Monday, December 20, 2021

Crystal Ball: What global brokerages are forecasting for 2022

 Manulife Investment Management – Disruptive tightening and China key risks

Monetary policy—Global central banks are sounding more hawkish—U-turns from the Bank of England (BoE), policy adjustments from the European Central Bank (ECB), a Bank of Canada (BoC) that’s actively tapering, and a U.S. Federal Reserve (Fed) that’s set on winding down its asset purchase program. While our base-case expectation is that the market will be able to absorb these tightening measures if they’re implemented gradually, it’s still worth noting that:

• Global liquidity is declining, which has historically been problematic for growth

• If real interest rates climb too quickly, it can derail the equities market (as it traditionally has done), particularly as rates approach 0%

• The current environment creates scope for policy miscommunication that could create volatility in global interest rates and currency markets

The downside risks in the coming quarter are most concentrated in China, where the delayed effects of policy tightening (credit, monetary, fiscal, regulatory) are likely to continue to weigh on growth, perhaps a little more than expected or had been intended. We also expect broader regulatory clampdowns to persist through 2022. Unsurprisingly, investor sentiment toward China remains negative.

Crucially, we believe China isn’t well positioned to tackle risks associated with a stagflationary environment. Chinese macro dynamics will continue to be an important market driver in the months ahead, although it’s perhaps fair to say that investors have a better read of the situation now than they did in early 2021.

Invesco – 2022: A year of normalization

Expect global growth to normalize, remaining above its long-term trend but decelerating to a more sustainable rate as fiscal stimulus is gradually removed. We anticipate that inflation will peak in mid-2022 and then start to slowly moderate, backing down toward target rates by the end of 2023 as supply chain issues resolve, vaccination levels increase, and more employees return to the workforce. We look for the Federal Reserve (Fed) to remain patiently accommodative, with a rate lift-off in the back half of 2022, although other developed countries’ central banks might act more quickly. Finally, we expect volatility will increase as markets digest the transition to slower growth and a gradual tightening in monetary policy.

Bank of America – Markets to peak in 1Q2022

Global liquidity – the key predictive driver of global equity markets since the Global Financial Crisis – is on course for a peak out around March 2022. G-4 central banks’ balance sheets to expand by another USD750bn by that time (from USD30.7trnow to USD31.4trin Mar-22) and then peak out. Markets are likely to reach a high around the same time and then meander around aimlessly, probably with a downward bias as the earnings cycle in China surprises very negatively and the USD remains strong. Measure of global free liquidity – the gap between G-7 M2 and nominal economic growth – suggests a similar timeline.

The earnings cycle in many Asian/EM countries reliant on the Chinese economic cycle might also disappoint – unless, of course, we see a substantial credit easing in China soon, which does not seem to be likely.

Morgan Stanley – Normalization but not back to normal

Strong global inflation for now, but receding next year.

Global GDP to reach the pre Covid path by end 2022

EM central banks started tightening in 2021, DM central bankers to follow in 2022.

EM currencies to keep wakening at same pace as in 2021 and EM local currency bond yields to peak by middle of 2022.

Nomura - Supply constraints to morph into an export-led demand downturn in Asia

The emergence of the Omicron variant has increased uncertainty, but we see Asia’s bumpy upcycle extending into early 2022. Our bigger worry is demand. We expect an export growth downturn to begin from mid-2022 and are more circumspect on the rotation into domestic demand.

The inflation rate will likely edge higher, but the underlying theme will remain one of benign inflationary pressures and gradualism on monetary policy normalisation. Alongside an export downturn, high debt and scarring effects, we see lower terminal policy rates in this cycle.

China: We expect economic growth to slow sharply to a below-consensus 2.9% y-o-y in Q1 2022 and 3.8% in Q2, before Beijing’s pain threshold is triggered.

India: Higher CPI inflation will trigger faster policy normalisation (100bp, even as scarring effects weigh on growth starting from mid-2022.

Korea: Japanification risks are rising. We expect growth to disappoint, the BOK’s rate hiking cycle to end in January and two rate cuts to ensue in 2023.

ING Bank – Another difficult winter for Eurozone

Even before the appearance of the Omicron variant, the number of Covid-19 infections in the eurozone was rising rapidly, pushing several member states to reintroduce containment measures, with Austria even returning into full lockdown. As we expect more countries to tighten measures, growth is likely to slow significantly in 4Q and 1Q 2022, with a negative growth figure in one quarter not impossible. But on the back of booster shots and antiviral drugs, a strong recovery might follow, potentially leading to 3.8% growth in 2022.

