Equity To Remain Attractive Despite Challenges

Even as the corona virus shock dictates how global economies perform in the near and medium term, it is fundamentally reshaping the investment landscape for global investors. There are accelerating structural trends in inequality, globalisation, sustainability and macroeconomic policies triggered by the virus shock. Amidst heightened uncertainty, strategic asset allocation becomes the most crucial investment decision. Yogesh Supekar discusses the outlook for the equities with the help of industry experts while Anthony Fernandes highlights the YTD performance of various global indices and asset classes

The Sensex is up by almost 46 per cent from its corona virus-pushed market lows in March, 2020. This sudden, sharp and smooth recovery has not only surprised market participants but has also led to some confusion in their minds. Usually stock markets are leading indicators of economic reality and stock prices often reflect the optimism seen in businesses in real terms. But the stark contrast in stock prices and ground realities have pushed several market commentators to conclude that there is less or no correlation between stock prices and the economic realities – at least in the near term.

There is also a raging debate on whether the financial crisis of 2008 has done more damage or whether the virus-led disruption has led to larger disruptions in the market. The comparison, many believe, will help us understand how and by when will the global economies start operating at full capacities. Taken at face value it does look like the initial pandemic contraction is larger than the great financial crisis (GFC). However, the manner in which the policy response has been executed and the cumulative impact on the economy will likely be much less in the current crisis when compared to the GFC situation. The strong policy response will cushion the blow much better than it did during the financial crisis of 2008.

The US Federal’s attitude to do ‘whatever it takes’ to bring normalcy in the markets has appeased investors globally. In fact, the US Federal has used its full range of tools and at times created new ones in a far shorter timeframe than in 2008. These policy actions have fuelled the current stunning record-breaking rally. As of now, the global financial system is flush with liquidity and the dilemma faced by global institutional equity investors is whether to chase growth or value. Emerging markets (EMs) have always been looked at as ‘growth markets’ by the developed world.

What the virus crisis has done is given a generational shock to EMs. The long-standing pillars of EMs have been superlative growth, strong balance-sheets and fiscal discipline. All these three pillars are now challenged due to the ongoing crisis. Each country will be studied with a microscopic view and the country with best fundamentals and fastest recovery from the current crisis may attract maximum investments. China, since it restarted its economy fastest, has a clear advantage over its EM peers. India is struggling with its infection rate now being the fastest in the world.

Thus, if investors want to know if the recovery in the equity markets both global and local is sustainable, the following signposts need to be tracked closely. 

☛How successfully the economies are restarting themselves while controlling the virus spread.

☛What steps are being taken by policy makers to minimise the economic damage with stimulus packages to support industries.

☛Whether there are any signs of permanent scarring of productive capacity.

Long-Term Impact of Pandemic

With the dynamics of business and economies changing it is expected that the fundamentals will be impacted for industries across countries due to macro changes. Some of the expected long-term impacts across world economies include:

☛Lower interest rates will prevail for much longer than expected. n Globalisation may reduce to unprecedented levels.
☛Huge debt may get piled up, both by the government and the corporates while the share of governments in respective economies may increase
☛Low inflation exists right now but there is risk of higher inflation going forward, and in some of the economies there might be stagflation. This is a situation where inflation increases with overall growth in the economy being muted.
☛Corporate profitability, one would argue, may increase due to increased use of technology on account of lockdowns generating cost-savings and productivity improvements. However, slower economic growth, inefficient capital allocation, higher taxes and labour issues can be expected to impact the profitability negatively.

Indian Market Performance

With the kind of challenges faced by the markets and the economy one would have expected a very different kind of performance from equity markets. Instead, what we have are at least 45 stocks from the list of 500 stocks that are BSE 500 components doubling on YTD basis so far. Over 1,000 stocks across market capitalisation gained more than 50 per cent since March 23 when the Sensex hit the bottom and as many as 318 stocks gained more than 100 per cent. Up to 715 stocks have hit fresh 52-week highs since March 23 and as many as 1,497 stocks have touched their respective 52-week highs in 2020 so far. In 2019, a total of 1621 stocks were seen making 52-week highs. This goes to show the momentum in stock prices in 2020 despite being faced by a deep crisis.

The highlight of the 2020 market so far has been the retail investors’ participation which is close to all-time highs, inching close to the performance of the year 2000 when retail participation was at its peak. FIIs and DIIs were net sellers while retail participation was on the rise since March 2020. Also, the performance of penny stocks took many by surprise with several of them proving to be multibaggers. This goes to show that the risk appetite of the investors has increased across the board over the past few months, thus leading to higher participation.

