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More of the Same

Aug 4, 2020

A cursory look at the headlines most of the past month would conclude that the theme was ‘some more of the same’ – rise in covid cases, disconnect between equity markets and economies, printing of currencies, expectations from Fed, US-China rivalry and uncertainty around the roadmap of the near future.

Global Macro

The United States has 4% of the global population, but over 25% of the 15 million diagnosed COVID-19 cases globally. This is an important data point as the country is a dominant economic force globally. Until now the stimulus contributed in limiting the pain but at the time of writing this the US Congress had allowed the USD 600 per week extra jobless benefit to expire. It is expected that a scaled down version of the benefit will be extended. Considering, as per a University of Chicago study, 68% of those collecting this money have been getting more than what they made earlier, the impact of scaling down of the benefits maybe felt in consumer spending.


Eurozone could be the ‘dark horse’ with Covid under control and lead influencers i.e. Germany and France agreeing on a stimulus and debt plan that could potentially set the stage for better growth in the coming years. European growth next year is projected to outpace the US by the biggest margin since 2007.


The economic recovery in China appears to be more mixed than the official data shows. As per China Beige Book’s latest survey, for the past quarter 30% of firms reporting outright contraction in sales nationally versus 33% seeing expansion. Among firms with declines, over a quarter saw sales fall by more than 10%.

Global equities marched shrugging of all concerns including a debt warning to US from Fitch. In contrast to the Robinhood investors there appears to be some sense of unease amongst larger investors. Sovereign Wealth funds held the lowest level of equities since 2014.


Debt yields around the world resumed their march downwards reflecting a combination of muted recovery expectations and more policy action. Real yields in many parts of the world are trending toward zero/negative and hence the theory that the consequent financial repression will cause asset prices to rise is gaining decibel. We think this could be applicable to India too in the long term and therefore, irrespective of the near-term uncertainties, Indian equities hold long-term promise.


While re-opening of the economy has been making headlines, localized lockdowns has been weighing down on our economic recovery. Export recovery outpaced non-gold import recovery and major port traffic slowed down. Rural India, however, is proving to be somewhat of an oasis with lower covid cases, increased allocation to rural employment guarantee scheme and a good sowing season in progress.

Indian Equity

While the equity markets have been chugging along since the big crash in the first quarter of 2020, there was some unease about the rise. However, as earnings started coming through better than expectations and reliance announced blockblusters deals of its Jio platform, the unease gave way to optimism. Pro-EM sentiment also helped boost markets.

Indian equity markets were up 7.5% largely aided by Reliance Industries (up 21%) IT Index (up 22.5%) and Pharma Index (up 11.7%). Sectors we have been expecting to demonstrate earnings resilience through these times are Pharma, Consumer Staples, Non-lending financials, Information Technology, Telecom and Export and Agri linked companies. Early earnings trends seem to support our stance.

Earnings Update

The earnings season for quarter ended March 2020 had barely ended and we are already in the next earning season. As of now 24 of the 50 Nifty companies and about 120 NSE 500 companies have released their earnings for Q1 FY2021. Given that economy was under lockdown for most parts of the quarter a sharp decline in sales and profit was expected. However, the corporate earnings have been better than expected so far. Sales for these Nifty companies has declined by 9% YoY while net profit has declined by 12.2% YoY. For the NSE 500 companies, sales has declined by 11.9% YoY and net profit has declined by 7.3% YoY.

Operating profit margins for most companies have also been better than expectations. In fact, for the NSE 500 companies that declared their earnings results currently, operating profit margin ex of financial sector has improved to 23.6% in Q1 FY21 up from 22.6% in Q1 FY20 and 21.4% in Q4FY20. This suggests possible cost cutting measures, improvement in efficiency adopted by firms. Large part of margin expansion was led by Healthcare, Materials, and Consumer Staples sector.


