Playing in the safe zones

COVID-19 developments continue to drive sentiment. The Indian trends with the virus remain largely intact with recorded coronavirus cases reaching new peaks, recovery rate relatively high and mortality rates surprisingly low. Containment and restriction measures, although with some relaxations, persist in regions, especially key urban centres, in August.

Supply-side easing

Activities in the supply side of the economy largely continue to improve in rural, industrial and urban districts, except perhaps segments like perishables that are reflected in the higher consumer price inflation prints. High-frequency indicators suggest that, after witnessing a strong recovery, the data is plateauing.

Recovery plateauing

Demand pick-up is expected to be largely led by the rural economy in the coming months, duly supported by government initiatives, a good monsoon season and better income support. The urban population is getting more used to working from home and forming larger “social bubbles” and “safe zones” that may revive some demand beyond essentials.

Employment and credit are key

The return to the normal Indian consumption trend from the pre-crisis era, however, will be gradual at best. As indicated by the unemployment data published by the Centre for Monitoring Indian Economy (CMIE), after sharply recovering to the pre-COVID-19 levels in July, the data worsened in August in rural and urban segments. CMIE’s latest publications indicate that salaried jobs have taken the biggest sustained hit in the quarantining phase.

By contrast, while informal jobs have increased from pre-pandemic levels after being hit by the lockdown, formal jobs have not. Non-salaried forms of employment have risen to 325.6m in July from 317.6m in 2019-20, or 2.5% growth in informal employment. However, salaried jobs are 18.9m lower, a whopping 22% loss during the lockdown.

Wage bills on the up

The wage bill for 1,560 listed companies in India nudged up 2.9% in the three months to June compared to the same period a year ago, according to declared results to mid-August. This is the lowest growth in wages in 18 years. Banks saw a 16.6% surge and securities brokers a 13.5% hike in wages. Meanwhile, manufacturing companies’ wages shrank by 7%. The services sector was a mixed bag.

A sustained recovery in employment and wages is a key indicator to watch out for. Other factors worth bearing in mind are how the emergence of lenders from debt moratoriums, loan restructuring and a looming potential credit crisis affect an expected pick-up in credit demand.

Markets taking the lead

Financial markets continue to take the lead on recovery expectations, taking support from the high liquidity levels, low rates and an accommodative monetary and fiscal stance. The limited room for further fiscal stimulus or monetary policy support appears likely to be used more sparingly and at a slower pace in coming months.

While this can support a higher base for valuations, leaving aside the possibility of major corrections, it may not be able to push the beta performance higher much further. Market polarisation in favour of resilience, quality and liquidity are likely to deliver alpha, with more businesses getting sucked into these “safe zones”.

Time to be nimble

With high valuations across asset classes, margins for error remain low in the safe zones. Investors need to be nimble, yet careful, in sectors and securities selection. In the search for yields and returns, risk analyses should not be compromised, especially when some of the risks are not easily measurable yet (for instance, credit risk).

Sticking to one’s asset allocation, portfolio diversification (including US equities, gold and private assets) and active management continue to appear key. Also, investors might lower their return expectations – not just due to lower risk free rates, but also lower risk premiums and alpha from active management.

Booked some profits on debt

With the consumer price index (CPI) at 6.9% in July, the risk of inflation remaining elevated in coming months appears higher. This may push out further rate cuts beyond the next policy cycle. Further, the inflation prints may remain vulnerable to risks from continued supply-side pressures, commodities and crude oil price reflation or domestic currency depreciation.

Our tactical overweight position on debt has seen significantly positive moves year to date in 2020 on the back of interest softening cycle and ample liquidity. While the Reserve Bank of India (RBI) is likely to cut rates by 25-50 basis points (bp) in the medium term (after 115bp cuts in repo rate cuts in calendar year 2020), the timing of the cuts may be delayed. Hence, it may be time to take some profits off the table, with our tactical stance on debt having shifted to neutral from overweight in mid-August.

Safety and quality

We expect a good monsoon and robust sowing season to contribute towards an eventual lowering in inflation. We also expect the RBI to continue with its accommodative stance, maintain ample market liquidity and “do what it takes” to support India’s economic growth.

In the medium term, potential headwinds include a significant increase in bond supply from the central government, state governments and public sector undertakings (due to fiscal slippage). This may lead to a continuation of the steepness in bond yield curve, with longer end rates remaining volatile and shorter end rates remaining low.

We continue to stick to our parameters of “safety and quality” with a view that once the loan moratoriums and associated forbearances are lifted, more downgrades and even possible defaults may follow. As such, high quality assets in the two to five-year segment seem attractive.

Indian equities

While we maintain our tactical neutral stance on Indian equities (as represented by broader indices), with risks balanced on both sides, opportunities exist to generate alpha as the “quality” basket of stocks widens in more sectors and in mid and small-cap equities. Buying possibilities may also arise as investors look for the lead sectors in the new cycle.

While valuations remain rich, especially in the “safe zones”, with any earnings beats getting priced in, money waiting on the sidelines for a meaningful correction is facing significant fatigue. Increased interest and flows witnessed in the primary markets and secondary sales (with qualified institutional placements and stake sales in excess of $20bn in the past four months) as well as private equity deals validates this as well.

For investors waiting to deploy their neutral allocations to equities, building up one’s appetite for short term volatility and focusing on bottom-up business dynamics and stock selection can help in taking deployment decisions. Staggering investments and portfolio re-balancing may help to smooth the ride for those who cannot bear particularly volatile returns.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

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