The liquidity-driven rally has pushed Indian markets further into ‘rich valuation’ territory. Says Vinod Nair, Head (Research), Geojit Financial Services: “In terms of valuation, they are ahead of fundamentals. In PE terms we are already above the pre-pandemic level. S & P 500 is at 22x on 12-month forward basis compared to 18x. And Nifty 50 one year forward PE is at 20.5x, which is higher than 18.5x before the onset of the pandemic. It may be high due to low actual earnings of FY20 and lack of growth in FY21. It is also due to the performance of a few sets of stocks with high weightage. Still, on a historical basis, we are in the bubble range in valuation and it is advisable to be cautious and place assets in safe categories and sectors.”

India in terms of valuation (PE) remains one of the most expensive markets in the world. With PE greater than 26 for Sensex, only Nasdaq and Brasilian Bovespa are the other indices trading at higher earnings multiple. The table below highlights India’s relative performance and the expected contraction in GDP as compared to other countries.

Market Outlook

Rahul Sharma
Associate Director and Head (Technical and Derivatives Research), JM Financial Services Ltd.

Over the last few days, FIIs are on a buying spree in the cash segment, especially after crossing the 11,000 mark, which is either a sign of FOMO or perhaps they are eyeing something which we are not aware of. However, traders are advised to stay light on longs and stay close to the door as it seems like the party may end in the near future. Technically, Nifty faces multiple resistances around the 11,200 – 11,400 zone and if the support zone of 11,000-10,900 is breached this time it may attract a lot of shorting interest from the bears.

Major long-term support levels are seen at 10,350 and 9,800. A correction from here, if it happens, will only make the uptrend healthier. If history has to rhyme with the 1987 crash and the recovery thereafter, we may see corrections getting bought into and eventually markets getting over this year’s crash, which may be triggered by the US’ elections or possibly a vaccine development. Volatility has been a hallmark of 2020 due to which it has been a trader’s paradise so far and we hope the rest of 2020 will be no less. 

Viram Shah,
CEO and Co-Founder, Vested Finance.

"Currently we are witnessing a new wave of Indian investors entering the global markets for the first time. Led by young and aspirational investors who want to own global technology brands, Indian investors are increasingly reserving 10-15 per cent of their portfolio allocation to international markets. Even during the lockdown quarter, deposits on our platform that allows Indians to invest in the US markets grew 50 per cent as compared to the January-March quarter."

Outlook on Small-Caps and Mid-Caps

Rohan Patil,
Technical Analyst, Bonanza Portfolio Ltd. 

From a technical point of view, the small-cap index is moving strongly on an absolute basis. In fact, the Nifty Small-Cap 100 price has moved above the previous week’s swing high decisively, which indicates a rise in optimism. At the same time, it has neglected its bearish ABCD pattern and this gives double confirmation that more upside is due in mid-cap. On a relative basis, for the last seven weeks, it is consistently outperforming the border index (Nifty) and so one can definitely expect a continuation of further retracement of fall from the high of February 2020. In the case of mid-cap, the charts are indicating strength in the current move on an absolute basis. The stronger buying has pushed the Nifty Mid-cap 100 index above 50 EMA and there is a bullish golden cross on a smaller timeframe moving average. All this indicates a bullish outlook but on a relative basis it is not able to outperform the broader index. 

Commodities have rallied in 2020 with bullion markets doing the best on YTD basis so far. On YTD basis the following commodities outperformed Sensex and Nifty:

Deepak Jasani,
Head (Retail Research), HDFC Securities 

What strategy may work the best in the current market situation?

The difference between the macros (which are worrying) and stock market values (which are soaring) creates doubts in the minds of investors to keep participating in the bounce. On the other hand, FOMO is also bothering them. Investors can relook at their asset allocation and bring down the equity portion if it has exceeded the intended allocation as planned by the investor. In case the equity portion has not been exceeded, investors can keep reshuffling their portfolio by part booking profits on stocks that have run up much more than the markets and parking that sum into sectors that are currently neglected and within that sector look for the best 1-2 companies to invest. For investors who are woefully short of the intended asset allocation as far as equities are concerned, they can shortlist 3-5 stocks for staggered investing over the next 5-8 months. 

What is your outlook on IT stocks?