Inflation is expected to drop below 2% towards the end of 2022, with the average for the entire year staying above the ECB’s target. As the medium-term inflation outlook has become more uncertain, the ECB is likely to be more cautious in its forward guidance. The Pandemic Emergency Purchase Programme will end in March, but a small transitional programme could be introduced to smooth the tapering process. We now see a first rate hike at the end of the first quarter of 2023.

UBS – Discovering the new normal

Financial markets face a Year of Discovery, as we find out what “normal” rates of growth and inflation look like, and how economic policy responds, after two years dominated by the effects of the pandemic. It will be a Year of Discovery for many individuals, too, as we rediscover lost pleasures while considering the enduring impact of the pandemic on our lives, goals, and values. The year ahead presents an opportunity to align your portfolio with the key trends impacting our world, and with what matters most to you.

We expect currently elevated rates of inflation to subside over the course of 2022, as supply-demand mismatches resolve, energy prices stabilize, and labor market frictions ease. This should be supportive of equities, by alleviating risks to corporate margins and reducing the likelihood that interest rates will need to be  hiked quickly. Nonetheless, the process of discovery of a new balance between supply and demand will create uncertainty that investors will need to navigate.

World economic growth may remain well above trend in the first half of 2022, followed by normalization in the second half, as reopening completes, excess savings are spent, and emergency stimulus measures are withdrawn.

We start the year with a positive stance on equities, and particularly the winners from global growth, including Eurozone stocks, though slower growth over the course of 2022 should also start to favor healthcare, a defensive sector. Low rates, yields, and spreads speak in favor of a continued hunt for “unconventional” yield. We also have a positive stance on the US dollar. Looking longer-term, we see opportunity in disruptive technologies—artificial intelligence (AI), big data, and cybersecurity—and in investments related to the net-zero carbon transition.

Economy – Uneven recovery to pre-pandemic levels, accelerators missing

The latest macro data indicates that the Indian economy may be standing at an inflection point. Having survived a major accident in the form of Covid19 pandemic, the economy looks stable, having progressed well to reach closer to the pre Covid level of activity. Of course, for next few quarters the economy may still need to use the support of government spending, before the virtuous cycle of higher investment and consumption kick starts.

Post pandemic, the challenges before the government are multifold; and so are the opportunities. A successful resolution of these challenges could trigger a virtuous cycle of growth and catapult the economy to the higher orbit. A failure may not be an option, as it could cause a disaster of unfathomable proportion.

Besides, merely achieving a full ‘V’ recovery to the pre pandemic level of economic activity will be inadequate, since pre pandemic the economy was slowing for many years and was completely unable to generate adequate jobs for the burgeoning youth population. The government will need to apply multiple accelerators for the sustainable growth to reach to the target of 8% plus.

The pandemic has widened the divide in the society, as the recovery so far has been rather ‘K’ shaped. Income and wealth inequalities have widened. Disparities in access to digital infrastructure have amplified the divide in social sectors like healthcare and education. The gap between organized and unorganized sectors has enlarged materially. To maintain harmony and peace in the society, these gulfs would need to be managed.

As per a study done by the Azim Premji University scholars, “one year of Covid-19 pandemic has pushed 230 million people into poverty with a 15 per cent increase in poverty rate in rural India and a 20 per cent surge in urban India."

CMIE data showed that “the unemployment rate has gone up as high as 12 per cent in May 2021, 10 million jobs have been lost just on account of the second wave and 97 per cent of the households in the country have experienced declines in incomes”.

The labour force participation rate was at 40.22% in the period between May-August 2021, according to latest data by the CMIE. It has remained at about 40% since the start of the pandemic, compared to about 43% before it. This is the lowest the labour force participation rate has been since 2016, when data was first compiled.

Exports, one of the key growth drivers, have persistently failed to deliver in past one decade. There is no sign of any major improvement in exports, especially when the global growth has already plateaued after post pandemic push. Considering that India’s capex is closely related to exports and global trade, the probability of any material pick up in private capex appears slim.

Poor export growth and high petroleum and gold imports have resulted in sharp increase in trade deficit for India. Consequently, INR has come under pressure. USDINR is its weakest level now and looking even more vulnerable given its outperformance vs EM peers in past one year.

Persistent food and energy inflation is key concern, though other industrial input prices have shown signs of stabilizing. Given the poor wage growth for semi-skilled and unskilled workers, a large part of the population is reeling under the impact of stagflation, hurting the consumer sentiments. Consumption slowdown is one of the key economic concerns currently.

The best thing for Indian economy is that the government has sufficient fiscal leverage available to accelerate the investments. At Rs5.5bn the FY22e gross fiscal deficit is lower than the pre pandemic years. The April-October 2021 fiscal deficit is just ~36% of budget estimates. The government has thus gathered enough ammunition by adhering to higher duties on fuel and lower revenue spending to manage its fiscal balance. Buoyant revenue and aggressive disinvestment may help in improving it further.






