in past three years.

In my view, the PE re-rating cycle may be mostly over. Any improvement in equity returns from this point onward will have to be driven entirely by earnings growth. The corporate fundamentals would need to show material improvement over next 9-12 months to sustain the present valuation levels.

The current implied earnings growth over FY22 is well over 28%. Even if we can manage this kind of earnings growth (not my base case) due to very low base (almost no growth for over 4yrs now), FY23 could be a challenge. I therefore expect a PE de-rating in CY2022 when the interest rates would begin to normalize.

IT, Insurance, Healthcare and large Realty are the sectors that look positive for 2021. Amongst others, agri input may continue do well as food inflation drives higher spending power in the sector.

5.   Alternative return profile

Real estate: Real estate prices may continue to rise in 2021 as the interest rate and government policies may remain supportive for most part of the year.

Gold: Gold may continue to remain in favor as a strong safe haven asset during 2021. Though the prices may not see material up move.

Fixed income: It is reasonable to expect fix income returns to remain in 5-6% range, as liquidity remains easy and credit demand does not pick up materially. The yield gap that favors equities presently may however not sustain for long in 2021.

Overall, in my view, the return profile of alternatives is neutral for equities.

6.   Greed and fear index

Historically, the most successful, though intuitive, indicator of greed overtaking the fear in market is outperformance of small cap stocks over large cap stocks.

The sharp outperformance of broader markets in 2H2020 indicates that greed has made a strong comeback in Indian markets. There is little to suggest that the sentiments may change in next couple of months. The Greed and Fear balance therefore is unfavorable presently. I expect the broader markets to underperform overall in 2021, with most of the underperformance coming in the later part of the year.

7.   Perception about the political establishment

The recent tendency of aggressively pushing for economic reforms; responding strongly to the geo political challenges; and divergence of Covid-19 cases from global trend has turned the public perception about political establishment favorably. A better show in impending West Bengal and Odisha elections may further improve it. For 2021, therefore  expect the political conditions to remain mostly a positive factor for the markets.

Outlook for Indian markets

In view of the positioning of the above seven key factors, my outlook for the market in 2021 is as follows:

(a)   NIfty 50 may move in a large range of 9365-14700 during 2021. It would be reasonable to expect + 5% return for the year for diversified portfolios. Focused and thematic portfolios could return materially higher yield in 2021.

(b)   The outlook is positive for IT, Insurance, large Realty, healthcare agri input, and consumer staples, and negative for commodities, services and consumer finance. For most other sectors the outlook is neutral.

(c)    Benchmark bond yields may average below 6% for the year.

(f)    Residential real estate prices may show a divergent trend in various geographies, but may generally remain strong. Commercial and retail real estate may also see some recovery.

10 key risks to be monitored for the market in 2021

1.    Relapse of pandemic due to virus mutation or inadequacy of vaccine, leading to a fresh round of mobility restrictions.

2.    Worsening of Sino-US trade relations leading to cold war like conditions.

3.    Material tightening in trade, technology, and/or climate regulations in India and globally.

4.    Hike in effective taxation rate to augment revenue.

5.    Material escalation on northern borders.

6.    Prolonged civil unrest.

7.    Stagflation engulfing the entire economy, as inflation stays elevated and growth fails to meet the expectations.

8.    More exits from EU.

9.    One or more Indian states failing to honor its debt.

10.  Material rise in bank NPAs after forbearance ends.

I do not see hyperinflation as one of the key risks in 2021.

2021 - Strategy

Asset allocation

2021 may be one of the most difficult years for investors, in terms of high volatility, poor expected returns from diversified portfolios and continued low return expectations from cash and debt. In view of this, I shall increase the flexibility of my portfolio. I shall keep 30% of my portfolio as floating, while maintaining an UW stance of equity and debt.

Large floating allocation implies that I shall be trading actively in equity.

(a)   The fixed equity allocation would be 40% against 60% standard.

(b)   The fixed debt investment would be 20% against 30% standard.

(c)    I would park 10% in cash/money market funds.

(d)   30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for 2019 would be ~8%.

Equity investment strategy

I would continue to focus on a mix of large and mid cap stocks. The criteria for large cap stocks would be growth in earnings; while for midcaps it will be mix of solvency & profitability ratios and operating leverage.

(a)   Target 6% price appreciation from my equity portfolio;

(b)   I shall be overweight on IT, Insurance, Healthcare, Agri input and large Realty stocks.

(c)    For trading I will focus on large cap liquid stocks.

Miscellaneous

I have assumed a relatively stable INR (Average around INR74/USD) and slightly higher short term rates in investment decisions. Any change in these assumptions may lead to change in strategy midway.

I would have preferred to invest in Bitcoin, but I am not considering it in my investment strategy due to inconvenience and unease of investing.

Factor that may require urgent change in strategy

·         Material rise in inflation

·         Material change in lending rates