The BSE-30 and Nifty-50 indices gained 4.1% and 3.5% in October in local currency terms. On the global front, focus shifted to the upcoming US Elections and lockdowns returning across Europe while on the domestic front, monthly indicators suggested a fast return to normalcy of economic activity even as both Covid cases & positivity rate continued to decline in India. The domestic recovery gained further strength with most high frequency indicators like GST collections, Power demand, E-Way bills (trucking activity), Rail Freight volume, Auto sales etc. all showed further improvement. The Monetary Policy Committee (MPC) kept the repo rate unchanged at 4% but retained the ‘accommodative’ stance. Second round of fiscal stimulus worth ~0.4% of GDP was announced by the FM which comprised of mix of consumption nudge primarily focused on govt. employees and an infra push but most of it being in the form of advance or already budgeted expenditure meant smaller additional cash outgo for the govt. With respect to the ongoing quarterly result season, earnings so far, have been largely better than expectations as sequential growth and cost controls led to beat for most Nifty companies who have reported results. MSCI (Morgan Stanley Capital International) announced that it will implement changes in Foreign Ownership Limits (FOL) in its indices containing Indian stocks with the November rebalance, which could potentially trigger foreign inflows of >$2bn. In flows, Foreign Portfolio Investors (FPIs) bought US$2.7 bn worth of equities in the month while Domestic Institutional Investors (DIIs) sold US$2.4bn. Within sectoral indices, Bankex, Realty, Infotech and Power outperformed, whereas Healthcare, Auto, Metals, FMCG and Oil & Gas underperformed the BSE Sensex.

At the time of writing this piece, the US election is entering its final stages and current trends point to a close finish. However, the US and global markets appear to be steadily shifting focus to post-election events, key among which is govt’s ability to regain control on the second wave of the pandemic observed in some of these economies and agreeing upon the next round of fiscal support that may be necessitated.

For India, we have been highlighting the importance of underlying earnings support for market valuations to hold up and in that regard the current result season has been very enthusing. A broad-based improvement by bulk of corporate India in a quarter, wherein activity levels are still short of the pre-covid peak and material street upgrades to earnings is comforting. Additionally, the distinct trend of reduced leverage and improving balance sheet strength seen in multiple sectors including banks and financials is creditable. Even as earnings expectations may remain fluid for a few quarters, qualitatively we would expect them to trend positively hereon.

Global and domestic monetary policy remains a key risk in our view and inflation readings of the recent past, though mainly led by supply-side dynamics, can confound policymakers. However, with Govt’s borrowing calendar for 2HFY21 largely unchanged v/s earlier and RBI’s continued dovish messaging, we expect interest rates and liquidity to remain supportive for the foreseeable future.

As a fund house, our portfolio positioning, while balanced at one level, does tilt towards an eventual cyclical recovery. Presently, we are incrementally inclined to gradually add to segments of the market such as financials, parts of consumer discretionary and industrials that are probable beneficiaries of a strengthening economic cycle and which still lag the broader market. Earnings-based valuation parameters would stay elevated for a while but need to be seen in the context of benign interest rates and depressed earnings cycle else they may throw up incorrect conclusions. Yet, investment choices of today require to be adequately justified on long-term intrinsic or franchise value of enterprises for them to attract our attention. We continue to adopt the middle path in portfolio construction with regard sector exposure, market cap bias and balance between growth and value.

Ever since the economy has started to open after 4 months of strict lockdown the economic indicators have started to showcase some revival. While initially it appeared to be a quick ‘V’ shaped recovery it was plateaued out soon after. The last month seems to be a strong recovery for the automobiles and two wheelers.

Notwithstanding the recovery of the economic indicators in the last few months, the Q1 GDP shrank by a historic 23.9% and is expected to be an ~10% shrinkage for the whole FY21. Governments efforts to revive the economy and control the spread of the virus remained highly challenged due to a variety of reasons. While there have been few economic stimulus announcements the monetary policy measures from RBI possibly remained more relevant in these times. Now in the last few weeks the active number of positive Covid cases have started to drop, igniting some positivity across the country and encouraging the government to open up restaurants, trains and allowing more people for commercial activity.

The monetary policy actions of RBI along with the liquidity infusions from RBI has pushed bond yields lower and helped soften both deposit and lending rates. The headline Consumer Price Index (CPI) data has posed hurdle for RBI and MPC members to potentially continue with the easy monetary stance. While last month RBI Governor did mention that the rise in inflation will be looked through, it remains to be seen if continued rise in inflation or a protracted long period of high inflation doesn’t dissuade the Governor. High CPI inflation along with growth contraction has been perplexing for the policy makers.

Deteriorating asset quality within the banking system seems to be delaying the credit growth despite surplus liquidity within the banking system. We expect the real non - performing assets (NPA) levels within the banking system to move into double digits and approx. closer to 15%.

Going ahead, we do feel that there is a fair chance for the inflation to soften if the supply bottlenecks are addressed by the government. However, the persistent strong food prices over the last few months seems to be refusing to moderate. The spillover of higher food prices into non-food articles may cause rise in the core inflation and slowdown any possible moderation in the headline CPI. Continued open Market Operations (OMO) in both central govt. bonds and now state govt bonds did soften the bond yields over the last few weeks. However, yields have remained volatile and there has been some retracement in yields too. However, the drop in bond yields has been short-lived since the tax revenue of the government has remained benign. However, it’s expected the bond yields may start to move south in case the tax collections pick up over the months due to opening up of the economy and the governments steadfastness to hold on to the original borrowing calendar.

Outlook

• We expect growth to remain soft to contracting, and inflation to eventually slow down over the next few months. However, it would depend on food prices. RBI forecasts a contraction of GDP in FY21.
• For economic recovery the private sector investments and overall consumption needs to recover. Both fiscal and monetary stimulus works as an enabler for pick up in consumption.
• The challenges of the banks (led by rise in NPA, drop in capital adequacy) is the headwind for credit growth.
• Expect rate reductions to restart along with liquidity infusion from RBI. We would expect OMO and Long Term Repo Operation (LTRO) to continue over the months.
• Yields to remain benign and the steepness of the yield curve to reduce as and when increased OMOs are announced by RBI.

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