Valuations – Elephant and blind men

The valuations of Indian equities, or the global equities in general, has become subject of intense debate, with participants analyzing the markets with personal biases and prejudices.

A variety of models, methods and timeframes are being used to justify the current valuations as reasonable, or reject these as unsustainably high. Many analysts have preferred to ignore the aggregate valuations and adopted different yardsticks for various classes of businesses.

Given that the benchmark Nifty has close to 38% weight of financial services, it may not be appropriate to give undue consideration to the aggregate PE ratio of the index for benchmarking the “market” valuation. Some analysts prefer to use global indices (e.g., MSCI India Index) to assess the valuations of Indian equities.

Many new age businesses which are solely focused on revenue growth and may not be profitable in short to mid-term. For these businesses applying the conventional valuation methods might not be appropriate.

Nonetheless for reference purposes, on conventional parameters, post the recent correction, the valuation of Indian equities may be marginally higher than the long term (10yr) averages, and do not appear to be a cause of significant concern.

However, midcap valuations relative to large cap is high; India PE premium over global PE is still quite high, and the risk premium (Equity yields vs Bond Yields) is very low. Therefore, the upside in short term may be limited.




2021: Indian Equities - Nothing to complain

 The Indian equities performed decently in 2021. Investors would normally have nothing to complain about the returns on their equity portfolios.

·         The benchmark Nifty is up ~21% YTD2021. It is 6th consecutive year of positive return on Nifty. Nifty has now returned positive return in 9 out of past 10years (2012-2021).

·         Nifty has averaged 15881 (based on daily closings) in 2021, which is 44% higher than the same average for 2020. Based on change in average, this is best performance since 47% gain in 2006; implying strong returns for SIP investors.

·         For long term buy and hold investors, five year rolling CAGR in 2021 is ~15.7%, which is best performance since 2013. Five year absolute Nifty return in 2021 is ~107%, also highest since 2013.

·         The market returns were fairly broad based in 2021. Smallcap (~56% YTD2021) and Midcap (~44% YTD2021) have done significantly better than Nifty (~21% YTD2021). Broader market indices are now outperforming the benchmark Nifty on 3yr and 5yr basis. The household (retail) investors investing in diversified portfolio have also therefore recouped the underperformance of 2018-19.

·         Nifty has outperformed most of its emerging marker peers in 2021; and has performed in line with the top performing major global markets US and France.

…but some concerns emerging

In recent weeks however the market has given some cause for concern that have clouded outlook for the year 2022. Having quickly recovered all the losses from panic reaction to the pandemic, and moving about ~50% higher than the pre pandemic Nifty highs of ~12500, the Indian equity markets now appear tired and indecisive.

·         After topping ~18600 in October 2021, Nifty is not back to ~17000 level, where it was in August 2021. However, during this 3200 odd point up and down journey of Nifty, the actual outcome might be very different for various investors, depending upon their portfolio positioning and activity during this period. Considering that the daily volumes were highest around the peak level of October 2021, it is likely that some investors got greedy at the peak and invested larger amount in mid and small companies. They may have lost 10-25% of his latest installment of investments.

·         In 4Q2021, Nifty has averaged over 17800, against the current level of ~17000. A large proportion of stocks are trading below their technical key levels, e.g., 200DMA, indicating underlying weakness in markets.

·         The market breadth has been consistently negative since August 2021.

·         Indian markets have outperformed most of the global peers in past 20months. The global investors are now looking at the underperforming markets in search of better returns. Many global brokerages like Credit Suisse, Morgan Stanley, CLS, Goldman Sachs etc., have downgraded the weight of Indian equities in their portfolios to allocate more to China etc. The global flows to India may therefore slow down further. Foreign investors have been net sellers in secondary markets for past many weeks.

·         RBI has started to normalize the excess liquidity through variable rate reverse repo auctions of 14-day and 28-day. Currently, INR6tn/INR8.6tn excess liquidity is being absorbed through VRRR auctions. Going ahead, the RBI plans to increase the amount and tenor of absorptions through VRRR. This could impact the cost of borrowing for market participants and therefore impact the market sentiments.

·         Despite recent market correction, greed continues to dominate fear and household flows remain strong. The probability of a sharper correction in broader markets therefore remains decent.







Saturday, December 11, 2021

RBI stays committed to growth

 In its latest policy statement, RBI has reiterated its unwavering commitment to growth, ignoring the concerns about it missing the inflation curve. There are not many precedence in past two decades when the RBI has shown such unwavering commitment to growth despite mounting inflation concerns and global tightening pressures.

