India continues to witness a perfect storm. A once in century medical crisis has disrupted economic activities, which in turn, is reflected in financial market stress. Sectors catering to necessity are doing better than those catering to luxury. On the other hand, hospitality, entertainment and aviation have been hit badly. Major sectors such as auto, real estate, BFSI are also feeling the stress. Sectors like FMCG, Telecom, agri industries are less affected.
Financial year 2020-21 (FY21) will witness negative gross domestic product (GDP) growth for the first time after 1980. In April, steel production was down 87 per cent year-on-year (YoY) and power generation was down 22 per cent YoY. Overall business outlook, as measured by the PMI Index, was down to lifetime low. The risk of the second wave continues to exist as we do a calibrated opening of the economy.
Other countries are also in the same boat. As per IMF, the US is likely to see -5.9 per cent while the EU is likely to see 7.5 per cent contraction in GDP despite high fiscal and monetary stimulus.
However, there is a silver lining. Fertiliser sales nearly doubled in May over last year. It’s a sign of a boom in the agri sector. Britannia posted over 20 per cent revenue growth in April and May. Power demand has begun to inch up again – a sign of economic activity recovering from bottom. ‘Fastag’ & E-way bill generation of May also show some recovery from bottom.
There is also demand for good quality Indian papers, as reflected in successful offerings by Reliance Industries (RIL), Hindustan Unilever (HUL) / HDFC Life / Bharti Airtel and Kotak Mahindra Bank. MSCI & FTSE has proposed to increase India's weight in emerging market (EM) indices over next quarter. This can bring anywhere between $3-7 billion foreign portfolio investor (FPI) flows in Indian equities.
That said, at its recent peak of over 10,000, NIFTY was discounting a number of these positives. Lower oil Import bill of around $40 billion, lower trade deficit with China due to boycott of Chinese goods, lower gold import bill, smooth implementation of economic package announced by the government, execution of monetary package in terms of improved credit flow and reduced borrowing cost. The market is also discounting an early medical solution to the Covid-19 pandemic in form of drugs or vaccine.
In my opinion, if the actual events and news flow is better than what is discounted by the market, markets can recover from here. On the contrary, the actual events and news flow is worse than what is priced by the market, then one must brace for a steep fall. It will be inappropriate to say that markets have bottomed till medical solution to the Covid-19 infection is discovered.
At current levels, it is time to be overweight on equities. While the market looks expensive on price-to-earnings (PE) ratio as earnings have declined significantly, the market-cap to GDP ratio at 64 per cent is below the historical average of 75 per cent. Forward price-to-book (P/B) at 2.2x is below historical average of 2.6x.
We believe that investors can upgrade their risk appetite by one level to capture below-average valuations and can invest half of their incremental investment in a staggered manner in a falling market. The other half can be invested when the medical solution emerges for business normalcy to return on a permanent basis.
Extremely conservative investors can look at hybrid funds, like equity savings or debt hybrid, for participation in equity markets at the current valuations. Those requiring regular income can activate the sweep (SWP) option in these funds. This will give them higher tax efficiency.
Short-term investors, on the other hand, may consider ultra-short term debt for their investing needs. Likewise, for long term investors, dynamic bond and credit risk funds still provide good opportunities. Prudent asset allocation also calls for some weightage to gilt funds. We continue with our recommendation on overweight Gold and offshore funds like before.
(Nilesh Shah is managing director, Kotak Mahindra AMC. Views are his own.)