Indian lenders have been at the centre of investor attention ever since the RBI announced moratorium on loans in April 2020 and then the extension till end of August in May 2020. Most large private lenders saw their book under moratorium decline from about 25-30% of their book to less than 20% and in some cases as low as high single digits. While this is a positive development the real extent of the damage to asset quality of Indian lenders will only be known once the moratorium ends and lenders start collecting pending dues from borrowers.

However, one thing is evident the better-quality lenders with good balance sheet, strong liability franchise, good credit management teams and sufficient capital could consolidate market share in current times. They have better ability to absorb any rise in NPAs. They will also be able to deliver loan growth when demand revives given stronger liability franchise. Finally, in current environment as other lenders suffer, better-quality lenders could potentially pick and choose the better-quality borrowers.

Portfolio Strategy Commentary and Actions

On a 12 month forward basis we are currently trading at the most expensive valuations ever. As earnings recovery gains momentum the metric may moderate, but only if it doesn’t get outpaced by this liquidity fuelled rally! Through this entire period of uncertainty, we have focused on managing risk over chasing alpha. That has held us in good stead during the peak crisis. As extreme fear receded, we put cash to work but maintained a defensive stance in our portfolios and continue to do so. We think the equity markets may be getting ahead of itself and this may not be the right time to add risk into portfolios.


In our techno-fundamental strategy Sanctum Smart Solutions, we protected downside by aggressively hedging portfolios. When hedging costs turned prohibitive, we increased cash allocations. As markets demonstrated momentum in April 2020 we deployed almost all of our cash but have continued to focus on managing risk by hedging portfolio partially and by buying deep out-of-the-money puts to protect in case of sharp corrections.

The strategy is designed to hold a significant part of the portfolio in Nifty stocks that exhibit momentum strength in the 12-15 month period. We churn this only when the long-term trend changes rather than applying short stop losses. We have termed this the ‘Stalwart’ segment of the portfolio. Our weights in Reliance, Pharma and Telecom have helped this segment deliver a return of 3.8% over last 6 months.

The ‘Star’ segment, a relatively smaller part of the portfolio, primarily comprises large and midcap industry leaders that we hold for the medium term. Sharp rally in the midcaps and larger pharma stocks helped shore up the drag from financials and limit loss of the segment to 1.4% in last 6 months.

The ‘Satellite’ segment which usually is 20%-25% of the portfolio is meant to take higher risk and therefore has stricter stop loss measures. A lot of the positions got stopped out as markets corrected sharply in March-April. As the negative trend intensified, we cut down exposure to this segment to single digits and maintained cash.


In line with our global market views, in Sanctum Global Allocator, our portfolio management strategy that invests in domestic feeder funds of global funds, we added to European equities toward the end of May. European equities had been left behind in the global rebound post the crash in March 2020 and as highlighted above prospects for European equities seem better. On the other hand, we reduced weight in US and emerging markets equities last month and are underweight both the geographies. We currently hold about 10% cash as protection against the run up in the markets over the past few months.


Fixed Income and Alternate Route to Markets

Fixed income markets have seen stellar returns over the last few months as global central banks cut policy rates and provided significant amount of stimulus in anticipation of economic slowdown due to the ongoing pandemic. On similar lines, Indian fixed income markets have rallied hard and as highlighted in our previous commentaries this has meant that most of the low hanging fruit has been taken. Yield on AAA corporates is sub 5% for short-term papers and sub 6% for longer-term papers.


On the other hand, going down the credit curve is still fraught with risks as weaker firms could face disproportionate amount of stress amid economic slowdown. While there could still be opportunities in select names in AA to A+ segments, there are limited avenues for those looking at regular income at low risk.

We believe, such clients should consider Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) to get a regular income as well as diversify their portfolio. For the uninitiated, REITs pool in money to invest in real estate properties while InvITs pool in money to invest in infrastructure assets. Both are mandated to invest 80% of the money in completed, rent/income generating assets. REITs and InvITs are also mandated to distribute 90% of the money collected to unit holders.