The decision of the Monetary Policy Committee of RBI to maintain status quo on policy rates and keep the policy stance “accommodative” despite mounting inflationary pressures has provided some relief to the financial markets. However, it has divided the experts on the mid-term economic impacts.

The bankers have generally welcomed the RBI’s policy stance as credit and growth supportive. However, economists believe that this leniency on inflation may not end well. They believe that this profligacy of RBI will leave it much behind the curve and force it to make disruptive tightening in mid-term.

There are some questions over the autonomy of MPC also. A small section of analysts believes that the government may have hijacked the MPC agenda, forcing it to ignore its primary mandate of price stability; and support the government through continuing monetary stimulus.

In my view, the monetary Policy Committee (MPC) and RBI have taken the most appropriate path by staying focus on growth.

There is no conclusive empirical evidence available to indicate that RBI has been able to influence prices through monetary policy. On the other hand, the monetary stimulus (lower rates and accommodative liquidity) has invariably shown positive results. This is particularly true in episodes of inflation with negative output gap, implying underutilization of capacities.

There are ample indications to suggest that RBI is working in close coordination with the government. Sharp cut in duties on transportation fuel 2 weeks ahead of MPC meet shows that the government is addressing the RBI concerns on prices.

RBI’s lower inflation forecast for next quarter, when the US Federal Reserve Chairman has indicated that the inflation may not be transitory as believed earlier and OPEC’s resolve to maintain prices around present levels, further indicates that RBI is comfortable with the government’s assurance to reign energy prices.

The latest Monetary Policy Statement of MPC also does not seem to concur with the US Fed assessment on inflation. It continues to believe that inflation is transitory and it will ease in next few months.

To summarize, RBI has made it clear that the monetary policy shall remain consistently growth supportive for next many quarters. It will wait for conclusive evidence on stabilization of growth trajectory before changing its policy stance. Any changes till then will be implemented by managing the liquidity through open market operations.

The governor highlighted in his press statement that “the Reserve Bank has maintained ample surplus liquidity in the banking system to nurture the nascent growth impulses and support a durable economic recovery. This has facilitated swifter and more complete monetary policy transmission and the orderly conduct of the market borrowing programme of the Government. The Reserve Bank will continue to manage liquidity in a manner that is conducive to entrenching the recovery and fostering macroeconomic and financial stability.”

 

Market Democratization needs renewal with affirmative agenda

 It was a sunny afternoon in winters of 1991. I was enjoying coffee at a famous public café in Connaught Place (New Delhi) with couple of my friends. All of us were waiting for our CA Final result, which was to be announced in couple of weeks. My friends were senior to me and were already working, having completed their articleship two years ago. We were discussing the economic changes that were getting unleashed in the country by the new regime that had assumed office a few months ago.

The economic changes had not impacted me in any positive manner by then. INR devaluation had led to inflation spike disturbing our household budget. Some of my close relatives who were running micro and small industries (then called SSI) were deeply worried about sustainability of their business as they were now exposed to competition from larger businesses and imports. My cousins had their own set of worries. The implementation of Mandal Commission recommendation was reaffirmed. The competition to get government jobs and admission into public educational institutions had intensified for general category candidates. The aftershocks of former Prime Minister Rajiv Gandhi’s brutal killing, gulf war, Punjab terrorism, were still being felt in Delhi. Overall things were not looking great from where I was standing that afternoon.

My friends who had started investing in stocks were however in high spirits. They had earned very good profits by trading. Their employers had promised them promotions if they pass their final exams. They already had a new Idol in (now infamous) Harshad Mehta to look up to. That afternoon, they could not see anything wrong. Arguably, this was their best time in life.

Our discussion was obviously not harmonious.

About an hour later, a middle aged man with very ordinary personality entered the scene. Tarun, my friend, excitedly jumped out of his seat to greet him. “Meet Mr. Hemant Pandey, my stock broker. Hemant ji advices me and also helps in executing my trades at Delhi Stock Exchange. He also knows brokers who can execute trade at BSE”, he proudly introduced the man to us.

And here begins the story.

On enquiry, I found that Hemant, a college dropout, was an “authorized agent” of a “sub-broker” of DSE broker. A friend of his friend was a remisier (a person authorized to go on trading floor) of a broker at BSE. He was therefore able to place orders of his “clients” to brokers at DSE and BSE. Though it could usually take upto 4 days to execute a trade and get confirmation of trade. The brokerage charged ranged between 2% to 5%; and only “market price” orders were acceptable. Delivery of physical share certificates with a valid transfer deed was not guaranteed. It was mostly on “best effort” basis.

