Globally, vaccination drives are the key focal points. 2020 has been a year of the ‘V’: First the Virus, then V-shape recovery, and now Vaccinations. Eventual victory over the pandemic should prevail but the question is when and not whether. The wide availability of effective vaccines should lead to economies allowing social activity and high-contact services to resume seamlessly thus, gradually moving closer to pre-pandemic levels.
However, crisis mode measures should continue: Central banks are likely to maintain the easy monetary policy and the fiscal policy of governments should also continue albeit to a possibly smaller extent than last year; this will lead to lower-for-longer policy rates and a rise in inflation causing negative real interest rates. As economies recover from the slump, GDP growth is expected to recoup lost output next year though it will take a couple of more years to return to potential growth.
Further, unemployment is also likely to stay elevated as pandemic job losses, similarly, might not be recouped fully.
The Biden-led political leadership in the US could place some more focus on multi-lateral trade and a more predictable foreign policy, less linked to Twitter, that can likely lead to inclusive growth.
Nevertheless, any delay in mass vaccinations; re-escalation of US-China tensions, or any new geopolitical events could pose risks.
Commodities rally led by global reflation
Global commodities broadly are to benefit from the reflation trade. Outlook for risk assets incl. commodities have improved mainly due to “something better than nothing”-attitude for vaccines. Liquidity glut and gradual recovery in trade activity could provide further demand boost to industrial metals and agricultural produce.
Oil prices should be dictated by how OPEC+ meets rising demand and whether US shale producers stay low on capex coming out of the pandemic. US Democrats’ pro-green and pro-Iran stance is likely to cap any such sharp up-moves. This could lead to input price inflation benefiting / impacting resources exporting/importing economies.
Still gold has a play in portfolios
Gold was one of the best-performing assets in 2020; with investors in buoyant mood and expected recovery in economic growth, Gold is unlikely to repeat last year’s gains in 2021. While unusual volatility and uncertainty have exited the equation, Gold is still a preferred hedge against inflation. Also, expected USD weakness in medium-term and easy money supply around the world augur well due to its inverse correlation to commodities and the low opportunity cost of holding unproductive assets like gold respectively.
India – A bright spot post-pandemic
Back home, the Govt. has been focused on structural reforms over the last few years – GST, IBC, RERA, Corp. tax cuts, Infrastructure push, Land, Labour and Agriculture laws, phased manufacturing and now Atmanirbhar Bharat (PLI) – building blocks for long-term growth. This has improved Ease of Doing Business and has been attracting foreign capital – through both FDI and FII.
The aim is to make India self-reliant and benefit from MNC’s China+1 strategy – consequently, several sectors stand to benefit like: electronics and white goods manufacturers, capital goods and defense equipment players, Pharma KSM/API intermediate producers, auto and auto ancillaries, agriculture and specialty chemicals, food processing, and textile products.
The next leg of reforms could focus on Governance, Social Development, Sustainability along with unlocking of land supply, sectoral FDI policies, power sector privatization and financial system (capital markets, public finances) reforms. As always, consistent increase in demand needs to be seen to bring back private CapEx and bank credit growth in 2021.
Ongoing correction offers a medium-term opportunity
Indian equities have been healthy with most corporates delivering beats vs. analyst estimates across sectors, having positive management commentary & announcing structural reforms that could spur a robust earnings outlook. Healthy rural economy, reviving demand from a pandemic, government’s infra spending plans and the PLI schemes could heighten earnings growth for a reasonable period, could keep attractive destinations for foreign inflows.
Broader markets should benefit from healthy economic recovery as well as improvement in breadth. Bottom-up stock-picking approach to work better than the sectoral top-down approach from now on.
Even as absolute (P/E, P/B, Market Cap./GDP) and relative valuations (EY/BY) suggest Equities are expensive, while the improved visibility on macro and growth dynamics are aiding positive view on Equities.
Additionally, compressed historical earnings are the major culprit of exorbitant trailing PE multiples.
Inflation and massive borrowings to limit gains
On the Indian Fixed Income space, the RBI played a large pro-active role in ensuring financial stability amidst the pandemic – policy actions around liquidity, loan moratoriums and one-time restructuring addressed default risks. Market borrowing has been pegged at Rs 12 trillion for FY22 which pushes the fiscal deficit to 9.5 percent of GDP in FY21 and 6.8 percent in FY22.
The erstwhile FRBM mandated a 3 percent fiscal deficit by FY21 so this is a welcome move by the FM in a bid to resuscitate the COVID-19-stricken economy. Monthly GST collections have been making new highs in an attempt to pose a recovery which could act as a positive surprise for budgeted FY22 fiscal deficit. RBI’s MPC is walking a tightrope – though it has reiterated its growth focus and has maintained accommodative stance growth could already be panning out and sticky inflation could play havoc.
Concerns on growth, inflation, fiscal deficit and RBI auction devolvement could continue to harden bond yields despite RBI support. Prefer top quality corporate issuances/funds and short-term investments in debt portfolios and to avoid G-Secs and long duration.
US dollar likely to weaken
Investor sentiments in the medium to long term could opt for a risk-on environment in capital markets. Global capital flows could transpire away from safe-haven assets like USD, Sovereign Debt, Gold and shift into Equity, non-USD currency and commodities that could put pressure on the dollar index. The widening US twin deficits (current account + fiscal) could also weigh heavily on the dollar.
INR could see support from foreign inflows driven by equity index rebalancing and possible debt index inclusions. High foreign exchange reserves provide comfort for import cover though the rising US-India inflation differential could tilt the balance in favour of the USD. Also, RBI market interventions too in play and hence expect INR to be range-bound.
The author, Rajesh Cheruvu, is Chief Investment Officer at Validus Wealth. The views expressed are personal.