Vijay Kumar Gaba

 Wishing all Readers on the auspicious occasion one of various Indian traditional New Years, popularly celebrated as Chaitra Navratri, Gudi Padwa, Ugadi, Chetti Chand etc. in different parts of the country.

It is a pleasant coincidence that beginning of new financial year is coinciding with traditional New Year in many parts of the country. May the Lord Rama bless all with conscience, wisdom, devotion and courage to pursue the path of righteousness.

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FY22 started on a frightful note. The deadly second wave of the pandemic had just hit the country. The cities across the country were gasping for oxygen. The hospitals were terribly overcrowded and so were cremation grounds. In a country that supplies medicine to the entire world, thousands of people were begging for couple of doses of medicine. Remdesivir, Tocilizumab, Dexamethasone and Ivermectin had become common household names. Vultures were hoarding and black marketing essential medicine.

There were many instances of an entire building or neighbourhood being infected by the deadly delta variant of SARS-CoV-2 (Corona). Many middle class families had to rely on charity for daily meals. It was tough to find people who have lost no family member, relative or close friend to the pandemic. Everyone had an awful experience to share. The corpses floating in Ganges; mysterious graves on her banks and long queues of dead waiting for their turn to be cremated became symbols of the national tragedy.

The economy that was limping back to normalcy after a prolonged lockdown in 2020 regressed back into recessions. Pessimism and negativity dominated the sentiments, before a sense of resignation and renunciation overtook. The rich, the top medical professionals, the powerful and influential who could not save their dear ones were speaking about futility of money, knowledge, power and influence. Stock market was obviously not one of the priorities for most people.

Thankfully, the year has ended on a rather satisfactory note. Though the pain would linger for those who lost their people, businesses or jobs; most of the population appears to have moved on from the tragedy.

During the year, the country faced numerous macroeconomic and geopolitical challenges. Much of the challenges are still persisting. Considering the circumstances, the Indian stock market did extremely well in FY22.

India Market performance for FY22

The benchmark Nifty yielded an above average return of ~18% for FY22. The broader markets did even better with Nifty Midcap yielding a return of ~23% and Nifty Smallcap yielding a return of ~26% for the financial year.

Metals rallied hard on the back of a global commodity rally, yielding ~54% return for the financial year. IT, Energy and Realty were other top outperformers.

Though all sectoral indices ended the year with positive returns, consumption (both discretionary and non-discretionary) was a notable underperforming sector. Retail credit (mostly private banks), FMCG, Auto, and Pharma were top underperformers.

The market breadth was strong with three shares advancing for every one share declining.

Indian equities amongst best performers globally

Indian equities were amongst the top performing markets globally. Despite persistent selling by the foreign portfolio investors, Indian equities did better than the global peers. Even in USD terms, Indian equities did better than most European and Asian markets.

INR weathered the crisis remarkably well

Despite challenges on macro (higher fiscal and current account deficit and inflation) INR remained mostly stable. It weakened only marginally (~3%) against USD in FY22. INR; and ended stronger against EUR, JPY and GBP.

Bond yields higher

The benchmark 10yr bond yields ended at 6.77%, about 10% higher, as compared to the beginning of FY22. Considering the global trend of rising rates, higher inflation and sharp rise in fiscal deficit, this is a reasonable performance.

Amongst debt funds, high yield (credit risk) performed the best with ~9% average yield; while liquid funds were the worst performers with ~3.3% average yield.

Just when everything appeared to be settling nicely, the volatility in Indian equity markets has increased materially. The sharp corrections at any hint of adverse event highlights the jitteriness (and to some extent lack of conviction) of market participants. Considering that household investors (and traders) have increased their participation in the market significantly in past 6-8 weeks, the pain quotient of any sharp correction from here could be significantly higher.

Evidently, while the benchmark indices are now mostly flat for past 8-9 weeks, the sectoral shifts have been meaningful. Investors have adopted inflation (commodities) and cyclical recovery (mid and small cap) as a primary investment theme. Financials, discretionary consumption and realty sectors have witnessed a major “move out”.

The investors positioning seems to be, inter alia, based upon the following premise:

(a)        The earnings recovery witnessed in 4QFY21 shall continue for most of the FY22 and FY23.

(b)   The inflation which has been mostly a “supply shock” phenomenon in past three quarters will become a “demand shock” as cyclical recovery continues to gather pace and supply response lags the demand surge.

