Creeping virus: Time to Buy?

Now that you have read the implications and consensus opinion in my previous post, this talks about how I am thinking about the current situation 

What I will watch-out for in next few weeks?

• Whether the rising number of new infection cases, deaths, pressure on healthcare system, along with lesser availability of staple food will create social turmoil? I see it as a high possibility event, albeit it is best to wait to see any evidence. So-far we have been civilized, in India and globally.
• The next few weeks will prove whether the lockdown and ‘self-distancing’ measures that are being implemented succeed in flattening the current exponential path of infection rate. Even if it does, the economic damage it would have caused is immense – latest US weekly jobless claims is 5x the previous high, and therefore increasingly some people (Trump tweeted it too) are wondering if the ‘cure’ (economy lockdown) is more dangerous than the ‘problem’ (virus).  My view is if restrictions are ended too soon, we might see disease continuing to spread rapidly, which will be more dangerous problems later. Remember, as humans we know how to recover from economic recession/ depression, but we have no precedence to combat virus. So while market might cheer the news of no lockdowns, be watchful if we are digging a bigger hole for later. 
• With Wuhan and few Asian countries now restarting operations after 2 months of shutdown, it will be important to monitor if there is ‘second wave’ of infections. This is the biggest fear to my mind, which is not reflected in asset prices, in my view.
• For India, I am keenly awaiting govt. and RBI action to combat this problem. This week, we did set govt. announcing Rs 1.7trn package, mostly targeting bottom-end of pyramid, and broadly composed of existing schemes (only 1/3^rd is new spending). We also saw RBI announcing 75 bp rate cut and providing 3-month moratorium (not loan waivers) on term loans. But we definitely need more, as middle-income, SMEs and corporates are impacted too, and will need some relief on their rents, working capital, fixed charge, etc. We need innovative and unconventional policy announcements, and not the usual textbook approach. This point alone needs another post, but maybe some other day.

The Conclusions

After all the gyan above, which professionals like me are well versed to deliver now, if you are looking to just understand if it is time to buy or sell, and not just hear the politically correct answer, let me share what I am doing for my personal portfolio, which is geared for long-term (note: my professional view is different as objective there is to outperform in the near-term i.e 3-12m on rolling basis). 

After months of patient waiting on the sidelines, in the past two weeks I added 10% weight to Equities at average Nifty level of 8800  taking the allocation from 32% to 42% of my savings on following reasons: 

1. We are in oversold territory (RSI, market depth, no. of index stocks at 52W low or below 200 DMA)
2. Nifty track-record of last 20 years suggests that when 12 and 36 month rolling return is deeply negative or when VIX is at historic highs, the subsequent returns in the next 6-12months have been superior
3. Avg. peak to trough India correction has been 20% in the past 25 years (in US it is 35% in last 150 years), and we are already below that level this week. 
4. Mkt. cap to GDP at 55% in India is hovering around GFC crisis, and 
5. Lastly on my expectations that stock exchanges will be shut in lockdowns and reopen with gap-up only when things normalizes (this point was nullified as Exchanges are classified as ‘essential service’).

As you see most of my assumptions above are sentiment oriented (that might cause short-term pullback), and not really fundamental driven. Despite the fall, the markets are no-where being close to cheap (both on absolute & relative basis), and I believe there is still lot of euphoria around Equities from long-only investors (many compare equity yield to bond yield and justifies higher P/E perennially). While I am no expert on such broader strategy, I aim to now add more to my equity exposure in the next few weeks to take it closer to my targeted Strategic asset allocation (50%). Contrary to the conventional wisdom of 'waiting for the dip' to deploy more, I would rather invest whenever there are 'signs of rebound' and market strength until Nifty reaches 10k. I say this despite some of the skepticism in data I see below:

1. Looking at past market corrections, we are only half-way through compared to GFC (-60%), the Tech bubble (-51%), and 1992 Harshad Mehta scam (-53%) crisis. Not trying to be doomsayer here, but some are comparing current situation to even 1929 Depression, which will be truly unprecedented for Indian markets. So it is better to not be fully invested, and no point trying to be a hero.   
2. NIFTY trailing P/E at 16x is still meaningfully higher compared to 11-13x seen during past major corrections, and against trough of 9x seen during GFC. I am not relying on forward estimates (Nifty forward P/E at 13x, trading almost at historical avg, vs. trough at 8-9x), as no one has visibility and forward estimates are always slow to reflect macro challenges.

