The relentless surge in Covid-19 daily infections has brought the world to a fork in the road – one path is fraught with risks of vaccine development lagging the slow and steady re-openings whereas the other faces risks of permanent economic loss due to re-imposition of local lockdowns. The shape of economic recovery will be driven by the path chosen by each country which in turn will depend on multiple factors like healthcare infra, space for fiscal / monetary stimulus, economic growth trend pre-Covid, and in some cases, even politics. Even as US and LatAm are seeing daily cases dropping off from 2nd wave peak, few countries in Europe and Asia are now witnessing flare-ups but with much lower mortality. The battle is far from over and until a vaccine is widely available, economies will be constrained by measures aimed at slowing the spread of the virus. Though for now it may seem irrelevant given the pandemic black swan event the World is passing through, the emerging risks on the horizon are US elections (personalities vs policies), Brexit (orderly vs disorderly) and adverse geo-political developments (especially involving China or the Middle East).
ALPHABET SOUP OF ECONOMIC RECOVERY – WHAT WILL IT BE? U, V, W, L
The relentless surge in Covid-19 daily infections has brought the world to a fork in the road – one path is fraught with risks of vaccine development lagging the slow and steady re-openings whereas the other faces risks of permanent economic loss due to re-imposition of local lockdowns. The shape of economic recovery will be driven by the path chosen by each country which in turn will depend on multiple factors like healthcare infra, space for fiscal / monetary stimulus, economic growth trend pre-Covid, and in some cases, even politics. Even as US and LatAm are seeing daily cases dropping off from 2nd wave peak, few countries in Europe and Asia are now witnessing flare-ups but with much lower mortality. The battle is far from over and until a vaccine is widely available, economies will be constrained by measures aimed at slowing the spread of the virus. Though for now it may seem irrelevant given the pandemic black swan event the World is passing through, the emerging risks on the horizon are US elections (personalities vs policies), Brexit (orderly vs disorderly) and adverse geo-political developments (especially involving China or the Middle East).
COVID-19: 2nd wave being seen in Europe but with lower mortality rate
Source: World Health Organisation
GLOBAL EQUITIES: UP, UP AND AWAY
Risk assets continued to be lapped up as Equity markets rallied globally with the MSCI EM/DM up 2.2%/6.7%. Whatever shape the real economy might take, the markets have had an unexpected sharp ‘V-shaped’ rebound. The investors’ enthusiasm was lifted in Aug by the better-than-expected corporate earnings and upwardly revised future guidance. Some high-frequency data such as Google mobility indices, in-store card swipes, auto/housing sales, industrial production and PMIs point to continued MoM improvement albeit at a more moderate pace. But all is not hunky-dory yet – US weekly unemployment relief has ended in Jul with a new program still being debated and EU furlough benefits are ending in Oct which will then reveal real level of unemployment and its impact on consumption demand. Only time will tell if this frenetic rally is fragile or solid, but from a risk-reward perspective, investors would be a happy lot to keep their focus on quality and valuations
2020 General Election Poll averages seen favouring Democrat Biden
Source: Bloomberg, Real Clear Politics
Tactical rotation from US to EU is a preferred move given the likely potential to outperform driven by better handling of 2nd wave cases, relatively better position to finance fiscal stimulus and US elections uncertainty. Allocation to global equities ensures exposure to ‘New World’ and ‘WFH beneficiary’ companies in Tech, Healthcare, AI/ML, Gaming, Commerce & Communications
GLOBAL FIXED INCOME: TOO MUCH IS NOT ENOUGH; PREFER IG
The US Fed announced a shift to average inflation targeting, meaning it will tolerate inflation going above its long-term target of 2% to ensure full employment. The Fed just made Powell Put official by offering a blank cheque to the markets. The BoJ, on the other hand, has burnt its fingers with negative interest rates to defeat decades-long deflation. It has also been incentivizing banks with bonuses (an extra 10bps) to do exactly what they are supposed to do – lend, and this is when the BoJ’s balance sheet has already exceeded Japan’s GDP of $5tn. What happened to whole of the $2.2tn fiscal stimulus announced by ex-PM Abe is a question no one has answers to. The HY bonds outperformed Sovereigns / IG bonds this month as risk-off sentiments cooled off. We continue to prefer IG given credit rating downgrades, uncertainty around central bank policy outcomes and economic growth trajectory.
Global corporate defaults close to 2016 levels with 4 months yet to go
Source: S&P Global
GLOBAL COMMODITIES: REITERATE OW ON PRECIOUS GOLD
As the economies unlock slowly, demand seems to be coming back for commodities with the Commodity CRB Index up 6.6% adding to its 4.1% gain in Jul. Even Baltic dry index showed optimism. But with global growth likely to be subdued in near future, industrial metals and crude are not completely out of the woods yet. Gold did stumble a bit from its peak on tapering of risk aversion, but the loosened central bank policies and demand for volatility / inflation hedge could keep the glitter for long. Hence, reiterate OW on Gold.
