Time to go neutral on equity & use STP, BAF; look at duration in debt & gold ETF (2024)

We are experiencing the perfect storm of medical, financial and real-life crises. The huge liquidity influx from central banks helped push up asset prices. Major countries have announced massive fiscal stimulus to the tune of $7.4 trillion in response to the Covid-19. The resultant fall in interest rates has pushed around 86% of global debt instruments below the 2% yield mark.

This extremely high liquidity and extremely low interest rates around the world has helped markets, both on the bond side as well as on the equity side, recover from the lows of March-April 2020.

But there is extreme polarisation happening between the leaders and the rest. Top companies in some sectors such as technology, pharma and FMCG have seen more interest from investors while the second-rung ones are seeing limited focus. Top quality companies with little to no leverage and working capital efficiency are drawing investor attention. The same trend seems to be true in the US equities market too. There, the top tech companies seem to be outperforming the broader S&P500 index significantly.

The miracle economy is China, from where the virus originated and which is showing economic activity levels anywhere between 80-100% of pre-Covid levels. And this growth seems to be coming on the back of very high debt.

On the Indian economy front, overall expectations of GDP contraction range from -5% to around -10% for FY21. Earnings for Indian companies have also come down drastically. It is estimated that around 30% of companies in India make RoCE at least 2% higher than the cost of debt. In FY10, that number was close to 90%. This shows that the space to service overall debt has declined.

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Business resumption seems to be stuck as capital formation remains lukewarm. When your capacity utilisation is low, you will shy away from investing additional capital. Corporate India’s fund raising will also be hurt, as nearly half of the credit ratings across rating agencies have fallen into the ‘issuer not cooperating’ category. If we can improve our ease of doing business on the ground, then things can be very different and growth can recover substantially.

In this scenario, rural India may come as a saving grace for the economy. The government support to the rural sector by way of NREGA and PM Kisan Scheme is cushioning the impact. Relatively normal monsoon and strong sowing patterns also indicate the possibility of Bharat supporting the GDP.

Having said that, consumption metrics of urban India is showing revival. Power consumption has come to last year’s demand level. Mobility trend for workplaces is also showing an improvement.

But there are companies across sectors, which have been able to improve their working capital cycle by reducing both inventory and debtor days.

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From the market’s point of view, EPS estimates have seen sharp cuts in the past few months and may see further drop. Going forward, markets would be moving like a pendulum between optimism and fear based on various factors such as valuation levels, US-China relationship, out of the US presidential elections, consumption trends, trade & supply chain behavior and progress on a medical solution on Covid-19.

Current Nifty50 level @~11,000 is discounting lower gold imports, lower oil prices and lower trade deficit with China, a rebound in economic activities, smooth execution of economic package reforms, monetary stimulus, potential higher FPI inflows, medical solution round the corner. If the actual situation is better than this, then the market will continue to rise and if it’s worse than this, then the market would fall.

In this testing time, investors have to be selectively optimistic, focus on quality companies, and follow asset allocation strategy. From March 2020 onwards, we have been suggesting an ‘overweight’ on equities, but now we believe it is time to be ‘neutral’ on equity allocation looking at the sharp runup in prices and valuation and the potential crisis ahead.

Lumpsum investors can utilise this time to invest in high quality short duration debt funds and can initiate systematic transfer plans into a balanced advantage fund or equity funds. Recalling the 2008 experience, we suggest investors must stay steady on the SIPs. Lessons from 2008 crisis show those who continued with their SIPs, rather than pause or cancel them, generated wealth over long term.

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Now play duration in debt, go bottom-up in equities

Distributors can add value by suggesting prudent asset allocation to their clients. Prudent asset allocation will be critical in helping ride out this period. Equity overweight investors can consider dynamic asset allocation strategy. A BAF strategy that has low downside risk and higher upside potential provides a good investing option. Conservative investors can consider a debt hybrid strategy where the equity component is 25 per cent or less. This strategy keeps the equity risk limited and allows for debt component to anchor the investment and keeps volatility low and the equity component may deliver when equity markets enter bullish period.

We have been suggesting investors to look at gold allocation since beginning of March 2020 as we believe it is likely to do well. We are still bullish as central banks continue to cut rates and pump liquidity.

Gold ETFs across the world have received significant flows and today gold ETF inflows are higher than equity ETF flows.

On the debt fund side, we have been suggesting investors not to redeem in good quality credit risk funds as it was opportune time to stay invested. Investors can continue to invest in credit risk category from a three-year perspective as the current elevated credit spreads provide attractive opportunity to invest. We believe it is time to be long on duration. The long-term inflation outlook is on a downward trajectory. RBI has also adopted a benign and accommodative stance in the market and has more room to cut rates in future. In this scenario, investors can look at dynamic bond funds from a three-year plus perspective. This is the time to take one step on duration as interest rates are soft and likely to come further down.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

Time to go neutral on equity & use STP, BAF; look at duration in debt & gold ETF (2024)


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