1. Asset prices so-far reflect lockdown of few weeks/months and at max 1-2 quarters, but no one is yet positioned for vicious cycle of shutdown-reopen-shutdown existing for next many quarters/ years. We cannot neglect this possibility based on opinions from leading epidemiologists, especially in India, given the population density, ignorance, isolation fear, weaker healthcare system, migrating population, survival need to step out, etc.  
2. The RBI and Finance ministry response so-far has been very tepid, and I fear virus contagion could soon become financial contagion. - we are at risk of credit discipline getting disrupted for retail customer too (just as farmers, micro-finance history), and liquidity drying up in bond markets. The fact that the perceived high-quality Indian banks have corrected sharply with widening bond spreads, implies that there is perceived high level of stress in the system (NPAs could zoom again), which needs to be address soon before it becomes unsolvable.
3. On global equities, I am worried over ballooning Fed B/S (projected at 40% of GDP vs. 7-8% pre GFC) and US federal debt as % of GDP (>100% of GDP), which although provides great support to Equities in the near and medium-term, but it brings perennial risk for the asset class whenever there is regime change, and as US finds it tougher to finance the excesses. Isn't monetisation of the deficit ultimate sin in economics? But who cares to think so long-term these days rite?

Creeping virus: Unprecedented exogenous shock

For those who know me closely, or have been reading my thoughts on this blog, know how disinterested I have been in Equity investing for over two years now. Every time someone pitched a stock idea to me -some IPO name, some midcap winning business, some consumer sector stock which I track professionally- I would find some or the other reason to not passionately believe in that idea. And the underlying reason many times was not just about the business, but more with valuation for broader markets, and euphoria around India equity story. In the process, some of my friends have labelled me ‘skeptic’, ‘mandodi’ (bear), ‘veteran who is scared’, ‘pessimist’, etc. Many times those stock ideas would go higher by 30-40% in matter of few weeks, only making me more vulnerable to their follow-up questions, and sometimes even laughter.

Following brutal market correction in the last 1 month, this post is not to claim victory, as honestly I did not initially envisaged the novel corona virus problem to become so big. It is also not to say that I made huge money by going short (rather made some money by going Long on back-to-back Fridays, and lost some when I was short this Friday). But thankfully by staying Underweight in equities when I had ample liquidity, I am not losing significant wealth or confidence in this downfall, and importantly I am ready with ammunition to make investments in this distress times. So this post is about understanding the implications, market expectations now, etc., and discuss Equity allocation. Despite trying to be as concise and as objective as possible, this post could be long- given that we are in unprecedented situation, I am full of opinion, analysis, and ideas that necessitate penning down for the blog

The Event

• What started as being known as a virus problem in one region (Wuhan, China) in late Jan (23^rd Jan), that would create supply-chain issues, possibly lower demand from China and have negative implications to only few sectors (travel, luxury, autos, metals, etc), soon percolated into a global problem, as the virus spread to Europe (20th Feb) and to US (mid-March). 

• To contain this virus, government in China, and later in most other infected countries have announced lockdowns (restricting movement of people/ businesses), leading to reduced economic activity across the world, and dampening consumer and corporate confidence.
• Amidst this health scare, we saw oil price collapsing (25% on single day, down >60% YTD now) on ego clashes between Saudi & Russia over a production cut amidst potentially weaker demand. While the lower oil price will eventually be good for consumers, it is creating havoc among global Energy producers, some of whom have high leverage, which will negatively impact global credit markets as well.

