Vijay Kumar Gaba

Though one calendar quarter is too short a period to change one’s investment strategy, I have a habit of reviewing my assessment of markets and investment strategy every quarter. In my last Outlook and strategy review, I had highlighted that given the present circumstances, the outlook for the next year is pretty simple and straightforward. The return expectations of the investors may be moderate and focus may remain on capital preservation. I therefore continued with my standard asset allocation, and decided not to trade actively.

In my latest review of market outlook and investment strategy I noted the following:

(a)   The economic recovery post pandemic continues to be uneven. The larger unorganized sector continues to lag, while the formal sector is progressing well. The tax collections are therefore buoyant, and fiscal pressure is not constricting the public sector spending. The overall consumer demand growth however remains poor. The overall economic growth estimates have therefore been downgraded moderately.

(b)   The consumer demand is also impacted by stagflation like conditions, as higher energy and food bills have eroded the discretionary spending power of a larger section of population. The real income of consumers is not growing or even de-growing in many cases. There are no signs of any material change in this condition in the next few months.

(c)    Easing of Covid related restriction and Russia-Ukraine war has added to the exports momentum. Higher petroleum products and gold prices have materially added to the nominal value of exports from India. Despite highest ever exports, the current account deficit has continued to rise. The RBI has managed the currency market very well and INR exchange rates have remained much stable.

(d)   The financial sector has stabilized after a few tumultuous years. The asset quality has shown remarkable improvement and stability in past one year. The credit growth though has remained slow, the earnings of banks have been aided by good recoveries. In the past couple of months some encouraging signs of credit demand pick up have been sighted. Hopefully, credit growth will gain momentum in next few months.

(e)    The commodity prices are showing early signs of peaking on demand destruction and easing of logistic constraints. The rate hike cycle initiated by most central banks may hasten the process of commodity prices peaking, in my assessment.

(f)    The central banks in most jurisdictions have commenced hiking the rates and tightening liquidity. This may adversely impact financial asset prices, especially the leveraged equity and commodity trades in the next few months.

(g)    Higher inflation and poor pricing power (mainly due to poor demand growth) may continue to hurt the margins of many companies. As I had expected, the market has started to take cognizance of lower margins and poor volume growth in many sectors. The analysts have started to assign lower PE multiples in their forecasts. The earnings estimates may also be aligned with the new reality post 4QFY22 results. As the weight of expectations comes down, the market might trade much more comfortably for the rest of the year.

(h)   Geopolitical situation in Europe seems like part of a much larger Reset in global order. The contours of this reset will unravel in the due course.

History may not be a guide

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 India also bond yields are expected to peak around 7-7.5% 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 quarter of 2022 has been mostly on the expected lines. Despite the ongoing conflict between Russia and Ukraine, I do not see any reason to change my market outlook for the rest of 2022. I continue to expect-

(a)   NIfty 50 may move in a large range of 15200-19200 during 2022. It would be reasonable to expect 10% + 2% return for the year for diversified portfolios. Focused and thematic portfolios could return higher yield in 2022.

(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.

(c)    Benchmark bond yields may average 6.5% + 30bps for the year. Shorter end yields may do better in 1H2022, while longer duration may do better in 2H2022.

(d)   USDINR may average close to INR75-76/USD and move in the 73-80/USD range on a negative current account. 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

2022 may be one of the simpler years for investors, as the return expectations may be moderate and focus may turn to capital preservation.

I shall continue to maintain my standard allocation in 2022 and avoid active trading in my equity portfolio. My target return for the overall financial asset portfolio for 2019 would be 9 to 9.5%.

Asset allocation

Equity investment strategy

 The new year of the Goddess of Wealth (Mahalakshami) has started on a rather somber note for the Indian equities. After a very strong year since Diwali of 2020, the markets appear tired and uncertain.

The tailwinds of easy money and lower borrowing cost, which were among the factors that supported strong market performance since Diwali of 2020, appear weakening; whereas the headwinds of inflation, tighter money, and slowing growth appear gaining strength.

The valuation comfort that aided investors’ sentiments last year, is no longer available. The opportunity provided by the panic reaction to the Covid-19 pandemic has been mostly exploited by investors. Most of the low hanging fruits have already been plucked. The risk reward ratio is no longer favorable at the broader levels at least.

The Covid-19 pandemic itself, and the response to the pandemic created numerous opportunities in past one and a half year. The market readily identified these opportunities, and investors positioned themselves well in time to benefit from these opportunities in next few years. There is therefore little element of positive growth surprise in most of these opportunities; to the contrary the chances of negative surprises do exist. Some of the trends where investors are well entrenched could be listed as follows:

·         Acceleration in the process of consolidation of businesses, at the expense of smaller and unorganized enterprises that started a few years ago.