The IT sector can be looked upon as a truly defensive sector currently. The pandemic will have minimal impact on deliveries by IT companies through a combination of work from home and on-site work. Although there may be doubts about spending by key industries globally, resulting in their revenue visibility getting impacted due to the slowdown, IT sector’s importance has risen late due to the urgency by the clients to digitize their operations with a view to compete effectively and keep operating in tough times. Within IT, both the large-cap and small-cap have their own strengths. While the large-caps provide stability in order bookings and execution along with visibility in revenue growth despite the pandemic, the mid-caps have their own niche areas of speciality. These niches help mid-cap companies perform well in certain periods. These niches are also valuable to some investors as was seen in the recent buyout of Majesco US.

What are the key risks faced by the markets? Will FIIs park more money into Indian equities?

The risks include irregular monsoon, rupee coming under pressure, local interest rates starting to rise, emerging markets going out of favour, political setback for Prime Minister Narendra Modi, geopolitical troubles for India including the China front, US presidential elections creating some turmoil globally, stress in the financial sector spreading to the real sector, the pandemic having second and third round of infections, etc. If the global or local situation deteriorates and liquidity taps start to run dry, a sharper fall could ensue.

FPIs have a choice to invest across the globe. Some of them try to arbitrage by borrowing cheap abroad and investing in markets, including emerging markets, keeping in mind the currency depreciation possibility. Currently we are witnessing a virtuous cycle with a feeling of FOMO present in quite a few FPIs despite their belief that valuations are not conducive for fresh investment. Hence, the turnaround in economy and in corporate earnings or continued easy money policy or risk on sentiments across the globe due to no large geopolitical issues or inter-country conflict (even economic) can lead to continued flow into India by FPIs. Any reversal in these can lead to outflows though their quantum will depend on the intensity of the negative trigger.

Dr. K Joseph Thomas,
Head (Research), Emkay Wealth Management

Given the current abnormal situation, are you advising your clients to invest as of now?

The only way to make money in equities is by staying invested, or by making investments consistently over long periods of time. This requires one to invest on a continuous basis as there are opportunities which the markets present at all times. But to achieve this, one needs to shift one’s attention a little bit away from the frontline indexes and look at the broader markets. The indexes may run up, and may suddenly look like they are overcome by fatigue, but that need not be the case with the rest of the market. Whether the markets are up or down, the investment process continues so long as one’s destination is mapped to the long term.

In your opinion, what investment strategy will work in the current market environment?

One of the things to be taken cognizance of is the probability of higher volatility in the markets. This can be mitigated to a large extent by investing in actively managed funds. Here, the fund managers are expected to do whatever is within their competence to tackle the impact of excessive volatility on portfolios. This highlights the importance of investing in actively managed funds. Yet another approach to investing is taking exposures in a measured way. This is nothing but investing in a systematic way, in phases and in smaller lots, at periodic intervals. This is immensely useful because it leaves space for future investments, and allows taking advantage of volatility in the markets. It is helpful to keep a longer time horizon for investments, with appropriate target returns, in line with the risk profile. 

Can you justify the current market rally?

The current rally in the markets has come immediately after a big fall, and therefore it is only natural that the question of justification of the rally is coming up time and again. The market fall came on the spread of the pandemic and the resultant lockdown. The lockdown happened in all the major countries of the world such as US, India, China and almost the whole of Europe. This event was to have far-reaching consequences for growth, output and employment. Severe contraction in economic growth, high level of unemployment, shutdown of factories and production facilities, closure of markets, suspension of all travel, etc. have been the fallouts. We are just going through all this but in varying degrees and intensities as expected.

The fall was occasioned by these developments. So, the fall looked logical and reasonable. Quite soon afterwards the markets started recovering the lost ground. One of the prime factors for a pick-up in the markets is the fact that on two basic parameters of valuation the market looked cheaper to buy, both based on price earnings and price to book. This generated some interest in buying the markets. The intrinsic value of stocks seemed higher than the actual price at which the stocks were being quoted. Therefore, this was a good time to buy.

Coming to the other factors, it may be said that markets always move on expectations – expectations of improvement in economic conditions, growth coming back and employment picking up, and all this resulting in higher corporate profitability and earnings. There is also heightened expectation that a vaccine may soon be found for the pandemic. The market is obviously trying to price in optimism and is moving along in the hope of better conditions soon. Intelligent investors buy when there is contraction and low earnings, and they sell when earnings peak. While there is going to be definite contraction this year around, there will be better conditions as we cruise into the next year. This is getting priced in.

As you may be aware, we have seen liquidity expansion by the central banks in the domestic economy as well as in the US, Europe and Japan, and in many other countries. This liquidity expansion, also known as quantitative easing, has put more liquidity into the system. Liquidity supports markets as it leads to expansion of PE. This kind of expansion in valuation aided by cheap liquidity is behind the rise in the markets. But we need to be careful here. The liquidity-driven expansion may lose its sheen as liquidity gets withdrawn gradually from the system once growth starts picking up and central banks start following less accommodative or neutral polices during the period of economic revival. 