The implications

• Under this context, investors have fled risky assets (Equities, corporate bonds, commodities), seeking shelter in safe-haven investments like Government bonds, Gold, and US dollar. US equities took just 16 days from peak to enter bear market (>20% fall), quicker even than in 1929 Depression & 2008 GFC, & only second to 1987 selloff.  Currently, SPX is down 25% from its recent peak, after hitting a trough of 34% fall from its peak earlier this week (i.e we did see 13% rally this week from the lows, perhaps first signs of stabilization or selling exhaustion). The spike in VIX index, yield spreads, ETF discount to NAVs, all indicate we are in panic territory, albeit less so than earlier this week.
• In India, the fall has been similar (Nifty@8650 now is -30% from its highs, trough was 7600 making it -38% from highs) and is highly correlated to overnight US market closing and US futures trading during the day. While some may believe India is better positioned (lower crude, lesser covid cases ‘so-far’ helped by proactive response, less reliant on exports), in reality, the screen doesn’t reflect that, and we are acting just as a ‘derivative’ of  mother market in US. Nifty hit 10% lower circuit twice, on 13^th March (albeit it recovered intra-day and closed positive) and on 23^rd March, when it made a bottom (at least for now).
• This ‘shutdown’ and not ‘slowdown’ in economic activity, means it is unanimous now that we are heading into a global ‘recession’, and is reminiscent  of memories of 2008 financial crisis, and some have started viewing it similar to 1929 Depression too. However, what I see as the big difference this time compared to past crisis is that policy has reacted before, not after, a credit event (eg: Lehman bankruptcy)- an epic $7trn of QE and $5trn of fiscal stimulus has already been announced, with almost all major central banks (including India) announcing rate cuts. In fact, Fed’s emergency 50bp rate cut on 03^rd March (later another 100 bp on 15^th March) , when the markets had not even started falling scrupulously, raised some doubts if Fed knows more about the infections, than what was being officially announced by US govt. then.    

What is the consensus (fund manager, brokers, peer group) thinking now?

• Markets will not stop falling until the infection case ‘curve’ doesn’t flatten out globally, particularly in US. The general belief is that virus will be ineffective as weather turns warmers globally (in 2-3 months), and new case curve will flatten much before that.
• Unlike past crisis, which were mostly driven by financial problem, this time we are facing health scare, and therefore markets will recover only when we have ‘healthcare solution’ (low-cost speedier test kits, effective treatment, vaccines, etc).
• Albeit short-term markets could fall more (everyone say no one can predict the bottom), for long-term investors with 3-5 year horizon this is a great entry opportunity. I think the underlying assumption here is the age-old belief that Equities perform well in the long-run.
• The big gets bigger, so buy into Large Caps, Quality, and Defensive Growth stocks, and avoid Leverage. 
• While above points are unanimous, what remains debated is Fed’s unlimited QE (in other words privatizing losses) and fiscal stimulus will bring the much required financial market stability and importantly economic recovery later.

My view on consensus: As more number of investors start believing the above assumptions, the more likely markets will NOT follow that path. To my experience, consensus rarely gets it right in such situations. Last two weeks gave some signs that markets are losing their faith in central bank's expansionary policy, and if it had not responded to fiscal stimulus then the future would have been even darker. Also remember while recent news flow will be terrible, which could lead to further substantial downside on near-term economy and earnings, remember it is not how much bad it gets (depth) from here, but how long the bad will stay (duration) that will have bigger implication for markets. 

As always, Mr. Markets cannot be easily predicted- it is overwhelming to see that just when even the die-hard bulls got nervous (heard on CNBC in last 2 weeks), and with analysts getting very concerned over 21-day lockdown (announced on 24th March, 8pm) that will have hard impact on the economy, the markets have just found a bottom. While reasons to be cautious on India is justified, I would be watchful on global markets, more so than the local developments over the next few weeks. I think India has it own challenges beyond the near-term infection cases, from languishing GDP growth, population, unemployment,  and continued banking/NBFC problems. 

Read my next post to know how to position yourself under this circusmtances

Budget 2020: Fails to deliver on elevated expectations

The context:

For many years now, weeks heading into the Budget Day gives me adrenaline rush and excitement on what could be the key announcements, both for professional and personal reasons. This year too was no different, and given the sharp macro slowdown (FY20E real GDP of 5%) that called for a greater need of growth revival through fiscal measures, investors expectations had risen. Although, everyone was well-aware that the scope for stimulus was limited given the fiscal situation (just 3% YTD tax collections, & corp tax cuts already announced), nevertheless, high hopes had built-in for: a) lowering personal income tax rates, b) increase in rural/agri spending which is being hit substantially, c) some market-friendly measure (like abolishing LTCG/ DDT/ STT/ privatization, etc.) to boost sentiments, d) higher infra/capex spending, and d) some path for NBFC/banking stress resolution.