Flight to safety leading to higher Gold prices and lower TIPS yields
Source: Bloomberg
INDIA MACRO: A STORY OF TWO HALVES – GLASS HALF EMPTY OF HALF FULL
Real GDP contracted by 23.9% YoY in 1QFY21- the worst quarterly decline ever reflecting the full impact of stringent lockdowns in April/May – against the consensus estimate of an 18% slip. Barring Govt. expenditure, which grew by 16.4% – the highest in last 3 years – all the other key categories witnessed a sharp decline leading to 29.3% decline. Agriculture provided some saving grace as it grew by 3.4% YoY and is expected to be the only segment to report full-year growth for FY21. The sombre data shows how much hard work lies ahead to get the economy back on the rails. McKinsey Global Institute warned of massive unemployment if significant reforms are not kicked-off immediately. But Govt. spending has slowed down in Jul-Aug and they will find it difficult to increase spending due to a big rise in debt this year. In fact, the meeting of the GST Council underlined the fact that the Govt.’s coffers – both at the Centre and States – are empty. Time to think out of the box.
Balancing Act: India GDP impacted severely due to very stringent lockdowns, but Agriculture still stood out
Source: Bloomberg
Also, looking at Jun data shows a rear view of the economy. It should give some solace to look at the Manufacturing PMI for Aug which rose to 52 from 46 in Jul. It is a good sign as this is the first time after Covid-19 that the indicator has gone above 50 which separates expansion from contraction. Auto OEMs have also reported YoY growth in Aug wholesales. Notwithstanding the rising daily Covid-19 cases, the Govt. has taken confidence from the high recovery / relatively lower fatality rate and health infra readiness to move into Unlock 4.0 with a few restrictions and containment zones under conditional lockdowns. High capital flows, low oil prices, good monsoons are among the factors which indicate signs of revival.
India Manufacturing PMI back into expansion zone after 5 months
Source: Bloomberg
INDIA EQUITIES: SURFING THE WAVE; OW ON LARGE CAPS
Several companies smartly raised capital in Aug taking advantage of the unending liquidity – most of them private lenders like Axis Bank, ICICI Bank, HDFC. This led to record-high net monthly FII flows of INR 48,000 crores. The VIX index also moderated to below 20 as a vote of support. DIIs continued with their profit booking via lumpsum outflows though it will be interesting to see how the SIP book fared in Aug (vs INR 7,800 crores in Jul). Though SEBI’s new rules with regards to pledging/re-pledging and cash margin requirements, implemented from Sep-1, would help control the misuse of funds and securities of investors, it could disrupt daily trading volumes as it would reduce speculators supply of indirect collateral from their brokers. This and unlocking of the economy could curb the rising participation of retail traders and falling delivery volumes leading to more rationality. PE valuations at index levels are frothy on both trailing and forward basis and hence prudent investing is warranted to ensure mishaps and permanent loss of capital. Surfing the wave (of liquidity) feels wonderful till it breaks – Mohammed El-Erian.
Mixed performance across Nifty sectoral indices: Pharma at the Top
Source: Bloomberg
Investors should focus on top-quality companies and margin of safety while constructing stock portfolios or investment managers to meet this objective rather than follow the herd. Given the sharp bounce in mid-caps and favorable earnings outlook for large caps, we prefer staying overweight on large caps.
INDIA FIXED INCOME: RBI HAS GOT ITS HANDS FULL; OW CORPS/SHORT-TERM
A pause at the Aug-6 MPC meet came as a surprise for certain quarters which was later followed by hawkish commentary from all MPC members. The words inflation, growth and uncertainty appeared 147, 43 and 12 times in the MPC minutes giving a hint as to stagflation weighing heavy on the minds. RBI finally bowed down to sticky headline CPI staying higher than its upper bounds for several months in a row, though, in their own words, it is transitory and expected to cool down in 2HFY21. It also announced a ring-fenced one-time restructuring for moratorium loans (including personal loans for the first time). Petitions have been filed to waive interest on loans for moratorium period as also the interest on interest which the SC is currently hearing. RBI’s Financial Stability Report pointed to scary GNPA ratios of 12.5%/14.7% for SCBs under baseline/very severe stress scenarios. Waiver or not someone is bound to get hurt.
G-Sec supply concerns led to heightened volatility in Aug
Source: Bloomberg
G-Sec volatility shot up as a small tit-for-tat ensued between investors and RBI – debt manager for the Govt. RBI quickly announced Operation Twists to address the G-Sec supply concerns. The fiscal deficit for Apr-Jul came in at 103% of BE and severe downgrades were seen in below AA segment, hence, we continue to be wary of G-Secs and lower rated bonds. We prefer high quality corporate issuances or funds and short duration investments in portfolios.
CURRENCY: CONTINUE OW ON INR AS USD SHOWS SIGNS OF WEAKNESS
As envisaged, the dollar index weakened to levels last seen in Apr 2018 as it depreciated against all other major currencies. The EUR/GBP/CHF are now up 8.7%/10%/8.8% on a YoY basis vs USD. The INR also gained as FII flows and FX reserves made record-highs supplemented by the current account moving into surplus zone. The up move was further accentuated by RBI’s withdrawal from USD FX spot buying as it focused more on INR liquidity through the OMOs. The moderation in EMBI spreads and VIX could lead to further FII flows. Technical indicators are also suggesting USD-INR in a downtrend and there is scope of a move towards 71.50-72 which is a multiple support zone.
RBI has been actively managing USDINR in FX spot market
Source: Bloomberg
GOOD TO KNOW:
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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 31-August-20.
ROUTES TO MARKETS: MODEL ALLOCATIONS