Sankar Chakraborti,
Group CEO, Acuité Ratings & Research 

How is the Indian economy expected to grow in FY21?

Given the severe impact of the pandemic and intermittent lockdowns across the country that are likely to continue across Q2, we are expecting real GDP to contract by 10 per cent in the current financial year (FY21). While Q1 is expected to contract by over 30 per cent, we reckon that the economy will continue to contract even in Q2. What this means is that chances of a V-shaped recovery are rather slim. Instead, the recovery will be more gradual over the next few quarters and culminate somewhere in FY22.

What are the key risks facing Indian economy at this juncture?

Households postponing consumption is to our mind the single biggest risk faced by the Indian economy. This is because consumption is the engine of India’s economic virtuous cycle and all operational as well as capital expenditure is dependent on it. The negative credit off-take as well as contraction seen in other macro variables is ultimately a reflection of weak domestic demand. We note that poor economic performance is not just a function of the current lockdown and the supply disruption thereof but the increasing economic uncertainty that is translating to lower spending and a propensity to save despite a low interest rate environment. A consumption-inducing policy is therefore the key at this juncture and it must precede all else.

Why can’t India print money and inject cash in the economy the way western economy does?

Unlike the USD and Euro, the Indian rupee lacks a reserve status in the world and consequently the excess money supply created by merely printing cash has to be absorbed domestically. It has been observed historically that deficit financing by the central bank (printing money) is often inflationary (lasting at least a quarter depending upon the magnitude) if not utilised productively. In any case, deficit financing is a window of last resort and a consensus between the RBI and the Indian government will be critical. If and when the RBI decides to monetize the government debt on a large scale, a formal plan must be in place much in advance. It is recommended that this money, if created, should be used for capital expenditure instead of household handouts. We believe that there is a possibility of a second fiscal package, if any, to be partially financed via this window. 

Conclusion

As of now, markets lack the advantage of value they had when we witnessed the fastest market correction ever at a time when there was a fall by nearly 40 per cent. The market looked cheap with its PE being close to 16 after the correction pushed Sensex to sub 26,000 levels. With Sensex trading at above 38,000, the PE multiple of 26 suggests the valuations are not very attractive. That said, the ‘known unknowns’ are already factored in and it will be a mistake to have a negative outlook on the equity markets. Cautious optimism is required more than anything else in the current markets.

The recovery will continue as more efforts are being made by policy-makers across the globe to bring economies to normalcy. What matters for equities is the ‘longer-term impact on earnings’. For long-term equity returns, it is important to access the time taken for earnings and dividends to recover to the pre-pandemic levels. With the stimuli packages announced worldwide the recovery is expected to be fast-tracked and some of the economies may see a V-shaped recovery. India may show relatively slow recovery due to lack of stimulus as compared to some of the developed economies.

India is opening up rather gradually and may recover faster with more focused stimulus. The market will take cues from fresh news expected this week. Chances are that it will correct with every hint of negative news. The market outlook is neutral to positive in the near term to medium term with expectations of more stimulus packages to hit the markets even as an increasing number of countries are reopening quite fast. A positive development on the vaccine front will also keep the markets from falling. And even though the high-frequency economic indicators are pointing to a slowdown, it may prod the US Federal to continue with its dovish guidance. This may keep the interest rates lower for a longer period and that augurs well for equities.

Equity investors should remember that record level of fiscal stimulus, sustained lower interest rates and low inflationary environment together create a supportive environment for risky asset outperformance such as equity. The US dollar is sliding and it should weaken as the global economy recovers given its counter-cyclical behaviour. It is observed that the dollar typically gains during global downturns and declines in the recovery phase. A lower US dollar could keep gold prices higher. While shining gold prices is pleasing, the trend often means that the market participants are not confident about the economic growth prospects.

In such uncertain times when the direction is not clear on many fronts, quality always fetches a premium. Those businesses with strong balance-sheet, steady cash flow and quality growth will be chased by both institutional and HNI investors. Thus, it makes sense to strictly stick to quality stocks as the rally may get narrow until further clarity emerges on the vaccine front. It is advisable to have a stock-specific view rather than taking a blanket call on the market. Investors can take long bets on sectors that show promise such as chemicals, specialty chemicals, IT, pharmaceuticals, insurance and FMCG. Buying on dips could be the most profitable strategy in such market conditions.