Even as 2020 is about to come to an end, the Covid-19 pandemic is not over just yet. Rather it seems to have tightened its grip with global daily infections rising unabated and mobility restrictions coming back especially in Europe. As half the world enters winter season, packed with festivals, lack of social distancing and other seasonal flus could overwhelm the public health systems, wiping off the hard work done so far. This just goes on to say that the final outcome cannot be determined unless the event is completely finished. Same holds true for the most awaited global quadrennial affair – US Elections. Unlike always, decisive winner would not be known immediately due to delay in counting of mail-in ballots and litigation risk. Being the largest economy, US leadership has an out-an-out influence on rest-of-the-world’s decision makers, lending an overarching importance to US President elect. There continues to be an overhang of uncertainty and answers to these central questions hold key: When will an efficacious vaccine be available for mass inoculation? How much policy space and political will is left for further stimulus? What about trade and military disputes with China? And the perennial one – which path will Brexit take?
IT AIN’T OVER TILL ITS OVER
Even as 2020 is about to come to an end, the Covid-19 pandemic is not over just yet. Rather it seems to have tightened its grip with global daily infections rising unabated and mobility restrictions coming back especially in Europe. As half the world enters winter season, packed with festivals, lack of social distancing and other seasonal flus could overwhelm the public health systems, wiping off the hard work done so far. This just goes on to say that the final outcome cannot be determined unless the event is completely finished. Same holds true for the most awaited global quadrennial affair – US Elections. Unlike always, decisive winner would not be known immediately due to delay in counting of mail-in ballots and litigation risk. Being the largest economy, US leadership has an out-an-out influence on rest-of-the-world’s decision makers, lending an overarching importance to US President elect. There continues to be an overhang of uncertainty and answers to these central questions hold key: When will an efficacious vaccine be available for mass inoculation? How much policy space and political will is left for further stimulus? What about trade and military disputes with China? And the perennial one – which path will Brexit take?
Global infections rising unabated, but mortality looks under control
Source: Bloomberg
GLOBAL EQUITIES: TIME TO WAIT-AND-WATCH
Globally, equities sold off as investors realised that valuations had discounted a quicker than expected normalcy. No doubt several real time macro indicators have made a bottom, but the climb out of the hole to pre-crisis highs remains a challenge for many. Low hanging benefits of the unprecedent stimulus have been plucked and booster doses are now inevitable. Even as management commentary stays positive, temporary job losses could turn into permanent layoffs in US and Europe as national lockdowns return, thus impacting consumer spending. As US election outcomes tend to have a ripple effect around the world and across asset classes, volatility shoots up at such times as seen from sudden spike in VIX index. Though such events could offer attractive opportunities, it is important to exercise caution. Even as surveys, polls, and bookies have indicated a clean sweep for Democrats i.e. a Blue Wave scenario, the outcome could turn out to be quite different. And then there is also the tail risk of a contested election where either party could sue the other. Markets hate uncertainty and tend to move on quickly once it is out of the way.
Global PMI seems to have flattened after moving into expansion zone
Source:Bloomberg
Global Equities have hit an air pocket since Sep; at Oct-end US, China have exceeded Jan-20 levels whereas EU, UK are still 20-30% away
Source:Bloomberg, MSCI Indices returns from 01-Jan-2020 to 31-Oct-2020
Despite the surging cases, it is preferred to be tactically overweight on Europe, while staying invested in US and see through the volatility. There are several benefits that offshore investing brings to domestic-only portfolios.
GLOBAL FIXED INCOME: LIQUIDITY TRAP; PREFER IG
Not only have global central bankers slashed policy rates leaving little room for further cuts, but they also resorted to unconventional measures. Though, their ammunition is now getting exhausted, strength of recovery still needs to offset the severity of collapse to restore earlier trend levels. Allowing policy fatigue to set in now could lead to double dip recession or even L-shaped GDP shock. At the same time, fiscal support too has eclipsed previous records. Now we are in a global liquidity trap and going forward, monetary policy will have limited effect because it addresses supply-side lending whereas need is to stimulate demand-side spending. Liquidity risks have been managed and solvency risks now predominate. Vulnerable but viable sectors require support, a problem better addressed by fiscal policy. Given that existing default risks could get accentuated due to repeated lockdowns, IG debt is preferred relative to HY
GLOBAL COMMODITIES: AT RISK FROM FALTERING GROWTH; OW GOLD
As China recovered swiftly from the pandemic it opportunistically bulked up on commodities at subdued prices leading to some improvement in industrial metals and agricultural produce. But Oil has had to deal with issues on both sides, supply – Hurricane season, labour strikes – and demand compression from faltering global growth as mobility restrictions return. Gold remains a preferred play on volatility, inflation, easy money supply and negative yielding debt. Hence, we maintain Overweight stance on Gold.
