Vijay Kumar Gaba

Fear, paranoia and resilience prevails in 1HFY22

The financial year FY22 started with the country reeling under the impact of an intense second wave of Covid-19 pandemic. The images of citizens struggling for life saving drugs and Oxygen, overcrowded cremation grounds and corpses of the victims of pandemic floating in the Ganges were imprinted on peoples’ consciousness. For once, disease, death, and desperation dominated the popular narrative.

The life seemed still with everyone becoming fearful and paranoid. It felt that spirituality and austerity would dominate the behavior of common man for many months to come. The government went into overdrive to build health infrastructure, provide assistance to helpless citizens and planned, what would eventually become, the biggest public vaccination drive ever in history of mankind. The austerity and fiscal discipline did not appear to be anywhere in the list of top priorities.

The macro economic data for 1QFY22 however presented a slightly different picture. Private consumption was the largest contributor to the growth and government had refrained from spending much.

The 1QFY22 growth came in better than most had anticipated as the sporadic lockdowns did not affect the economic activity. The recovery in 2QFY22 appears to be much better than estimates, with many indicators reaching pre pandemic levels. The growth estimates for FY22 have been accordingly revised upwards by most agencies.

…did not impact financial markets

The financial markets also did not reflect the sentiments peddled in the popular narrative. Despite, the government incentives to promote local manufacturing; acceleration in award of contracts for large infrastructure projects; the government support and incentives for MSME credit; significant expansion in digital banking ecosystem; revival in real estate market, etc. the credit demand growth is persisting at multi decade low levels.

The stock market has witnessed heightened activity, with benchmark indices gaining close to 20% in 1HFY22 on the back of much higher participation from the household investors. Mid and small cap stocks dominated the activity, indicating the strong dominance of the sentiment of greed over the sentiment of fear.

The market rally has been rather intriguing, given that environment for equities has not been very supportive from conventional wisdom viewpoint.

The following factors, which have bothered the equity markets historically, have been conspicuous by their exalted presence.

·         The energy prices (Achilles heel of the Indian economy) have climbed sharply higher. The second round impact of the energy inflation have also become visible in higher costs of production and freight.

·         Food inflation has persisted at elevated levels. In fact, headline inflation has persisted above the RBI comfort zone for many months, terminating any chance of further monetary easing by RBI. The debate now circles around the tightening schedule of RBI.

·         The vulnerabilities of the Chinese financial system have been exposed with one of the largest real estate developer defaulting on its debt obligations.

·         The central bankers of developed countries gave clear signals that the monetary easing has peaked and their next step would most likely be the monetary tightening.

·         RBI has shown tolerance for higher yields and slightly weaker INR.

·         Institutional investors have remained on the fringes for most part of the 1HFY22.

·         The cold war like condition between US and China has intensified further. Polarization of global trade majors is also increasing

·         Geopolitical situation at northern borders remains alarming, with no resolution in sight for Sino-Indian standoff at LAC and increasing influence of China and Pakistan in Afghanistan.

·         The strong leader of Germany lost elections to the left alliance, reinforcing the trend of the left leaning socialists gaining power in most of the large countries, the environment for free trade and globalization continues to worsen.

·         The weather has been extremely erratic world over. Unusual weather pattern were seen across continents. Unusual snow fall and drought in Latin America; Drought, extreme heat and wild fires in North America; floods in Europe, China and Indian sub-continent caused extensive damage to crops and supply chain disruptions. The prices of industrial raw materials and food increased materially world over.

·         The corporate earnings have been stronger than the estimates in 1QFY22, but the valuations in many pockets are seen prohibitively high. The valuations in commodity sectors like metals and chemicals etc. seem to discounting the current inflationary trends to the eternity.

Money in pocket may not reconcile with profits shown in SM timelines

Regardless of the presence of the supposedly adverse factors, the equity markets have remained quite resilient so far.

However, in past couple of weeks the volatility in markets has increased significantly. While various commentators and observers have attributed the rise in volatility to one or more of the above listed factors; it is pertinent to note that these factors have been present, and widely acknowledged for past many months. It would therefore not be justifiable to attribute the market volatility and jitteriness to these factors alone.

The anecdotal evidence indicates that in view of the above listed factors, the participation in equity markets in past six months has been rather tentative and lacking in strong conviction.

Most investors appear to be actively trading, frequently booking small gains/losses. Thus, even though the benchmark indices have shown strong gains in 1HFY22, not many personal portfolios may be showing the matching gains.

Now, as the market commentary turns to “cautious optimism”, “fairly priced”, “Long term Story in tact” from “abundant opportunities”, “recovery trade”, “TINA for India” etc., the unconvinced investors/traders lacking in conviction are turning even more nervous.

Of course greed is still the dominating factor and not many market participants are taking money off the table; they are even quicker in booking profit and losses.

Sector shopping in search of quick gains is also gaining higher momentum leading to faster sector rotations, giving an illusion of abundant trading opportunities. Obviously, the money in pocket is not reconciling with the money being made on social media timelines.