The segment is fairly new in India and we have only two of each type available. And some of them have good quality assets, stable cash flows and are trading at attractive yields relative to high quality fixed income assets making them attractive investment opportunities. Case in point being the stellar demand seen by recently completed IPO issue of Mindspace Business Park REIT. Notwithstanding general concerns around possible slowdown in commercial real estate leasing as work from home gains traction, the IPO was subscribed 13 times overall, and 15.8 times in the HNI/ non-institutional investor category. The performance of the IPO highlights the realisation within investors as well as wealth managers to diversify their portfolio into other assets as well. We believe, for long term investors these instruments are worth an allocation in their portfolios at the right price.


Gold has been one of the best performing asset classes in the past year. INR gold has rallied by close to 50% in last one year and traded at an all-time high of INR 53,615 (MCX Gold Spot for 10g of gold) on 31st July 2020. While a weaker INR against the USD helped INR gold, even in dollar terms gold has gained almost 38.5% in last one year. As yields in US/Europe shrink further this asset class is gaining further momentum. Geopolitical tension is another driver of gold and the US- China trade rhetoric has been escalating over the past weeks after a brief lull. Consumer demand for gold, however, has been weak. According to a world gold council report jewellery demand plummeted by 46% in the first half of the year and bar and coin demand fell by 17%. This is understandable as consumers tend to reduce discretionary spends in times of uncertainty.

The question we are asked often is, are we now late to the party? We believe, many of the above-mentioned factors are still supportive of gold. While countries have lifted restrictive lockdowns, economic activity in most parts of the world has not returned to normal. The Covid19 pandemic is not yet over. US China tensions have only increased as both countries ordered shutdown of each other’s consulates. Even as equity markets have rallied uncertainty remains. Similarly, low interest rates look like they are here to stay. Given the extent of economic dislocation expected it is unlikely that global central banks would tighten monetary policies anytime soon. Finally, technical momentum also suggests positive long-term trend for gold.

Another factor to consider is the opportunity cost, i.e. investment opportunity offered by other asset classes. As we discussed above, high quality fixed income assets are offering low yield, taking credit risk is not advisable, equity markets could be volatile going forward even as they have rallied over the last few months. This suggests limited opportunity cost of holding gold. We continue to remain overweight gold in our model portfolios.

Technical Trends

Nifty is forming a high top and high bottom structure on daily chart since April lows. It is currently facing resistance around 11,300 levels where the rising resistance trend line connecting highs of 10,553-10,811 is seen. Thus, Nifty needs to cross and sustain above 11,300 levels for a rally towards 11,650 levels. Above 11,650 the next resistance is 12,000. In the immediate short-term 10,900-10,850 levels are supports where rising support line connecting lows of 7,511-8,807 is seen. We can say there is a reversal of trend only when Nifty breaks below the previous swing low of 10,560. If Nifty breaks below 10,560 the next support is 10,200 and then 9,900. India VIX after decline in latter half of June month is again stabilizing in the region of 26-23. Any move above 26 it is likely to lead to profit booking in the market.


Gold continues to be in an uptrend. It has formed a major base and has seen a breakout on the upside to a high of 1,983. In the short-term prices can rally towards 2,240 and over the medium-term towards 2,450.

US dollar index has broken below the support zone of 95.70 and 94.65. Now next major supports are seen at 89.20-88.50 levels. USDINR is range bound between 76.50 and 74.80. Brent crude is also range bound between 37-45 levels, consolidating after the recent rally. However, the bias for Brent crude remains positive and if crude crosses above 45, we can expect a rally towards 50 and then 54 levels.


We think our holding positions do not warrant a change since the environment we are in, remains much the same. We continue to be fully invested in equities but with a defensive stance. We had mentioned in our last note that excessive liquidity tends to upfront moves and we witnessed this in the AAA/AA+ private sector bonds. The spreads have collapsed and are now at/marginally below long-term averages. We recommend investors to incrementally invest in Ultra-short term funds and bide time for better investment opportunities. We continue to scout for fixed income oriented alternate opportunities as we think over the next 2-3 years returns from debt funds may be around mid-single digits. We have been overweight gold much of the past year and continue to maintain our position.

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