The RBI monetary policy announced on December 4 bore a dovish undertone. The equity and bond markets have taken this as a positive indication signaling a focus on economic growth. The inflation projections for Q3 & Q4 FY21 and for H1FY22 have been revised substantially upwards.
Liquidity during the rest of FY21 is expected to remain in the range of Rs 6-8 lakh crore. This will ensure a lower rate at the shorter end of the yield curve (around 3 to 3.5 percent for 1 to 90-day tenor) while the longer end is managed using G-Sec and State G-Sec Open Market Operations. Good quality corporates and banks are able to borrow short term monies at low rates (around 3-3.5 percent per annum). Though this is an encouraging sign for the corporate bond market, investors will need to factor in low-cost borrowings risks by corporates. For now, the saving factor is that the bond market is allocating monies at low rates to good quality borrowers. However, pressures of excess liquidity should not push lenders to take on additional risks by diluting lending norms.
The RBI also mandated commercial banks to not declare any dividends for FY20 to boost capital. While this would aid banks in the short run, it also means creating a hedge against a possible rise in NPAs in FY22/23.
Inflation being a key concern, FY21 is projected to close at an average of 6.51 percent. While food inflation has remained sticky and is likely to come off during January-February 2021, overall core inflation is worrisome. Commodity prices (like steel, copper, and aluminium) have risen over the last couple of months. Global crude oil prices are increasing on the back of positive data on COVID-19 vaccinations and economic growth. With Brent crude prices nearing the $50 a barrel level, India’s fuel inflation and current account balance will be impacted adversely.
The GDP growth for FY21 is expected to be revised higher to -7.5 percent from -9.5 percent. With companies tightening their belts over expenses and debt, the corporate bottomline growth is expected to be resilient. Travel and tourism will take longer to revive, while growth in sectors like IT, pharma, and banks will compensate for the loss.
Equity markets are basking in the deluge of liquidity of Rs 60,358 crore from foreign investors in November 2020. Domestic institutions have withdrawn Rs 48,399 crore during the month (of this, mutual funds have withdrawn Rs 22,665 crore).
The reasons for the seemingly dizzying valuations of equity markets are multiple.
â€¢> The US Presidential election outcome is now decisive.
â€¢> COVID-19 vaccine development and availability is not a concern with multiple companies offering vaccines and billions of vaccine vial orders already confirmed by global economies.
â€¢> Economies, across the globe (except Europe and few other countries), have recovered swiftly.
â€¢> The US Dollar Index (DXY) has dropped 11.8 percent from a level of 102.82 in April 2020 to 90.72 in the first week of December 2020. A weak USD has resulted in increase in foreign flows to other/ emerging markets.
â€¢> Compared to other major global indices (in US dollar terms) on a CY20YTD basis the Nifty has had a tepid return of just around 3 percent versus Nasdaq (+36 percent), South Korea (+25 percent), Taiwan (+21 percent), Japan (+18 percent), S&P 500 (+13 percent).
â€¢> Locally, Indian companies have reported one of the best quarterly growth numbers in Q2FY21.
â€¢> Bloomberg Nifty EPS for CY18A, 19A & 20E is at 455, 475, 486, respectively â€“ showing a CAGR of just 2.21 percent over three years. Nifty EPS growth (CAGR) in last 21 years has been at 9.48 percent. FY22/23 could well be the years where earnings would inch up towards the long-term average.
In FY22, equity may give better returns than fixed income. However, the strategic asset allocation strategy of investing between fixed income, equity (Indian and International), gold and alternatives always must be adhered to.
In the current markets where fixed income will give returns lower than inflation and equity valuations seem high, investment decisions are difficult to make. The way forward could be:
â€¢> Adhere to your Asset Allocation model. This is applicable at the sub-asset class level. Do not be under-allocated to either large, mid, or smallcap stocks/funds /PMSs.
â€¢> Ensure 70-75 percent deployment of your investment in equities. If the deployment is under 70 percent of the planned allocation, invest in a staggered manner over next 3 months till Budget 2021. Balance 25-30 percent can be kept as ‘dry powder’ to average in down markets.
â€¢> Do not book profits on your core/good quality stock portfolio. Sharpen your portfolio. Cut the tail and weed out the laggards.
â€¢> Add un-correlated assets like international equity and gold. Helps geographical and currency diversification apart from reducing portfolio risk. Each should be 5-10 percent of your overall portfolio allocation.
â€¢> For core fixed-income allocations, investors should position their portfolios towards high-quality issuers (AA+ and above) and consider Corporate Bond funds, Short term funds and Banking & PSU Debt funds.
â€¢> 5 & 10-year Bharat Bond ETFs can be considered as part of passive fixed-income strategy. These present a cost and tax-effective mode of investment.
In these uncertain times, a disciplined approach with cautious optimism could well be the way for a better post-COVID-19 investing experience.
(Nimish Shah is the Chief Investment officer – Listed Investments at Waterfield Advisors.)
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