2020 was a year like no other that the world would want to leave as far behind as possible or even erase from memory. But it is easier said than done. Even as we usher into the New Year with a lot of high hopes led by vaccine success, a new strain of the virus dampened the jolly spirits. Though 2021 will be a year when the global economy rises like a phoenix from the ashes of 2020, the speed of resurrection will matter most. The stockpile of vaccine doses will determine how quickly individual countries can return to normal. High-income countries are currently buying the larger share of doses but daily caseloads there are also rising significantly forcing some (UK, Europe, US, Japan) to repeat stringent lockdown measures to contain the spread. In the nick of time, Britain bid farewell to 2020 with a Brexit deal in hand and US Congress signed a $2.3tn relief plan in the last days of the last year. All eyes are now on Georgia run-offs as it will decide the final mix of US Senate and whether Biden presides over a united or divided Congress and if the narrative changes or stays.
2021: THE YEAR OF THE PHOENIX
2020 was a year like no other that the world would want to leave as far behind as possible or even erase from memory. But it is easier said than done. Even as we usher into the New Year with a lot of high hopes led by vaccine success, a new strain of the virus dampened the jolly spirits. Though 2021 will be a year when the global economy rises like a phoenix from the ashes of 2020, the speed of resurrection will matter most. The stockpile of vaccine doses will determine how quickly individual countries can return to normal. High-income countries are currently buying the larger share of doses but daily caseloads there are also rising significantly forcing some (UK, Europe, US, Japan) to repeat stringent lockdown measures to contain the spread. In the nick of time, Britain bid farewell to 2020 with a Brexit deal in hand and US Congress signed a $2.3tn relief plan in the last days of the last year. All eyes are now on Georgia run-offs as it will decide the final mix of US Senate and whether Biden presides over a united or divided Congress and if the narrative changes or stays.
3rd wave seen in the U.S., U.K., Japan and Europe…
Source: Bloomberg
GLOBAL EQUITIES: WALL OF WORRIES NOW BEHIND; OW EU, NEUTRAL U.S.
Dec-20 would go down the annals as yet another month of positive returns delivered by equity markets world-over. However, delving deeper within the month, 21-Dec-20 saw a surging spike in volatility as a new strain of COVID-19 specific to the UK reared its head. At that time, this new mutation had been responsible for 2/3rd of Dec-20 infections in the UK prompting Tier 4 restrictions in London and South East UK. However, in no time, vaccine makers swung into action and issued reassuring statements that the new strain’s mutations in the spike protein and receptor binding site would not deter most of their vaccines. Brexit is now done and dusted with its impact now mostly priced in all markets – equities and currencies. There will be no tariffs imposed on trade, but the UK will not get equivalence on services with the EU. In the U.S., Trump has finally signed the second stimulus package of $900bn which will extend many of the CARES Act support measures. Though this will stretch the country’s fiscal deficit to ~15% of GDP it will act as a bridge to the other side of the pandemic.
…but they also have larger share in the pre-purchased 7.25 bn doses
*COVAX is a global initiative to provide equitable access to COVID-19 vaccines
Source: Visual Capitalist
Net-net, with the withdrawal of most risks (save possibly, the Georgia Senate race) global equities remain attractive. Within which, we retain our tactical overweight stance on Europe, and stay invested in the U.S.
GLOBAL FIXED INCOME: SCRAMBLE FOR YIELDS; SWITCH TO HY VS IG
Central banks largesse in supporting their economies does raise concerns about permanent ‘moral hazard’ and ‘wealth inequality’ but deserves praise as well, as governments were not as swift in their crisis response. The never-ending liquidity support and lower-for-longer stance have also led to a sharp collapse in bond yields with shocking outcomes – PIGS are now safer than safe-haven UST! Average IG yields are now below 1% and the amount of negative-yielding bonds has now surged above $18tn. This has added to the financial repression suffered by savers since GFC. The monetary policy measures of bond-buying across a wider spectrum of risk assets successfully addressed the critical liquidity and default concerns. Start of vaccine drives in few countries have thrown some light on the near-term path of economic recovery and added a dose of confidence to take on risk. We have now turned tactically OW on HY bonds relative to IG earlier.