The event:

Are Fiscal deficit number credible? 
The headline fiscal deficit is now targeted at 3.8% for FY20RE (+50 bp vs earlier targets), & 3.5% for FY21E, both bang in-line with the consensus expectations. While the headline numbers suggests macro stability, quite often than not the devil lies in the details, based on projections assumed by the govt., and off-balance sheet financing. While the nominal GDP growth assumed at 10% (after 7.5% in FY20E), and projected tax revenue of Rs 16.3 trn (increase of 9% for FY 21BE) is realistic, the catch is it still assumes high FY20E tax base (+14% growth is assumed, 2x of GDP growth vs general 1.2x buyancy) on assumption of collections from the dispute settlement scheme. Further, on the revenue-side, disinvestment targets of Rs 2.1 trn appears optimistic (3x of FY20RE, forming 10% of govt. total income), and telecom spectrum/AGR revenues of Rs 1.3 trn (2x of FY20) may be tough to achieve (as the industry already has high debt).  On the expenditure-side, it will grow at 13% and the focus on rural India has stayed - albeit MNREGA allocation is down and higher agri spending is likely for PMKY (Rs 6k/ yr as transfer to farmers). Further, while fiscal deficit came at Rs 8 trn, the more keenly tracked number by investors is govt.’s bond borrowing program, which at Rs 5.4 trn for FY21E is again broadly as expected, and the remaining deficit is largely funded by the increase in national small savings fund (NSSF, Rs 2.4 trn, 2x jump already in FY20RE, and expected to remain flat next year).

Although the fiscal math remains challenging in my view, but then every year there are always some nitty-gritties like above that makes the assumptions look aggressive. However, with govt. having more data points than investors, we can presume that they have done their homework while setting these targets, and from bird’s eye perspective I see there is no out rightly very aggressive assumption (will await more details from brokers tomorrow). Further, govt. revealed off-budget financing details (again need to understand this better), at a time when some doubts were being raise on the relevance of the official deficit number, which should possibly help to bring transparency. 

Will personal tax new regime boost consumption? 
The budget introduced a new optional tax slab structure (that could save taxes up to 75k for income up to Rs 15L) if the assesses let go of deductions/ exemptions (HRA, LTA, 80C, 80D, Int. on housing loan, etc). This in govt’s view should help to simplify taxation for lower-end income-earners (say 3-10L), and thereby give assesses a “choice” if they want to save for the future or use these tax savings for consumption. While the salaried-class individuals are unlikely to shift (barring few who are currently not able to utilize their exemptions), what is more worrying is that the new system no longer encourages longer-term investments (ELSS, insurance, home loans EMIs), and gives option to those, who are generally ill-equipped to take correct decision. Also, this comes at a time when household savings rate is already falling, when India needs risk-capital to fund its growth, and when govt needs funds through NSSF to meet deficit targets. The more annoying part is FM’s statement in post-budget media conversation, where she believes new regime to be eventual path of taxation in few years (they are testing waters now), which implies to me that taxes will go up (rather than widely expected cuts) for the higher middle class in the subsequent years.

Dividend distribution tax abolished: Apparently, we were among the last few nations to remove this tax, which now allows dividends to be taxed in hands of recipients (at their respective tax rates) rather than at corporate-levels at 20%. This should benefit FIIs and MNCs who are located in low tax countries, apart from small retail investor. Thus, a small sentiment booster for the markets. However, promoters with large stakes will be negatively impacted (as their dividends will now be taxed at their rates, say 42%), and therefore such companies will now do more buybacks (taxed at 20%) rather than dividends, and might also announce one-off special dividend this year, to take out cash. Also, DDT removal could be seen with corp-tax cuts already announced, as it incentivizes companies to undertake capex spending rather than paying out dividends. Further, MFs until now use to levy dividends for equity funds at 11.5% and debt funds at 29%. For investors in high tax bracket, it now makes sense to switch to ‘growth-option’ MF rather than ‘dividend-option’, and do SWPs. 

