1 Jul 2020
We are experiencing the perfect storm of medical, financial, and real-life crisis. The huge liquidity influx by central bankers has helped push up the asset prices. Major countries have announced massive fiscal stimulus to the tune of US $7.4 trillion in response to the COVID-19. The resultant fall in interest rates has seen around 86% of global debt instruments go below the 2% yield mark. This extremely high liquidity and extremely low-interest rates around the world have helped markets both on the bond side as well as on the equity side recover from the lows seen in Mar-Apr 2020.
But there is extreme polarization that is happening between the leaders and the rest. Top companies in some sectors such as Technology, Pharma & FMCG have seen more interest from investors while the followers are seeing very limited focus. Top-quality companies with little-to-no leverage and working capital efficiency are drawing investor attention. The same trend seems to be true for the US equities market. There, the top tech companies seem to be outperforming the broader S&P index 500 significantly. The miracle economy is China from the Virus originated which is showing economic activity levels anywhere between 80-100% of pre-covid levels. And this growth seems to be coming on the back of very high debt.
On the Indian economy front, overall expectations of GDP contraction range from -5% to around -10% for FY-21. Earnings of Indian companies have also come down drastically. It is estimated that around 30% of companies in India make RoCE at least 2% higher than the cost of debt. In FY10, this number was close to 90%. This shows that the space to service overall debt has declined.
Business resumption seems to be stuck as capital formation remains lukewarm. When your capacity utilization is low you will shy away from investing in additional capital. Fundraising will also be hurt for corporate India as nearly half of the credit ratings across rating agencies have fallen into the issuer not cooperating category. If we can improve our ease of doing business on the ground then things can be very different and growth can recover substantially. In this scenario, Rural India may come as a saving grace for the economy. The government support to the rural sector by way of NREGA and PM KISAN scheme is cushioning the impact. Relatively normal monsoon and strong sowing patterns also indicate a possibility of Bharat supporting the GDP.
Having said that, the consumption metrics of urban India is also showing some revival. Power consumption has reached back to the same level of demand as seen last year. Mobility trend for workplaces is also showing improvements. But there are companies across various sectors that have been able to improve their working capital cycle by the reduction in both inventory days and debtor days.
From a Market point of view EPS, estimates have seen sharp cuts in the past few months and may also further drop. Going forward markets would be moving like a pendulum between optimism & fear based on various factors like valuation levels, US-china relationship, US presidential election results, trends in consumption, trade & supply chain behavior, medical solution progress on covid-19, etc. Current Nifty 50 levels @~11,000 levels is discounting lower gold imports, lower oil prices and the lower trade deficit with China, rebound in economic activities, smooth execution of economic package reforms, monetary stimulus, potential higher FPI inflows, medical solution round the corner. If actually, the situation is better than this, then markets will continue to rise & if it's worse than this then markets would fall.
In this testing time, the investors have to be selectively optimistic, focus on quality companies, and follow the asset allocation strategy. From March 2020 onwards we suggested to be overweight equities but now we believe that it is time to be neutral to equity allocation looking at the sharp run-up in prices & valuation and the potential crisis ahead.
Lumpsum investors can utilize this time to invest in high-quality short duration debt funds and can initiate STP into a BAF or equity Funds. Looking at the 2008 experience, we suggest that investors must keep steady on SIP. SIP lessons from the 2008 crisis show that those who continued with their SIP, rather than pause it or cancel, generated wealth over the long term
Distributors can add value by suggesting prudent asset allocation to their clients. Prudent asset allocation will be critical in helping ride out this period. Equity overweight investors can consider a dynamic asset allocation strategy. A BAF strategy that has low downside risk and higher upside potential provide a good investing option. Conservative investors can consider a debt hybrid strategy where the equity component is 25% or less. This strategy keeps the equity risk limited and allows for the debt component to anchor the investment and keeps volatility low and the equity component may deliver when equity markets enter a bullish period.
We had been suggesting investors to look at Gold allocation since the beginning of March 2020 as we believe it is likely to do well. We are still bullish as central banks continue to cut rates and pump liquidity. Gold ETFs across the world have received significant flows and today Gold ETF inflows are higher than equity ETF flows.
On the debt fund side, we had been suggesting investors not to redeem in good quality credit risk funds as it was an opportune time to stay invested. Please go through the performance of our credit risk fund in this factsheet to see how investors who stayed invested have fared. Investors can continue to invest in the Credit risk category from a 3-year perspective as the current elevated credit spreads provide an attractive opportunity to invest. We believe that it is time to belong on duration. The long-term inflation is on a downward trajectory. RBI has also adopted a benign and accommodative stance in the market and has more room to cut rates in the future. In this scenario, investors can look at dynamic bond funds from a 3 year plus perspective. This is time to take one step on duration as interest rates are soft and likely to come further down.