Debt investors are in search of yields
Source: Bloomberg
GLOBAL COMMODITIES: JUMP ONTO THE GOLD BANDWAGON; OW GOLD
Liquidity glut by most central banks post the COVID-19 black-swan had pumped gold prices up to dizzying heights for most of 2020. But, from Aug-21 till Nov-21 Gold moderated downwards attractively, as most risks (COVID-19, U.S. election-related) seemingly receded. Secondly, the concurrent global economic recovery fueled a back-ended Copper rally this year, making gold relatively under-valued. Thirdly, this economic expansion could also stoke the biggest driver of gold demand – Consumption (of jewellery, bars and coins) – to reawaken from its slumber throughout 2020. The CFTC saw net long gold futures positions increasing m-o-m (as if), in corroboration. We increase OW on Gold by a notch.
Attractive Gold-to-Copper valuations coupled with a rise in net contracts
Source: Bloomberg
INDIA MACRO: RECOVERY PICKING UP PACE
India’s FY21 GDP growth estimates have been revised upwards by multiple agencies to single-digit declines from their prior double-digit contractions, owing to a strong recovery in demand and falling COVID-19 infection rates. The agriculture sector has been a silver lining amidst the pandemic, coming out of the lockdown unscathed due to a favourable monsoon and reservoir levels, with ~5% YoY growth in Rabi sowing. The Govt.’s finances have been stretched further by lower revenues with the fiscal deficit widening to 135% of BE and only 63% of the budgeted expenditure for the year being spent by Nov-20. While the annual disinvestment target of INR1.2tn from CPSEs has been an uphill task since the very start, the Govt. has pushed for the disinvestment of companies like BEML, BPCL, Shipping Corporation, Air India and Concor in a race against time to meet their deadline of Mar-21.
FY21 GDP decline estimates now within -10%
Source: S&P, Fitch Ratings, ICRA, NCAER, Goldman Sachs
Dec-20 reported highest ever monthly GST collections at INR1.15tn on the back of festive sales, inventory restocking and increased anti-evasion vigilance, while the Mfg. PMI came in at 56.4 – above the critical threshold of 50 for the fifth straight month, with manufacturers stepping up production and input buying. Demand for Electricity, Petrol and Diesel recovered strongly before seeing a small dip in Nov-20, however preliminary estimates for Dec-20 suggest some strength. Auto OEMs surprised with a strong show in Dec-20 as demand for personal mobility drove up monthly volumes for cars and premium 2W.
GST collections at record-high; YoY growth for 4th month in a row
Source: GoI
We expect the Govt. to continue with its reform agenda and support measures starting with the Union Budget in Feb-21. The FM has already signalled the budget to be visionary and focus will be on public spending to revive the economy. Rising deficits would not be of much concern as growth is paramount.
INDIA EQUITIES: IN A SWEET SPOT; OW EQUITY / MID CAPS
Indian equities like their global counterparts continued their upwards march ending the year with handsome 15%+ returns. While it can be argued that markets have run ahead of their fundamentals, it is also true that markets price forward expectations of growth. The NIFTY50 currently trades at a rich 38.5x trailing PE. However, an earnings growth expectation of 50% from these levels translates to a much more “fairly valued” 25.5x forward multiple and a 30% earnings growth results in 29.5x. As of now, 2-year forward CAGR positive earnings per Bloomberg for large caps slot in mid-way at 40%. Earnings surprise for 2 consecutive quarters has been lauded by markets as corporates have managed costs very well. RBI’s Jul-20 FSR had painted a bleak FY21 GNPA outlook for banks (12.5-14.7%) but timely moratoriums seem to have helped – Sep-20 GNPA has come in only at 7.5% with a possible additional meagre 0.66% had asset classification standstill been absent.
Mid/Small cap indices have huge potential to perform
Source: Bloomberg, Rebased to 100 as of 01-Jan-2018
Record-high FII flows have added fuel to the equity rally. Valuations are now expensive across all metrics (PE, PB, PS, Mkt. Cap./GDP) but negative real rates have made bonds unattractive too. Liquidity glut should provide support along with TINA factor, thus retaining our OW stance on equities vs. bonds. Mid-cap valuations are still below levels seen in end-2017. Retail participation has made a comeback in Dec-20 and delivery volumes for large caps are lagging their pre-Covid levels which make us turn a notch further OW on mid-caps.