Except Oil, most other commodities have recovered to Jan-20 levels
Source: Bloomberg, Prices rebased to 100 as on 01-Jan-2020
INDIA MACRO: GETTING BACK ON ITS FEET
Normalisation of supply chains, pent-up demand and arrival of festive season has led to encouraging rebound in economic activity. Though sustainability is equally important, a recovery in future now looks relatively better though it could be gradual. Above-normal monsoons, good crop production, reasonably high reservoir levels and Govt’s. fiscal focus has led to healthy rural demand and consumer sentiments. This does not take away from the fact that a larger and targeted fiscal stimulus is still the need of the hour. The Centre seems to have realised that and have announced a small stimulus package in Oct. Talks of spending on focused projects from National Infrastructure Pipeline are also doing the rounds. Given the economic multiplier effect of construction activities this could act as a key employment booster. Several PLI schemes have also been announced to incentivise local manufacturing under Self-Reliant India strategy. But it is evident from 1HFY21 data, that Govt. has resorted to substantial spending cuts (revex/capex +1%/-12% YoY). Such restraint could act as a drag on growth in 2H and lead to double-digit decline in FY21 GDP
Encouraging YoY rebound in high frequency macro indicators
Source: CEA+ET, PPAC+IOC, GoI
Mfg. PMI at 58.9 surged to a decade high in Oct as demand bounced back strongly. Not just sequential, but a few macro indicators also reported YoY growth like GST collections, auto volumes, power & fuel consumption, and rail freight. Largest 2W/4W OEM even reported record monthly sales while tractor makers complained about supply chain snags and capacity constraints as they failed to meet higher than expected demand. Even as Services PMI moved into expansion zone after 8 months, recovery is still patchy with hotel occupancies, air and rail traffic, bank credit growth quite far from pre-crisis levels. We must stay vigilant to avoid resurgence in cases and cannot let Covid-19 loose again.
Auto OEMs (2W/Cars) reported healthy Oct sales led by channel stocking to meet personal mobility needs plus festival demand
Source: CMIE
INDIA EQUITIES: CAUTIOUS OPTIMISM
With a few listing duds, the IPO frenzy quickly settled down as investors turned their focus on Sep-quarter results. The IT sector companies began with a bang as they surpassed existing optimistic assumptions on deal wins and margins. Consumer staples saw continued demand revival, but the surprise package was the discretionary space (Jewellery, Autos, FMEG, AlcoBev) also reporting YoY growth primarily driven by retail demand. Positives were also seen in the most unexpected corners – Cement and Metals – as companies not only reported YoY volume growth but also showcased their adept cost management resulting in enviable margins. Though pure-play investment themes (industrials, EPC) are not yet out of the woods, outsourced manufacturers are reaping benefits from China+1 and indigenisation strategy. Finally, lenders have reported collection efficiencies less than initially feared, though true picture on NPAs is still 2 quarters away. Management commentary was also positive across the board.
Just like June, even Sep. quarterly results are beating estimates
Source: Bloomberg, 229 of NSE500 cos that reported results till 04-Nov-2020
Given the heightened volatility on account of US Elections, it is prudent to focus on asset allocation and portfolio construction while avoiding the noise. Hence, we stay Neutral between Equity and Bonds. Relative valuations, delivery volumes and retail participation are favouring Mid caps over Large caps. Though, MFs have seen lumpsum outflows, SIP book has held on. Also, strong FII inflows in Oct have lent further confidence to domestic retail investors. Thus, we are turning tactically overweight on Mid caps vs Large caps.
INDIA FIXED INCOME: LOWER-FOR-LONGER; OW CORPS/SHORT-TERM
Although, the MPC meet was a status-quo affair as far as policy rates are concerned (in-line), by no means was it uneventful. There were many firsts: The MPC voted on likely period of accommodative stance by committing to it at least until end of FY22. The RBI also announced that it will conduct OMOs in SDLs as a special case during FY21, in addition to doubling the existing OMO amounts for G-Secs. A new on-tap TLTRO was made available for specified sectors to be deployed by FY21 end and it could take the form of loans as well. Given the backdrop to this meet, Governor Das acted with clarity, by giving a strong forward guidance, renewing commitment to stable market yields, and assuring further liquidity. Such lower-for-longer stance could be tantamount to financial repression where savers are disincentivised to protect the investors.
RBI managed to provide some comfort at long end but yield curve steepening has not stopped
Source: Bloomberg, Sovereign Yields (Treasury Bills for Months, G-Secs for Years)
RBI talked about converting market participants from combative to competitive. Though long end of the curve saw some compression, it was lower than short end, and will need continuous support from RBI to stay that way. We continue to remain focused on top quality corporate issuances / funds and short duration investments in debt portfolios.
CURRENCY: FAVOUR USD ON NEAR-TERM RISK-OFF
Safe-haven status of USD makes it more attractive in times of volatility such as now. Any Risk-off sentiments (from delayed US election results, pandemic lockdowns) could lead to flows to assets like US Treasuries, Gold in turn pulling up the USD and dollar index. Though, twin deficit concerns would weigh heavy on USD over medium-long term, the immediate near-term could see support for the dollar. On the other hand, EMs including India could see reversal of FII flows putting pressure on INR. Factors like record-high FX reserves, stable external debt-to-GDP, and current account surplus would continue to offer stability to INR. For now, we turn tactically Overweight USD vs INR.
FX Reserves reached a record high $560bn offering strong import cover
Source: Bloomberg
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 30th Ocotber 2020.
ROUTES TO MARKETS: MODEL ALLOCATIONS
Glossary: COVID-19: Corona Virus Disease; U.S.: United States; 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; MPC: Monetary Policy Committee; FII Foreign Institutional Investment; YoY: Year on Year; MoM: Month on Month; MPC: Monetary Policy Committee; Capex: Capital Expenditure; MF: Mutual Fund; IPO: Initial Public Offering; USD: United States Dollar; INR: Indian Rupee; FDI: Foreign Direct Investment; FX: Foreign Exchange; VIX: Volatility Index; OEM: Original Equipment Manufacturer; PLI: Production Linked Incentives; Revex: Revenue Expenditure; FMEG: Fast Moving Electrical Goods; AlcoBev: Alcohols & Beverage; EPC: Engineering, Procurement and Construction; OMO: Open Market Operations; NPA: Non Performing Assets; SDL: State Development Loans; TLTRO: Targeted Long Term Repo Operations