Money made on Twitter wall is exponentially higher than what broker’s statement is depicting and that is making the investors/traders both nervous and greedier for now. So expect, the current state of volatility and low returns to continue for few more months at least.

Economy fast recovering to pre pandemic levels

As per the consensus estimates, Indian economy shall recover to pre pandemic level latest by the middle of FY23; in what is popularly called a “V” shape recovery.

The growth thereafter is expected to be more moderate. The normalized long term growth trajectory may however not reach 6%+ level (seen in pre pandemic period) till FY27 at least.

Corporate earnings - 2QFY22e growth to be moderate as base effect withers

Nifty 4QFY21 and 1QFY22 EPS growth was the strongest in more than two decades. Poor base effect and strong pent up demand were the primary causes attributed to such sterling corporate performance.

However, these factors are seen tapering from 2QFY22 onwards, and the cost pressures are rising. We may see revenue growth as well as margins moderating this quarter.

…though the long term earnings trajectory earning to remains robust

Regardless of the moderate 2QFY22 earnings growth, the long term earnings growth (Rolling 5yr CAGR) trajectory is expected to remain strong for FY23 and later years.

Markets – Greed dominates the Fear

During 1HFY22 the market performance was dominated by the cyclical sectors like Real Estate, Metals, Energy and Infra. IT Services was the only non-cyclical sector that continued with its good performance from 2HFY21. Financials and Auto were the major underperformers.

Given their underperformance for much of the past 3-4years, sectors like Realty and Metals were significantly under-owned, it is therefore likely that most investment portfolios might have underperformed the benchmark indices.

 

FII remained net seller while DII were small net buyers in 1HFY22

During 1HFY22 over Rs59716cr were raised through 26 IPOs. This compares with Rs54576cr raised through 33 IPOs in the entire FY21. However, an analysis by the brokerage firm MOFSL highlighted that almost 52 per cent of IPO investors sold shares on the listing day. This clearly indicates towards lack of conviction amongst investors, including institutional investors, in the new businesses. Most IPO investors appear taking this as a trading opportunity to make some additional money from the funds lying in the savings account earning a pittance.

India outperformed the peers by wide margin

During 1HFY22 the Indian equities outperformed the major global market by wide margins. Nifty gained close to 20%, whereas the second best Index S&P500 of USA gained 10%. Amongst peers Brazil was the worst performing market with a loss of 7%.

Market outlook and strategy

As of this morning, there is great deal of uncertainty as to the shape of the global order that would emerge in next couple of years. It is highly unlikely that we would get much clarity over next 6-12months. To the contrary, it is more likely that the conditions become even more uncertain and unclear.

Insofar as India is concerned, I continue to feel that 2HFY22 may just be a continuation of 1HFY22, with some added complexities and challenges. The country may continue to witness protests and unrest. The consolidation of businesses may continue to progress, with most small and medium sized businesses facing existential challenge. Disintermediation and digitization 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.

Market Outlook – 2HFY22

The outlook for markets in the near term is mostly negative.

Macroeconomic environment - Neutral

Global markets and flows - Negative

Technical positioning – Negative

Corporate earnings and valuations - Negative

Return profile and prospects for alternative assets like gold, real estate, fixed income etc. - Negative

Greed and fear equilibrium - Negative

Perception about the policy environment - Positive

Outlook for Indian markets

In view of the positioning of the above seven key factors, my outlook for the Indian equity market in 2HFY22 is as follows:

(a)   Nifty 50 may form a short term peak in next couple of months. The process of forming the top has already started. In case the market follows the trajectory of 2HFY08, we may see the top around 18700-18900 level, followed by a sharp correction. However, if Nifty follows the pattern of 1HFY07, we may see top around 18200-18300 followed by a sharp 20% correction and a sustained rally thereafter.

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

(c)    Benchmark bond yields may average below 6.5% for 2HFY22. INR may average close to 74 in 2HFY22.

(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 continue to see recovery.

Key risks to be monitored for the market in 2HFY22

1.    Relapse of pandemic leading to a fresh round of mobility restrictions. (Less likely)

2.    Significant worsening of Sino-US trade relations.

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.    Premature monetary tightening.

Investment - Strategy

Asset allocation

2HFY22 may be a difficult period for investors, in terms of high volatility, poor expected returns from diversified portfolios and poor return from long bond portfolios as yield firm up. In view of this, I shall continue to maintain higher flexibility of my portfolio; keeping 30% of my portfolio as floating, while maintaining a broader UW stance of equity and debt.

Large floating allocation implies that I shall continue to trade actively in equity. 30% of portfolio would be used for active trading in equities and debt instruments.

My target return for overall financial asset portfolio for 2021 continues to be ~7.5%.

Equity Strategy

I would continue to focus on a mix of large and midcap stocks. The core criteria will be old economy cyclicals which are cheaper from historical and contemporary perspective, have decent market share, are changing business model to suit the new conditions, and would benefit from economic recovery.

I would target 6-7% annualized price appreciation from my equity portfolio.

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