That was the situation of Indian financial markets when the liberalization started 30years ago. Having direct access to a stock brokers’ office was sufficient to make someone “important” in his/her social circle. Something similar to if you have direct access to a Minister’s office today.

The people in their 20’s and 30’s who are spammed daily by multiple brokerages to open a trading account at zero brokerage, would never be able to fathom what it was like to be a stock trader or a “retail investor” in pre 1994 days.

Democratization of financial market is one of the most understated reforms of past three decades. The impact of democratization of society in past three decades is visible in almost every sphere. People belonging to the bottom of the pyramid have done particularly well in politics, administration, sports, entertainment, business & professions and science.

However, the easy and free access to financial and banking services has been the most remarkable achievement. Financial inclusion, as we call it popularly, is one of the core pillars of the entire socio-economic development endeavor in past three decades. Technology (especially digitalization) and Telecom Infrastructure are two other strong pillars which have supported the financial inclusion as well.

The tendency to overregulate is one of the undesirable aspects of modern democracy, as it promotes chaos, rebellion and anarchy. Since, the global financial crisis we have witnessed this tendency to overregulate dominating the financial markets also. As a natural corollary, the chaos (heightened volatility), anarchy (unassimilated assets trading at unfathomable valuations) and rebellion (rejection of conventional wisdom in favor of untested experimental ideas) is also prominently visible in markets. May be time is approaching fast when the democratization of financial markets that started three decades ago would also need an affirmative agenda for renewal.

Like Robinhood Markets of US, which pioneered commission-free investing model which allowed many people to start investing, including those who otherwise would never have ventured into stock markets, many platforms have emerged in India also. Zerodha, for example, is now the largest stock trading platform in India in terms of number of clients.

There are multiple platforms for trading of unconventional financial products like cryptocurrencies (e.g., Bitcoin) and Non-fungible tokens (NFTs).

Advent of new technologies, new products, new set of investors, new methods of valuations and different risk profiles perhaps require a fresh approach to the financial markets regulatory framework.

So far the regulators and governments have adopted an incremental approach for regulating the emerging developments in financial markets. This is apparently resulting in overregulation, misregulation, rebellion and chaos.

Margining and disclosure norms which are not in synch with the current market realities; abundant trading in unregulated (grey) markets; mushrooming of unregulated crypto & NFT exchanges and platforms; participation of large number of individual investors with inadequate financial literacy and risk tolerance etc. are some of the problems that are plaguing the markets.

Some of the problems that may require a totally new approach to regulations could be illustrated as follows:

·         Under pressure from market forces, the market regulator SEBI has been forced to defer the implementation of proposed tighter margining norms.

·         The managements are disclosing so much irrelevant and redundant information to the market, on the pretext of regulatory requirement. The relevant information many a times is getting lost in this overwhelming deluge of redundant information.

·         There are numerous cases of offer for sales (in guise of initial public offers) where the existing investors have exited at apparently unjustifiable price. The managers of these issues owe no accountability to the gullible investors who may lose substantial money.

·         Trading in new assets (Cryptos, NFT etc.) so far is unrestricted. There are numerous traders who may not be adequately skilled to understand the risks. There is no visible effort from regulators so far to improve the literacy and awareness level of these traders. It is therefore desirable that for the time being the trading is restricted to the discerning traders only.

President Biden stated on the International Day of Democracy, “No democracy is perfect, and no democracy is ever final. Every gain made, every barrier broken, is the result of determined, unceasing work.” He has made it clear that renewing democracy in the United States and around the world is essential to meeting the unprecedented challenges of our time. He brought the global leaders from government, civil society, and the private sector together to a global democracy summit, to “set forth an affirmative agenda for democratic renewal and to tackle the greatest threats faced by democracies today through collective action.”

It is imperative that this principle is applied to the financial markets also. The promised new code for the regulation of financial markets must take a fresh approach to regulation rather than adhering to the usual incrementalism.

Saturday, December 4, 2021

Are Foreign Portfolio Investors (FPIs) dumping Indian securities?

The media headlines are implying that the foreign investors have been incessantly dumping Indian equities; and this could be one of the primary reasons for currently ongoing correction in the equity prices.

Though there is no evidence of any strong correlation between Nifty and foreign flows over medium to long term (3 months and beyond); these flows have been seen increasing the volatility in near term.

In particular, if the correction in prices is sharper, the selling by foreign investors is highlighted prominently, adding to the nervousness of the non-institutional investors. It is therefore important to know the actual trend of foreign flows; and analyze whether the selling is part of any structural change in their view or just a trading tactics to enhance their return.