                                     

Doing LIC IPO might actually open Pandora’s box:  Govt’s ambitious disinvestment target relies on LIC IPO, IDBI sale, BPCL, Concor, SCI, Air India, among others. The largest proceed is expected to come from LIC IPO, which will not be an easy task, as it requires legislation change, favorable market conditions given its large size, and will face stiff opposition from political parties & unions for selling the perceived ‘jewel’ of the nation. With Rs 27 trn in AuM and market leadership (66% share) in a high-growth potential sector, it could command valuation of 8-10 trn, and thus investor’s demand could be very high. However, contrary to popular belief, I have had my doubts for long on LIC’s governance, their unknown investment management team, and often joke about them being the biggest Ponzi scheme in India. I say this because LIC has been bailing out successive government’s unexciting disinvestment programs in the past, has been a lender of last resort for PSU banks capitalization, and few reports suggest its equity fund performance is very poor in the recent years. Yet, it continues to reward policy holders/ agents through attractive returns, albeit with limited transparency & through govt support. As it undergoes IPO, we could possibly see more skeletons coming out here.

Infra boost: To attract foreign investment in infrastructure, govt has announced sovereign wealth funds will get 100% exemption on income, FPI limit in corporate debt market is increased to 15% (prior: 9%), and there is also some proposition to have some gilt series being traded without any FPI limit, that will allow Indian govt bonds to be included in global bond indices. The govt has not compromised on capital expenditure (18% in FY21BE), albeit expenditure spending growth is low in Defense and Railways, but solid on roads and smart cities. 

Conclusion: No stimulus, lacks out-of-the-box thinking

While many believe that Budget is unlikely to be the only place to announce big steps, and quite often govt. has announced reforms outside the Budget day, nevertheless, I still look up to the event as it likely lays out the path on which govt. is heading. The broad message this time seem to be: a) the higher middle-class (income >15L) and rich will continue to be taxed more on all its income avenues, so as to meet govt. obligations towards farmers/agri which is a large section of population, b) focus remain on supply-side measures (corp tax cut, DTT, govt. spending, PPP infra, etc) rather than the demand-side (consumption boost), and therefore GDP growth is poised for possible medium-term recovery rather than on short-term revival, c) fiscal prudence and macro stability is given due importance, and d) more willingness towards foreign flows for infra-building. The biggest disappointment to me is the new tax regime, as it complicates the structure rather than the stated objective of simplification (at least until the compulsory full transition comes into effect), and the lack of urgency in govt.’s action - if we do not pull the growth trigger now, then when is the question on my mind.

On markets, the bond market should heave a sigh of relief (they were closed for trading yesterday) as fiscal deficit and FY21 bond supply has no negative surprise, and we should see some rally in bonds, in the near-term. Though this could fizzle out, if progress towards budgeted numbers for disinvestment is slow. On the equity side, Nifty corrected 300 points on Budget day, and is down 6-7% from its recent highs at 11,650. The budget has lost opportunity to give any boost to revive economy, and lacks any reformist/ radical announcement, and therefore broker’s GDP growth estimates might be pushed further ahead. And with so many expectations building up until the budget day, I will not be surprise to see another 3-5% downside from here for Nifty to hit 11,000 immediately next week, on ceteris paribas basis (coronavirus developments, global markets performance, geopolitical developments, etc). The only savior could be lower bond yields, which should support banking sector,  lack of any big negatives for FIIs (unlike the previous July-19 budget), and possibly any indication from FM/ secretaries that more steps are coming. 

Key sector winners: None in my view, but market might reward IT and Staples on risk-aversion, high dividend payouts (on DDT removal), and perceived boost to lower-end consumption (new tax regime).

Key sector losers: Real estate/Autos/ Infra (vs rising expectations), Insurance/ AMC on no tax exemptions (though it corrected already 10% today, and could be interesting to evaluate the actual impact), cigarettes (on excise duty hike).