·         Enhanced role of technology in business and household management. The trend is most visible in digitalization of financial services, retail selling of products and services, entertainment & socializing, and education & skill enhancement, etc.

·         Rise in public expenditure to support employment and capacity building.

·         Enhanced policy support for private enterprise for capacity building to achieve the goals of sustainability, self-reliance, employment, higher growth etc.

·         Commodity inflation due to global imbalances in demand-supply equilibrium for many commodities. The inflation could have been resulted due to logistic constraints, underinvestment in capacity enhancement in past one decade, sudden and sharp rise in localized demand due to opening of economies post pandemic caused lockdowns; and speculative positioning aided by cheap and abundant money.

There is little margin for error in the market, as evident from the recent episodes of violent market reactions to marginally below expectation results and adverse policy decisions. Significantly increased jitteriness before most routine market and policy events like scheduled policy meets, declaration of quarterly results and monthly sales numbers etc., is also indicative of the dithering investors’ confidence in the markets.

Multiple downgrades of emerging market equities in general and Indian equities in particular; acceleration in the selling by foreign investors and sharp correction in some bloated pockets of the markets in past three weeks has further added to the nervousness of the investors.

Outlook for the new Diwali year

The market outlook for next 12 months is uncertain. For the next few months, the markets will be guided by the direction of global monetary policy and consequent direction of flows. The expected slowdown in growth due to elevated commodity inflation and exhaustion of policy stimulus may also adversely impact investors’ sentiments. However, there is nothing to indicate a substantial decline in the market or a protracted phase of uncertainty. The sentiments shall improve as the time progresses and investors adjust their return expectations and asset allocations.

It is important to note that the government has very well protected the fiscal position and managed to overcome the external vulnerabilities while managing the pandemic. The twin deficits, which have traditionally bothered the Indian equity markets during the periods of slower growth and global monetary tightening, may not be matter of material concern this time around. Indian equities may therefore not witness any material sell off as the global monetary tightening cycle kicks off.

Having fully recovered from the economic contraction caused by the pandemic, the Indian economy is now faced with the challenges to find new propellers for the economic growth. The policy initiatives to accelerate growth appear promising. Substantial public outlay for infrastructure capacity building and incentives for private investment in new capacities augurs well for a strong new growth cycle which may have already taken root and show accelerated growth in FY23.

Accordingly, my outlook for the Indian equities for next 12 months is as follows.

·         For next few months, the markets may remain volatile and weak. This volatility and weakness may provide good opportunities for restructuring the portfolios and positioning for new growth drivers. Overall, benchmark indices may yield single digit returns for the new Diwali year.

·         Investors might consider moderating their return expectations and altering their asset allocation accordingly. The equity returns of past 18months were exceptions and should be seen as such only. Benchmarking portfolios to these returns and taking avoidable risk is totally unadvisable.

·         Any precipitous rise in bond yields in next few months may be a decent opportunity to increase the debt allocation.

·         While technology remains a key driver of growth, buying anything at any price might not be the best strategy for investors.

·         Real estate appears to be one of the preferred spaces for now. However, sharp rise in domestic rates could suddenly change the sentiment for real estate. The investors need to therefore tread very cautiously in this sector. For smaller investors taking leveraged bets in illiquid asset is not advisable. It is important to note that unlike the previous real estate cycle, this time the investors have an opportunity to invest in good quality real estate through liquid, affordable and dematerialized instruments, viz., REITS.

Trivia

India is a fascinating amalgam of diverse cultures and traditions. Most ethnic communities here follow a lunar calendar. However, there are many which follow a lunar/solar calendar, Some communities also follow a solar year. Accordingly, there are numerous “New Year” days in our country.

The Government of India follows two calendars - Lunar calendar based on Saka Samvat and Solar based Georgian calendar. The new financial year and academic years (mostly) follow  April-March cycle based on Georgian calendar. Most Hindu communities follow a Lunar based calendar based on Vikarm Samvat. The New Year for these communities starts with the first day new moon in Chaitra Month (March/April). Only in Gujarat and Rajasthan, Balipratipada (first day of new moon in Kartik month) is celebrated as New Year.

The fact that the stock markets in India celebrate Balipratipada as New Year, signifies the important role Gujarati and Rajasthani communities have played in the development of financial markets in the country. To some it may also imply the overwhelming influence of these communities on the financial system of the country.

Nonetheless, it is important to note that Vikarm Samvat 2078 actually started om 13 April 2021 for most of India. For the Government of India, the new year (Saka Samvat 1943) started on 22 March 2021.

(One version of this article was published at moneycontrol.com on 4 November 2021)

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