The market participants, who track the daily foreign flows closely and get influenced by the provisional net flow data released by SEBI every evening, must note that—

·         “Foreign portfolio investors” (FPIs or FIIs) is not a uniform class of investors. This includes a variety of overseas investing entities with divergent investment objective, horizon, and strategies. These include, pension funds having a very long term horizon; hedge funds and alternative investment funds with short term investment horizon; dedicated India funds which raise money from individual investors for investing in India only; emerging market funds which invest in all emerging markets including India; ETFs which track benchmarks like MSCI Emerging Market Index; MSCI India Index; iShare Asia ETF; iShare EM Dividend ETF etc.

All these overseas investing entities usually do not act in unison and mostly have different approaches to investment. Their universe of stocks to invest could also be different.

·         The provisional data of FPI net flows, released everyday evening by SEBI does not represent the actual net FPI flows into India. This is just provisional data of net flows into secondary markets as reported by the custodians to SEBI. The real net flows include investment in primary market and debt securities also.

·         Many FPIs just run an arbitrage or long short book. They take self-cancelling positions in equities of various regions (e.g., Europe vs Asia), categories (e.g., emerging vs developed), countries (e.g., ndia vs Indonesia) or segments (e.g., cash vs derivative) to take advantage of short term trading opportunities. Their positioning usually does not reflect their fundamental view on a country, region, or category.

·         Forex rates could be an important consideration in many FPIs’ investing strategy. Thus, many a times net foreign flows could be influenced by FPIs view on INR exchange rate rather than the equity valuations.

·         Selling by FPIs does not necessarily mean outflow from the country. Many times, it is just an asset allocation call between equity and debt; a short term tactical trade; or sale in secondary market to buy in primary market.

An analysis of the trend in FPIs flows for past 10years, and in particular, since the first lockdown (March 2020) due to Covid-19 pandemic, highlights that FPIs have remained consistently positive on India. Despite multiple downgrades of Indian equities by global brokerages like Morgan Stanley, CLSA, Credit Suisse, Goldman Sachs etc., no significant selling has been seen so far. Though, on relative basis the flows to India as compared to other emerging markets might have slowed in past few months.

It is pertinent to note that the sovereign rating upgrade by the global rating agency Moody’s a few months earlier also did not have any noticeable impact on the foreign flows into Indian securities – equity or debt.

In fact, the domestic institutions have invested significantly lower amount in Indian equities in past 10yrs as well as during the period since March 2020, as compared to the net flows of foreign investors.

The following are the key data relating to the foreign and domestic flows:

FPIs’ risk reward is different from Indian investors

In past one decade, Nifty 50 has yielded a return of 215% in INR terms. However, USD denominated Nifty 50 has returned less than half (~106%). The USDINR exchange rate has deteriorated from Rs53/USD in December 2011 to Rs75/USD presently. The yearly average exchange rate of USDINR in past 10years has been Rs66.7/USD. The risk reward of overseas (USD) investors there is very different from Indian (INR) investors. They have to manage the currency risk, in addition to the market and business risks of Indian equities.

 


FPIs investment in Indian equities consistently more than DIIs

In past 10years, the net investment of overseas investing entities has been mostly higher than the investment made by domestic institutions. Even during the Covid period (since March 2020) FPIs have invested more than the domestic institutions.

In past 10yrs, FPIs have invested a net amount of Rs7.15trn in Indian equities, as compared to Rs2.07trn investment made by domestic institutions. Since March 2020, FPIs have invested a net amount of Rs2.08trn in Indian equities, as compared to Rs26.6bn net investment by domestic institutions.



40% of FPI equity investments are in primary market

Over past 10years, FPIs have net invested Rs7.15trn in Indian equities. Out of this, Rs2.92trn has been invested in primary market and the balance Rs4.23trn in secondary market. On net basis, FPIs’ flow have been negative only once in 2018. However, if we consider secondary market alone, FPIs have been net sellers in 3 out of past 10 years, i.e. 2015, 2018 and 2021.



FPIs sold Indian debt in 2021 despite rating upgrade

FPIs have invested Rs1.69trn in Indian debt securities in past 10years. Since March 2020, they have net sold Rs921bn worth of Indian debt.

The lower FPI investment in debt, despite high yield differential with developed markets, could be a matter of concern. Lower rating and lower FPIs quota in government securities could have been couple of many reasons for the low interest in Indian debt. However, even a rating upgrade few months ago and materially increase in quota during past few years has not resulted in flows into Indian debt securities.

Interestingly, FPIs have been net sellers of Indian debt in 5 out past 10 years.

