Vijay Kumar Gaba

I am almost illiterate insofar as the concepts of mathematics, physics, chemistry and biology are concerned. I have even not considered reading any guide for dummies to understand some elementary things about these concepts, though many times I have felt the need for this. The consequence is that whenever anyone uses these concepts to explain a practical situation to me, I have only two options – either believe that person fully and accept the explanation offered by him or reject his explanation completely and leave the problem unresolved. Usually, it is not the explanation offered by that person, which governs my decision to accept or reject. It is my faith in that person itself. If I trust that person, I accept his explanation in full; and vice versa.

When I see people blindly following (or even refusing to hear) some religious preacher, politician, business leader, domain expert, investors, trader, etc., I fully appreciate their behaviour. It is primarily due to (i) total refusal to entertain unassimilated ideas; and (ii) faith in such a person.

I have also learned that the tendency to outrightly reject the ideas that do not conform to our belief system, prejudices and preconceived notions is an obstruction in the process of our evolution in life. The resistance to entertain ideas that we do not assimilate immediately often deprives us from the opportunity to break the linearity and take a leap forward.

I recently read in a BBC article that “A healthy human eye has three types of cone cells, each of which can register about 100 different colour shades, therefore most researchers ballpark the number of colours we can distinguish at around a million. Still, perception of colour is a highly subjective ability that varies from person to person.” (see here) Obviously, different people see the world differently. And this “ability” to see things differently from others is what makes this world worth living, in my view. Else, we humans will be no different from machines that yield the same output from the same input.

There is another natural phenomenon that needs to be assimilated well. Nature has endowed us with a special vision mechanism. Our vision spectrum is designed in a way that we can vividly see the things that are placed closer to us. However as the things go further our vision begins to blur and after a point we see only the illusion of horizon. Only a few human beings acquire the ability to see at longer distances through perseverance. These Able people or Visionaries guide the ordinary mortals, with limited visions, to the future.

Besides, a conscious effort is made by the vested interest groups to further limit the natural vision of the ordinary human being by making them wear blinkers of ignorance, prejudices, morality, hunger, duty, responsibilities, bigotry, etc. It is just like we limit the vision of horses with blinkers so that they focus on the directed path and do not get distracted or spooked.

I find these thoughts also useful in formulation of investment strategy. To make a successful investment strategy, an investor must:

(a)   Not reject unassimilated ideas outrightly.

(b)   Accept that different people see the same thing differently and all of them could be right from their own perspectives.

(c)    Become a visionary through perseverance or put on blinkers and be guided by the experts.

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

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

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

Continuing from yesterday (see Preparing for chaos - 3)

In April, I had shared my thoughts about the investment strategy for post COVID-19 world (see here). The strategy was based on the assessment of situation based on the information available till then. Though the strategy has worked out very well so far, I must admit that luck might have played some part in this.

The present circumstances indicate that the socio-economic, geopolitical and political repercussions of the COVID-19 pandemic would be much deeper and wider; and would be felt over a much longer period than earlier anicipated.

I continue to believe that

1.    The current crisis is unprecedented in the sense that it has seriously impacted the liquidity, solvency and viability of a large number of businesses, all at the same time. The number of businesses going out of business before this crisis ends would therefore be much larger than the crises faced by global economy in past 75 years since the end of WWII.

2.    The only way out of this crisis is to inflate a colossal bubble in asset prices, which is equally unprecedented.

I believe that the foundation of next big global bull market will be laid in next 12 months. Like every time before, the next bull market will be much bigger than the previous one. We shall see a large bubble building in the market that will change many things in the real economy as well; much like the internet bubble of 1990s reshaped the global economy forever.

3.    The new trade and strategic blocks will emerge to provide leadership to the world. The world may de-globalize, localize and re-globalize at the same time. Collective leaderships and many smaller common markets like EU having deeper cooperation may emerge. Digital international highways may become more common than the traditional physical movement of people. The assets and currencies may get further dematerialized. The international travel protocols may change to include medical tests as a prerequisite for all international travel.

4.    People rather than material will become the focus of policy formulation. The demographic trends may see dramatic shifts over next 2-3 decades. It could be either through liberal but orderly immigration or incentives to procreate more in developed nations.

5.    The global wealth and income inequality may increase to alarming levels. The number of poor (below poverty line) may rise disproportionately across the world, especially in emerging countries. This could potentially trigger a fresh wave of communism across the world fueled by increasingly isolated China and Russia.

I further believe that the present view of European and Japanese resurrection may not come true in true sense, as adverse demography will keep hindering their ambitions.

In Indian context, I believe that we may just follow the global trends and not create a trend of our own. I do not see any significant acceleration in growth trajectory normalized for poor base effect of FY21. Indian economy may struggle to avoid getting trapped in whirlpool of stagflation and may just avoid that. The interest rate may not fall as much as anticipated earlier, but may still remain low. Consumption may sustain, as the agriculture sector that employs maximum workers in the country, may continue to do better, especially in terms of investment and fiscal spending.

As an investor therefore I shall avoid committing strongly to any specific sector or asset class for next couple of years. I will continue with my "Buy and Hold with regular rebalancing" strategy for selected stocks.

Asset allocation

I shall be reducing my equity allocation to neutral (60%) from overweight (70%) in next one month. I may also consider bringing it further down to underweight (50%) in 3QFY21. Accordingly debt (30%) and cash allocations (10%) shall also be brought to neutral position.