Vijay Kumar Gaba: Equity

Wednesday, July 6, 2022

2H2022 – Market outlook and investment strategy

In my past couple of strategy reviews, I had noted that given the present circumstances, the market outlook is pretty simple and straightforward – Moderate return expectations and focus on capital preservation. In fact, in the past three months the investment environment has become much more uncertain and complex. The geopolitical uncertainties, fiscal policy fatigue and monetary policy dilemma make short term forecasts very complex. These factors further support the idea of keeping the investment strategy simple and continue giving preference to capital preservation over higher returns.

I continue to believe that the economic and market cycles are now becoming much more shallow as compared to the 80s and 90s. The recessions nowadays last for a couple of quarters, not many years. Inflation peaks at 7-8%. Despite all the brouhaha over unprecedented QE and uncontrolled inflation, US rates are expected to peak at 3%. In fact the bond market in the US may already be pricing in a reversal of monetary policy and beginning of a rate cut cycle in 2023. In India also bond yields are expected to peak around 7.5% despite higher fiscal deficit and high inflation.

The market corrections (except the knee jerk reaction to pandemic led lock down) are also shallow and short lived. Unlike in the 1990s and early 2000s, we no longer see 20% plus correction in benchmark indices more frequently now.

The point is that defining market outlook and defining an investment strategy on the basis of that must factor in the new trend of shallow cycles. Relying on historical data of deep cycles may lead to unsatisfactory results.

Market outlook

The market movement in the first half of 2022 has been mostly on the expected lines. Despite the ongoing conflict between Russia and Ukraine, and elevated energy prices, I do not see any reason to change my market outlook for the rest of 2022. I expect-

(a) NIfty 50 may move in a large range of 15200-18600 during 2022. It would be reasonable to expect 10% + 2% return for the year for diversified portfolios.

(b) The outlook is positive for IT Services, Financial Services, select capital goods, healthcare and consumer staples, and negative for commodities, chemicals, energy and discretionary consumption. For most other sectors the outlook is neutral.

(d) USDINR may average close to INR77/USD in 2H2022. Higher yields may attract flows to support INR.

(e) Residential real estate prices may show a divergent trend in various geographies, but may generally remain stable. Commercial real estate may remain best category

Investment strategy

I shall continue to maintain my standard allocation in 2022 and avoid active trading in my equity portfolio. I am further downgrading my target return for the overall financial asset portfolio for 2022 to 7%.

Equity investment strategy

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

Debt strategy

I will continue to focus on accrual strategy for my debt portfolio. In case the yields spike beyond 7.75% due to policy rate hikes by RBI, I would lock-in my mid-term funds (3 to 5yrs) in long duration bonds/funds.

Thursday, July 30, 2020

I am happy not owning Gold

Lately, I have received a lot of queries from readers about Gold. Everyone seems to have woken up to the idea of investing in yellow metal. Many readers have read a lot about the latest trends in the global financial markets, and appear to be in full concurrence with the idea of structural decline in the relevance of USD as global reserve currency; however the views about the rise of EUR or CNY as alternative reserve currencies do not seem to be sanguine. This uncertainty about the future of the global financial system is probably driving the interest of investors towards gold, which has traditionally been a popular reserve currency and preferred store of value during crisis period particularly.

Many readers have highlighted that it was perhaps a mistake on my part to cut allocation to gold in my portfolio. I would like to answer the queries and concerns of the readers herein below.

First of all, I would like to remind the inquisitors that it has been my consistent stand in past three decades of my investing life that in my view gold being mostly an unproductive asset, having little industrial use, does not qualify to be an "investment" grade product. Given its popularity and general acceptance in global financial system, it does qualify to be a decent alternative to the paper currency. It therefore does well with the rising inflationary expectations and negative real rate environment. I therefore use it more as a tactical shift from cash & bonds; and sometime as an opportunistic trade. I never use it as a permanent asset class in my asset allocation. (read more on this here Gold is glittering; but is it the endgame?) Incidentally, my wife and daughters are also not fond of gold; so there is no conflict on this issue at least!

In my investment strategy update for 2020 in December (see here), I had stated- "In view of the adverse risk reward ratio and growing divergence between bond and equity yields, I shall scale back my strategic equity allocation to 50% from 60% presently. The strategic asset allocation now stands at 50% Equity; 25% Gold and 25% Debt."

However, as the news of COVID-19 outbreak from China spread and global markets started to take note of the crisis in February I revised my asset allocation to sell the tactical allocation to gold and upgrade equities to overweight (see here). Incidentally, markets tanked in March affording me an opportunity to make the shift at favorable prices.

In April after the global economy went into a lockdown, I made a big call, increasing the equity allocation further (see "Time to Take Big Call") I maintained my equity overweight stance on asset allocation and increased equity allocation further to 70% from the previous 65%, cutting the debt allocation from 30% to 25%. The overweight stance on IT, Pharma and chemical (including agro chemical) was adequately emphasized.

I am pleased to note that the strategy has worked out well so far. Since the recent bottom of the market recorded on 24 March, IT sector has returned 61%; Pharma sector has returned 57%; Nifty is up 48%, S&P500 is up 41% and gold is higher by 29%. The chemical sector has also outperformed the benchmark Nifty and gold comfortably. Average IT sector mutual fund return has been 35% (absolute) in past 3 months.

I therefore do not see much point in this brouhaha over gold, and would prefer to continue with my strategy for some more time, till I see indications of an imminent and material correction in the equity prices.