 


FPI flows and Nifty poorly correlated

As mentioned above, FPI net investment is significantly larger than the domestic institutions’ net investment in Indian equities. However, there is little evidence to indicate that FPI flows materially influence the market direction over a longer period. Even on monthly basis the correlation between FPI flows and volatility is poor.

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Conclusion

FPIs are not a uniform class of investors. However, collectively they have been positive on Indian equities for long. There is no evidence to indicate that they are dumping Indian equities or causing unusual volatility in Indian markets. The headlines like “Foreign Investors dumping Indian Equities” therefore are best ignored. As per Prime Database, FPIs are presently invested in 1370 listed companies in India, an all-time high number. It would therefore not correct to say that FPIs invest in only a specific set of stocks; or only large cap stocks etc. Also, presently FPIs hold ~21% of all NSE market cap as compared to ~7.3% for all mutual funds in India. Thus after promoters (~51%), FPIs collectively own the largest share in listed Indian companies.

Services and exports drive growth; consumption a worry

 India’s GDP grew 8.4% yoy in 2QFY22, ahead of most estimates. RBI had expected the GDP to grow 7.9% last quarter. This better than estimated growth is some relief at times when worries about worsening of Covid-19 conditions.

The growth was largely driven by Agriculture (4.5%), services including construction (9.9%) and exports (19.6%). Manufacturing growth (5.5% yoy) was below estimates, dragging down the overall industry sector growth to 6.7% yoy. While all segment of services grew at a decent pace, public services and defence were the largest contributors, growing 17.4% yoy.

Business sentiments are at multiyear high, but consumer sentiment is not improving. The household outlook on income is still below pre covid level.

The government has done a good job in managing the fiscal conditions. Subject to the government completing the promised disinvestment, the FY22 fiscal picture may be much better than the budget estimates.

The Covid management is performing very well, with the number of infected people falling to 18month low level. The vaccination program is also progressing well. The new Covid variant has certainly created some uncertainty, but as of now it does not appear that we shall see prolonged and/or extensive mobility restrictions in domestic area.

Pandemic wasted two years of growth

Statistically speaking, FY22 GDP may end up close to FY20 level, registering almost no growth for two years. In fact, 1HFY22 real GDP is about 4.5% (Rs3.17trn) less than 1HFY20 GDP. The nominal GDP of 1HFY22 is just about 7.3% higher than 1HFY20 nominal GDP.

More notably, the contribution of manufacturing; construction; trade, hotel, transport, communication; financial services, real estate & professional services etc., in 1HFY22 is lower than 1HFY20.

The latest macro data, e.g., GST collections, PMI, mobility indicators, labour participation rate, etc. indicates that the momentum has continued in 3QFY22 also. If the concerns about Covid-19 subside in next few weeks, Indian economy may record over 9% yoy growth for full year FY22; and we may achieve the FY20 level of GDP, even though the recovery may continue to be skewed and driven by government expenditure and external trade.

Consumption continue to lag behind

Both private consumption (PFCE) and government consumption (GFCE) spending are still much below the FY20 level.

1HFY22 PFCE at Rs37.32trn is about 7.7% lower as compared to 1HFY20 PFCE of Rs40.44trn. Similarly, 1HFY22 GFCE at Rs7.83trn is about 5.3% lower as compared to 1HFY20.

Even in nominal terms, PCFE has grown just 2% in 1HFY22 as compared to 1HFY20. The nominal government consumption has however grown ~9% over this period.

Investment too below FY20 level

The amount of real investments (Gross Fixed Capital Formation or GFCF) in the economy during 1HFY22 was about 8.2% lower than 1HFY20 level. Even in nominal terms, the GFCF was merely 1.5% higher in 1HFY22 as compared to 1HFY20.

5yr of 8-9% plus growth will take us to long term pre Covid growth trajectory

Pre Covid, India’s long term growth trajectory (5yr rolling CAGR of GDP) was close to 7%, which is closer to the estimated potential growth level of 7.5-8%. The trend was declining since FY18, indicating impairment of potential growth.

Indian economy would need to grow at 8-9% CAGR for next 5years to achieve the pre covid long term growth trajectory of ~7%. To achieve the potential growth rate of 7.5%-8, much higher growth would be needed on sustainable basis.

This would need much more than the higher government support to farmers and manufacturing. Structural reforms that increase the employment opportunities, improve energy security, stabilizes food prices, make tax structure progressive, and improve social and physical infrastructure sustainably must be accelerated.

Headwinds developing for 4QFY22

Though the latest macro data is encouraging, some dark clouds have gathered at the horizon, obfuscating the visibility of growth in 2022.

·  The inclement weather in the ongoing Rabi season, and fertilizer shortages have likely impacted the agriculture sector.

