21^st July 2020

An unprecedented rally, despite once in a century PANDEMIC, has foxed most market participants!

Since the lows made in March 2020, both Indian as well as US Equity markets have witnessed one of the most stunning and unprecedented rallies. They have shot up close to 45% in a short span of 3 months.

In the backdrop of once in a century PANDEMIC, this up move has foxed most market participants as there is a complete disconnect between the grim economic outlook on one hand and the buoyant Financial markets on the other. What is behind this move!

1. First, the rally was driven by the gush of liquidity/low interest rates, as the central banks all over the globe, expanded there balance sheets aggressively. In an unprecedented move, they pushed the envelope further, by extending purchases to include Corporate Debts too.
2. Second, investors and analysts moved their attention to FY 22 & FY 23 earnings rather than FY 21, which they all understood was going to be a washout
3. Third, since June, the reopening narrative has been driving the optimism. Market is currently factoring that the second wave of COVID 19 is not a likely outcome, despite the opening up of various economies.
4. Fourth, the expectation that vaccine will be available early (by end of FY 20) is further fueling the optimism. Moderna & Oxford are the front runners in this race.

How does the valuation stack up?

We have evaluated the valuation on two metrics – Market Cap to GDP ratio & NIFTY earnings multiple. As this year is going to be a washout year, estimates for FY 22 have been used and compared with historical averages and range.

NIFTY is currently trading at a multiple of 18.0, based on FY 22 earnings estimate as against historical average of 14. (Note Multiple is based on 2 year forward estimates)

Market Cap/GDP ratio is currently 0.8* as against 0.5 to 1.0 range historically

(Note – * 0.8 ratio assumes that FY 22 will have the same GDP, and the market cap will grow at 10/12% by the time it is FY 22)

On both the above counts, market looks somewhat expensive, if we factor in the uncertainties. On one hand, there is risk that vaccine may get delayed. On the other, there are possibilities that second wave of COVID 19 may resurface. One can already see evidence of this happening in USA with daily numbers of new cases averaging over 70,000 per day.

What does the Market Technicals indicate?

US market (S&P 500) has been ranged between 3,000 to 3,240 since last two months, after a big upward move in the month of April & May. The momentum seems to have slowed down since then and the market is looking somewhat tired.

As regards the Nifty, it closed above the 200-Day Moving Average of 10,870 on Friday, a key hurdle level. This was the first time, since the slump in the stock market that started in February 2020. The index is currently trading at 11,150.

While Nifty may be poised to move up by another 2-3%, the market looks overbought with the index gaining 45% from the low of 7,511 on 23^rd March 2020. RSI at 72.5, too reflects the overbought conditions.

What factors will decide the future market directions?

a) Central banks may need to shrink their balance sheets

As economies recover or inflation creeps in, the central banks may need to unwind the expansion of their balance sheets. This in-fact can be a significant drag on the markets and can quickly reverse the sentiments.

b) Markets to remain watchful of the Second Wave of COVID

The numbers are rising sharply in USA, India, Russia & Brazil. While the situation in other major economies looks to be in control, but we need to monitor the situation carefully. If the numbers keep rising, this can upset the positive sentiments.

c) Sero Survey done in 1^st week of july – Results for Delhi

Around 15% of Delhi’s population appears to have been infected with the coronavirus disease, according to initial results of antibody testing of 22,823 people across the Capital. Places like Delhi / Mumbai and other major urban agglomerates may soon be reaching the peak of new cases. This is because as greater number of people get infected, they no more transmit the disease, leading to slowing down of the transmission chain. The decline in Coronavirus cases in New York possibly happened due to the same reason. Hence, COVID 19, may not be a big issue anymore, as cases peak out or else vaccine is available by early next year.

d) Vaccine Development – Time-frame

Market participants are expecting that vaccine will be available by the year-end.

• Moderna; Phase 1 trial has shown very positive results both in terms of generating anti bodies on almost all the people, as well as not having any side effect.
• University of Oxford in collaboration with AstraZeneca has been developing a potential coronavirus vaccine. The vaccine candidate has already entered Phase 3 of human trials.

e) Geo Political Factors

Though US has reaffirmed, its trade deal with China, the simmering tensions between them may affect markets

f) Indo China Border dispute

Any flare up in the ongoing border tensions can impact the market. Further, as India aims for lesser trade dependency on China, certain sectors may be impacted positively

g) Additional stimulus package in Europe & USA

Both European Union & USA are considering approx 1 trillion USD of additional stimulus package. Early passage of these packages will hold the key to market sentiments in the developed world.

What is WealthSpring’s Equity Strategy?

At current market levels, we have gradually reduced our Equity allocation to 50% levels. Despite the significant optimism (liquidity, positive sentiment around reopening as well as early vaccine narrative) that prevails in the market, we do not plan to increase Equity allocation at current levels.

It is interesting to note that all sectoral indices other than Banking and Financial services are trading above the Pre Covid levels. It is as if there was no PANDEMIC!

As regards Technicals, we feel that US markets are looking tired. Indian markets too are overbought after a one way run-up of 45% during the last three months.

In view of the several positives that exists such as abundant liquidity, cases peaking out over the next few months in larger urban agglomerates as well as early vaccine possibilities, we plan to use any dip to 10,200 to 10,300 levels to increase Equity allocation to 70%.

Our Sector-wise Take

 

Sector	Weightage	Remarks
Banking	UnderWeight	We are somewhat underweight in this sector. The Banking sector’s loan book is about Rs 100 lac Crs and the total capital of all the banks put together is Rs 11 – 12 lac Cr. So if 4% to 5% of the loans turn bad due to COVID 19, the capital position of the banks gets impacted by 40%. Hence, the financial sector will need to be recapitalized. This will lead to significant dilution and that is why we do not expect banks to bounce back to pre COVID levels.
IT Sector	Overweight at lower levels	IT sector is well supported in view of greater offshoring tendency and also greater digitization in view of more remote shopping, remote content, remote education, Work from home etc…, The sector has bounced a lot in last 10 days. We plan to buy if we get a chance at lower levels.
Telecom Sector	Overweight at lower levels	– Bandwidth requirement will go up multifolds over the next 3 to 5 years. As capacity additions will be constrained, we expect ARPU to go up. – More interesting is the fact that for many of the value added services in 5G, technology companies need to partner with Telecom Operator such as for IOT, Autonomous cars etc. Hence Telecom operator will capture significantly greater portion of the value chain
FMCG Segment	Underweight	Valuation is too high. While last 10 years has been great for this sector, we expect that the next 3 to 5 years will be muted.
Automobile Sector	Neutral	We are overweight Heavy Commercial vehicle though (such as Ashok Leyland)
PSU Segment	Strong Overweight	The valuation is compelling and Dividend yield high. Strategic divestment can be a significant re-rating trigger. We plan to increase exposure at lower levels
Retail, Multiplexes, Airlines	Overweight	Vaccine visibilty is the trigger. Aditya Birla Fashion may be an interesting pick

What is our view on the Fixed Income Markets?

While there is still some juice left in the longer duration papers, however as the uncertainties on COVID 19 front reduces, we may have to quickly reverse our stance and move towards shorter maturities.

On the credit side, while AAA PSU bonds have had a great time since last 2/3 months, there is still value left in AA & AAA private sector papers.