(c)    End of forbearance period for loans may lead to accelerated delinquencies, especially from MSME sector.

(d)   RBI shall continue to pursue accommodative monetary policy, regardless of the fiscal conditions, inflationary pressures and pace of cyclical recovery.

(e)    The companies may further improve on the multiyear high margins achieved in 2HFY21 and justify PE rerating of mid and small cap stocks.

The investors’ positioning is mostly based on promise of higher fiscal spending and incentives for setting up new manufacturing capacities. Obviously the assumptions suffer from a certain degree of dissonance.

Stress in MSME sector that is driving financials down is not reflected in sharp outperformance of mid and small cap stocks. Fears of lockdown, poor income growth etc. are reflecting in underperformance of discretionary spending (auto, media, realty etc.) but the “demand shock” expectations in metals etc. contradict this positioning. Service sector underperformance also mostly belies the cyclical recovery thesis.

The participants’ positioning also does not fully factors, in my view, the recently added high risk dimension to the RBI’s monetary policy. So far the quantitative easing (money printing) has been the domain of the jurisdiction having a universally acceptable currencies (US, EU, Japan, UK). RBI has ventured into this with a partially convertible currency. This could be a two edged sword. Could make INR highly volatile and impact the CAD.

The following excerpts from some recent global research are worth noting:

“US producer price inflation has jumped to a 10-year high. Business surveys suggest pipeline price pressures continue to build with some surveys suggesting a greater ability to pass higher costs onto consumers. This will add to the upside risks for CPI in coming months and increasingly points to earlier Federal Reserve policy action.” (ING Bank NV)

“China’s renewed focus on de-carbonisation leading to steel capacity cuts, strong domestic demand and muted global coking coal costs are likely to sustain high steel margins globally over FY22-23E. Lower Chinese export rebate as suggested (for months now) in media articles can discourage Chinese steel exports further. India domestic HRC price ex- Mumbai stands at c. INR 60k/t , significantly higher than JM/street assumption of INR 48k/t, while the landed China price at c. INR 68.7k/t leaves significant room for further price hikes in the domestic steel circuit.” (JM Financial Research)

“After two consecutive quarters of solid earnings beats and upgrades, we expect another strong quarter, aided by a deflated base of 4QFY20 and healthy demand recovery for the large part of 4QFY21 – as attested by high-frequency indicators. Performance is expected to be healthy despite headwinds of commodity cost inflation in various sectors. The key drivers of the 4QFY21 performance include: a) Metals – on the back of a strong pricing environment and higher volumes; b) Private Banks and NBFCs – on moderation in slippages and improved disbursements / collection efficiency; c) a continued strong performance from IT – as deal wins translate into higher revenues; d) Autos – as operating leverage benefits offset commodity cost pressures; and e) Consumer Staples and Durables – on strong demand recovery despite commodity price inflation. MOFSL and the Nifty are expected to post a healthy two-year profit CAGR of 16% and 14%, respectively, over 4QFY19–4QFY21” (Motilal Oswal Securities)

“If our growth projections were to come to fruition, India’s economy would pass the US$6.4 trillion mark by 2030, with per capita income at US$4,279 – reaching the upper middle income country threshold. This implies a real GDP growth of 6% and nominal growth of 10-10.5%. A key ingredient to our forecast is our estimate that manufacturing as a share of GDP will rise from approximately 15% of GDP currently to 20% by F2030, implying that its goes from US$400bn to US$1175bn. We believe that the thrust toward a manufacturing-led growth will set in motion the virtuous cycle of productive growth of higher investment - job creation - income growth – higher saving - higher investment and India would be one of the few large economies offering high nominal productive growth.” (Morgan Stanley)

I shared my investment strategy with readers in December 2020. I expected 2021 to 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. After 3months into the year, I am even more confident about my view.

I continue to believe that to generate normal return on the financial asset portfolio one would need to maintain a certain degree of flexibility in portfolio. A part of the portfolio may be dedicated to active trading, at least in 1HFY22. I am therefore not changing my investment strategy for next 6months at least.

I may share my current investment strategy as follows:

Asset allocation

I shall continue to maintain high flexibility in my portfolio, by keeping 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 FY22 would be ~7 to 7.5%.

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. I shall maintain my underweight stance on lenders for at least 1HFY22.

(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

FY21 in retrospect