Vijay Kumar Gaba

 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 6^th 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.

 Wishing all readers a joyous New Year, and a brilliant 2021 ahead. Stay Healthy, Stay Blessed.

Top performers of 2020

In this last post of 2020, I would like to pay my tributes to those, who in my view are top performers of the year. Many readers may find it deeply personal view, totally unrelated to the investment strategy. However, I keep these at the core of my investment strategy. Without these performers, making any case for investing in Indian equities would be tough for me.

Migrant Laborers

One section of the population that has been hit the hardest by the pandemic is migrant laborers. These people mostly sustain on daily wages and have negligible savings. On announcement of lockdown, these people lost their livelihood, shelter and savings in no time. The uncertainty over resumption of normal life forced them to leave “unaffordable” cities and return to their villages. They got almost no support from the baffled and paranoid administration or industry. Numerous cases were reported where the workers walked hundreds of miles to their villages. One 15yr old girl famously carried her ailing father over 1200 kilometers on bicycle, from Gurgaon to their native place in Bihar. Unfortunately, all were not welcome in their homes also. In many cases the folks there saw them as competition and threat to the property.

The most commendable part of this story is that millions of distressed workers migrated back under severe stress and inhumane condition, but no significant episode of violence or looting was reported from anywhere in the country. To me it is a matter of great comfort. This indicate low probability of any major violent civil or industrial unrest in the country.

Women

The women, especially the working women who share the burden of running household with the men, also did a commendable job during the year. These women brilliantly managed the stress of managing household chores without any domestic help and significantly higher domestic workload, work from home, tighter budgets, stressed men and children. Numerous cases of domestic violence were reported against women, but they valiantly withstood all the pressures and performed way beyond their duty.

The quintessential Indian woman provides a strong pivot to the Indian economy. So long this pivot is unshakable, one can expect Indian economy and society to sustain.

Health workers

It is widely recognized that India is awfully short of qualified health workers. The ratio of population per health worker in India ranks amongst the lowest quartile of nations. The pressure on health workers during pandemic was incomprehensible. Nonetheless, the health workers across the country did a commendable job, risking their physical and social life. They tirelessly worked around the clock. They managed the deluge of patients and violent behavior of patient’s relatives rather brilliantly. The research workers toiled round the clock to develop the vaccine for deadly virus in record time. Many health workers reportedly caught the infection and lost their lives.

The availability of high quality health workers provides comfort. The enhanced awareness about their need and importance shall result in policy initiatives to improve their availability and accessibility. Access to affordable quality healthcare shall support the economic growth in next decade.

Learners

The lockdown impacted the students in the worst possible way. The schools were closed and students were forced to stay indoors. The corporate training programs were also impacted adversely due to mobility issues and paucity of funds. The pace at which the learners and trainers shifted to the digital medium is remarkable. Students even in remote areas were famously shown as making tremendous effort for adapting to digital teaching. Numerous people took advantage of lockdown and updated their skills using digital platforms. Thousands of learners reportedly took advantage of online courses offered by global universities like Harvard and upgraded their skill and knowledge base.

Though, it has temporarily increased the digital divide in the society with the lower economic strata feeling left out. Nonetheless, this has shown a path how India will be able to materially enhance its education, skilling and training initiative using digital platforms. The shortages of teachers and other resources will be obviated through affordable technology in next few years only. No one would need to go in expensive universities abroad just for the sake of acquiring knowledge. The global classroom has come to our digital devices. Nothing could be more encouraging for a growing economy.

Deliverymen

When the entire country was locked down and people were fearful for moving out of their homes, millions of deliverymen kept the country running. Risking their life, these deliverymen delivered essential items like food and medicine to every household even in the remote parts of the country.

These deliverymen form the backbone of the evolving retail trade. Ecommerce is inarguably the sunrise sector of the economy; and it cannot be imagined without deliverymen. One could find numerous workers who have been left redundant due to closure or downscaling of business, finding support in this occupation.

Unfortunately, this segment of the workers still remains mostly unorganized and exploitive. Hopefully we shall see the Ecommerce policy taking note of critical role played by this segment, and provide for their better social security and working condition.

Chart for the day

Some food for thought

“It is not the healthy who need a doctor, but the sick. I have not come to call the righteous, but sinners to repentance.”