·  Though the overall consumption growth has been lagging; the rural consumption has remained resilient in past one year. The latest data indicates that the resilience of rural consumption maybe breaking.

·   In view of the threat presented by the new variant of Covid-19, many countries have recently imposed fresh mobility restrictions. This may impact exports, which has been one of the key drivers of the growth.

·  Recently, the US Federal Reserve Chairman has indicated that they may consider unwinding the bond buying program (QE) faster than previously forecasted. This faster unwinding is widely expected to result in at least two rate hikes in 2022. Back home, RBI has also started tightening money supply through OMO and other means. The tighter money supply conditions may also impact the growth in 2022.

·  As evident from the recent commentary of consumer goods companies, the persistent inflation, especially energy and food, is beginning to impact the consumption demand.



Saturday, November 27, 2021

Market at crossroads – 2

 After topping ~18600 in October 2021, the benchmark Nifty is now back to ~17000, the level where it was 12 weeks ago. In general statistical sense, it could be said that market has not yielded any return since August 2021. However, during this 3200 odd point up and down journey of Nifty, the actual outcome might be very different for various investors, depending upon their portfolio positioning and activity during this period. The portfolio of a monthly SIP investor may not have changed much in this period; whereas someone who got greedy at the peak and invested larger amount in mid and small companies may have lost 10-25% of his latest installment of investments.

Of course, 12 weeks is an extremely short, and mostly irrelevant, period to account for the return on investment in equities. However, it could be a useful timeframe to assess if the market is changing its course.

Having quickly recovered all the losses from panic reaction to the pandemic, and moving about ~50% higher than the pre pandemic Nifty highs of ~12500, the Indian equity markets now appear tired and indecisive.

The indecision and tentativeness may be emanating from a myriad of factors. For example—

·         Indian markets have outperformed most of the global peers in past 20months. The global investors are now looking at the underperforming markets in search of better returns. Many global brokerages like Credit Suisse, Morgan Stanley, CLS, Goldman Sachs etc., have downgraded the weight of Indian equities in their portfolios to allocate more to China etc. The global flows to India may therefore slow down further.

·         Indian economy and corporate earnings have so far failed to match the exuberance of Equity prices, making the valuations of Indian equities relatively expensive, at least on the conventional parameters like price to earnings, EV to EBIDTA, price to book value, etc.

·         The inflation continues to be a significant concern in India. Despite repeated reassurances by RBI to remain growth supportive, the market participants continue to expect monetary tightening. The interest rate and liquidity sensitive sectors like financials, real estate and auto may be struggling due to this anticipation.

·         Many regions have recently witnessed fresh surge in Covid-19 cases. Market participants are watching this development closely. A significant worsening leading to fresh mobility restraints and logistic holdups could impact the markets adversely.

·         In past few months the activity in unlisted securities which are expected to be listed for public trading in next 3-12 months has increased materially. The money invested in these securities is typically locked up till 6-12month after the security is listed. Some active money has thus ventured out of the market.

·         The global money market is widely expected to become tighter in 2022, with many central bankers tapering the pandemic stimulus. The market participants may be unsure of the likely impact of this. A stronger USD due to fed tightening may led to outflows from emerging markets like India. However, a growth shock in developed markets could lead to surge of flows towards emerging markets.

·         The logistic constrains that prevailed in past 20 months are easing fast. The non-agri commodity prices have started to correct accordingly. The availability of semi-conductor chips, that hampered the manufacturing across the globe in past six months, has also started to ease now. The shipping rates are also in the process of normalizing. All this could have implications for the equity markets.

The sectors like metal users, merchandise exporters, auto makers that have suffered due to high commodity prices and logistic constraints, could see their operations and cost structures normalizing, whereas the firms which have made exceptional gains, like metal producers, may also see their profit margins normalizing.

Once the market participants are able to assess the impact of these factors on future earnings and market performance, we shall see the new leadership emerging in the markets.

For making a directional up move, the market needs a near consensus on the new leadership; which has been lacking so far.

The directional down moves usually occur on failure of a basic premise which has been near consensus (bubble burst); some unexpected event causing panic amongst investors (sighting of black swan); a prolonged economic recession; and/or major change in policies making significant negative impact on large number of existing businesses (transformational reforms). Nothing of this seems to be occurring at present.

It is therefore more likely that market may spend some more time at the cross roads, searching for a direction. Recent jump in implied volatility is just one confirmation for this premise.

Markets indecisive



Implied Volatility inches higher, but still moderate



Sectoral divergences stark



…thus Alpha strategies working best



Net flows subdued



India Outperformance normalizing



Net flows subdued



(See also Market at crossroads)