INDIA FIXED INCOME: YIELD CONTROL; OW CORP / ST
The tussle between RBI and bond market participants does not seem to end – another 10Yr G-Sec auction had to be devolved on Primary Dealers due to bids for higher yields. Soon after RBI announced an ‘Operation Twist’ OMO to exercise ‘yield control’. Investors concerned with persistently high inflation and fiscal deficit overhang are demanding commensurate reward to fulfil the large borrowing needs of the Govt. Lack of FII participation has also led to the burden falling completely on DII. Debt market reforms and greater inclusion of India in global debt indices could lead to wider DII participation and attract FII. Massive liquidity has pulled extreme short-end rates below the reverse repo rate of 3.35% hurting savers. There are concerns that inflation could also stay elevated if easy fiscal and monetary policy continues as guided. RBI could think of liquidity absorption tools like MSS bonds, closing the gap between repo and reverse repo and withdrawing from the FX markets to address yield curve steepening.
China attracted huge FII debt flows since inclusion in global indices
Source: Bloomberg
We continue to remain focused on top quality corporate issuances/funds and short duration investments in debt portfolios.
CURRENCY: RBI TAKES A DIFFERENT PAUSE; OW INR
While the RBI has paused on rate cuts since 22-May-20, it had all along (since Mar-19) been lapping up FCA diligently. Such was the vigour of dollar buying that during the roughest months of COVID-19 for India viz. May-20 till Oct-20, the RBI cumulatively purchased ~INR4.4tn of FCA which more than offset the combined foreign flows into equity and direct investments (~INR3.5tn) into India. However, in Dec-20, the RBI has finally paused this front and appears no longer “leaning against the wind”. As a result, the absence of this fuel should likely strengthen the INR as the longer-term tenet of covered interest parity@ should once again take a backseat.
The RBI has been bulking up on its reserves and staving off export uncompetitiveness, barring one-off Aug
Source: Bloomberg. Note: USD buying = RBI’s net buying of dollar assets. Net Rupee buying = sum of above flows. Aug-20: Investments by Google etc. into Jio Platforms.
TACTICAL ASSET ALLOCATION (TAA) VIEWS & PERFORMANCE
Source: Bloomberg. Assuming a 6% annualized yield for cash.
GLOBAL ASSET PERFORMANCE SNAPSHOT
Source: Bloomberg Equity/Fixed Income Returns/Yields in local currencies. Commodities in USD. Numbers for Fixed Income are Yields as of 31st December 2020.
ROUTES TO MARKETS: MODEL ALLOCATIONS
Glossary: COVID-19: Corona Virus Disease; U.S.: United States UK: United Kingdom; EM: Emerging Markets; DM: Developed Markets; PMI: Purchasing Manager’s Index; O(U)W: Over (Under) Weight;; HY: High Yield; IG: Investment Grade; GDP: Gross Domestic Product; GST: Goods and Service Tax; RBI: Reserve Bank of India; FDI Foreign Direct Investment; FII Foreign Institutional Investment; DII: Domestic Institutional Investment; YoY: Year on Year; MoM: Month on Month; USD: United States Dollar; INR: Indian Rupee; FX: Foreign Exchange; OMO: Open Market Operations; PE: Price-Earnings; PB: Price-Book Value; PS: Price-Sales Ratio; FCA: Foreign Currency Assets, mainly U.S. Govt./Treasury bonds; TINA: There Is No Alternative; FSR: Financial Stability Report; CFTC: Commodity Futures Trading Commission; OEM: Original Equipment Manufacturer; FM: Finance Minister; 2W: Two-Wheelers; MSS: Market Stabalisation Scheme; CAGR: Compound Annual Growth Rate; GNPA: Gross Non-Performing Assets; CPSE: Central Public Sector Enterprise; BE: Budget Estimates; PIGS: Portugal, Italy, Greece, Spain; UST: US Treasury; GFC: Global Financial Crisis; @: Interest Rate Parity dictates that an economy with higher inflation should see its currency weaken in the long run vs. an economy with lower inflation