—Jesus Christ (Spiritual Leader)

Word for the day

Amity (n)

Friendship; Peaceful harmony.

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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

 A literal interpretation of the latest statistics would indicate that Indian economy is passing through a recession and faces a specter of stagflation. A young demography like India can certainly not afford this condition.

The government officials have termed the recession as a “technical” one, induced temporarily by the total lockdown imposed in the wake of the outbreak of Covid-19 pandemic. The economic managers of the government have also vehemently denied any possibility of Indian economy slipping into a stagflationary trap.

In my view, however, this entire discussion based on official statistics might be “technical” in nature. Wandering through the streets of large cities and fields in the hinterlands over past few months, and interacting with people from various strata of the society, I am convinced that more than two third of Indian population may already be trapped in the stagflationary conditions, with their real income stagnant or declining over past few years and essential expenses rising. The economic and health shock of pandemic may have only accelerated the trend of deterioration.

Another noteworthy thing in the official narrative is that an attempt is being made to establish as desirable base for the future growth paradigm. This sounds unfortunate, as the pre March 2020 situation was worrisome and far from desirable state of economic growth. Therefore, in my view this “V shape recovery to pre March 2020 level” narrative is also ironical and redundant.

Nonetheless, as we approach end of calendar year 2020, it is useful to look at the latest economic trends; draw estimates for the next year and see if any changes are required in the investment strategy and investment portfolio.

I find the following economic trend worth noting. I shall continue to keep a close watch on these trends for my investment strategy purposes.

1.    The long term growth trend (5yr CAGR of Real GDP) of India’s GDP peaked in FY08 and has been declining since then. Even normalized for the sharp deceleration in pandemic affected FY21, the long term growth shall remain below 6% for next 3years at least. Success of recent stimulus program for promoting manufacturing and agriculture growth may add 50 to 75bps to India GDP by FY23. Even then the long term growth trajectory shall remain below the 9% rate desired to create enough employment for the fast increasing workforce of India.

2.    India’s savings rate, especially household savings rate, has been declining consistently for past 10years. On the other hand, the household indebtedness is on the rise. Historically, the domestic savings have supported both the public finances and private investments. Lower savings is making the growth and social sector spending more dependent on foreign capital. Nothing inherently wrong in borrowing from overseas; but it increases the external vulnerability, especially in the periods of crisis. The global monetary conditions indicate that the crisis may be more “norm” than “exceptions” in next decade. Obviously, a further deterioration in domestic savings will make us more vulnerable to global volatility.

3.    The export growth of India has been dismal in past decade. The stagnating exports in fact have been one of the primary factor behind declining growth trend in India. The government has apparently taken cognizance of this fact and taken a slew of measures to promote exports. I shall be keenly watching if these measures result in meaningful and sustainable acceleration in exports, especially manufactured exports, from India.

4.    After peaking in 2018, the non-performing assets in the Indian financial systems had shown encouraging trend in past two years. I shall be keenly watching the trend in NPA, once the relaxations given as part of support to businesses in post lockdown period end next year. A sharp rise in NPA level again would seriously impact the mid term growth prospects of the economy.

5.    The household and corporate investment in fixed assets has deteriorated in past decade. If the prevalent low interest rates fail to revive the investments in next couple of years, the mid-term growth potential of Indian economy could be seriously impacted. I shall be watching the revival of investment, which most analysts are expecting to happen in 2021.

6.    The real rates have remained negative for past many months now. It is estimated that the policy rates may have bottomed, and remain at present levels for most of 2021. This shall keep the real rates negative for 2021 also. I shall watch for any violation of this premise. The real rates turning positive may trigger a rise in short term rate and reallocation of assets.

7.    The tax collections have seen sharp decline in FY21. If the normalcy in tax collections is not restored in 2021, we shall see (i) material decline in government expenditure 9which has supported the growth revival so far); (ii) rise in effective tax rate; or (iii) both.

8.    Excess liquidity in the financial system has made the policy rates redundant in the near term. This situation cannot last for longer. Unless we see sharp acceleration in credit demand, RBI may be forced to change its “accommodative” policy stance. This may be negative for equities in the short term.