Investment markets proved their natural cyclical nature faster in the year gone by than perhaps ever before! From Greed to Fear to Hope and back to Greed in record time. Thanks to two opposite forces – the fear of the virus and the release of unprecedented liquidity into asset markets by all major economies of the world.
But is the worst over yet? Is there another edition of the disease just around the corner? Are we better prepared for any such episodes – at least mentally? And while Asia looks ready to move on, are the powerhouse western economies over the Corona hump? These could be the episodes yet to come in a continuing battle for human victory over disease.
We all know and understand the year gone by to be an aberration, but what will the near term hold for us as investors? Here is a factual and step by step recall of events and a tentative look into what lays ahead, by our equity and debt fund management teams that have successfully come through the worst without missing a step!
For as long as the current generation lives on, the year gone by would be discussed in our and the future lifetimes. The arrival of a global pandemic caused by a strain of virus, the altered human behaviour pattern and an overdrive towards a vaccine; a year certainly for the keep of memory. And as the vaccine arrives and gets approved; mankind may yet again prevail!
This note pens down the important events which shaped the market through this historic year and of course an attempt at crystal gazing.
The table below traces the returns of different fixed income indices through the past years:
Source: Bloomberg |Data as on December 28, 2020 | Past performance may or may not be sustained in future.
The pandemic and associated global lock down prompted all major central bankers to follow a similar all-too familiar approach: expand balance-sheet by buying assets from the financial system and the liquidity deluge ensured lower /negative-bound interest rates prompting a risk-on rally.
The year witnessed a unique phenomenon in April 2020 as near term West Texas Intermediate crude oil touched closed at negative prices for the first time in the history of oil prices. The frenzied selling was driven by a lack of storage space to hold the crude; thereby resulting in the negative rates. While other commodities too fell in April 2020, as the year progressed the entire commodity basket (ferrous, non-ferrous, agri) witnessed sharp resurgences prompting fears of elevated inflation.
The US dollar measured by DXY (a basket of 6 major currencies) depreciated sharply by around 7 percent through the year, prompting a surge in the metal and other commodity prices
The “whatever it takes” approach of the RBI to stimulate growth defined the overarching narrative of the Monetary Policy Committee (MPC) and RBI in CY20. This included several notable action of the central bank:
The domestic debt markets were dominated by these dominant themes:
A large part of crystal ball gazing rests on a single edifice: normalization of the domestic and global economy prompted by successful vaccination across the globe. Should the efficacy of the vaccination or a new strain of the virus emerge; all forecasts could come to a naught!
We feel that interest rates have bottomed out and may move up through the next year. With inflation rearing its ugly head, the probability of inflation getting entrenched remains highly likely.
We believe as situation normalises the next year, the probability of crude moving higher remains a distinct possibility. With a surge in commodity prices well underway, the market may get surprised by a surge in crude prices complicating the conduct of domestic monetary policy.
To clarify upfront, we are not talking of increase in the policy rates. But we think with global commodity prices holding up and the potential of inflation remaining at elevated levels; it may complicate the MPC’s accommodative stance through the next financial year and may force it to acknowledge the higher inflation into its policy construct.
There exists a distinct possibility of the yield curve flattening, credit spreads expanding and the money market rates dropping the reverse repo anchor as we move ahead to a normalisation of the domestic and global economy.
A brief summary of markets in 2020 can be captured in four parts:
The market phases during the year shifted from optimism to complete disbelief, to hope and back to optimism. CY21 will tell us whether the optimism moves to euphoria or stays at optimism or moderates to hope!
A big learning for investors across the world has been the role that liquidity plays to bridge the gap between fundamentals on one side and sentiments on the other.
It is important to keep in mind the liquidity-driven sentiments while analysing fundamentals and valuations. What is important is to understand is whether liquidity is driving fundamentals or fundamentals are driving liquidity. If it is the former, then valuations are running high and if it is the later, then valuations are reasonable and attractive.
In a world driven by excess liquidity and low/negative interest rates, investors may be keen to look at longer-term growth opportunities and willing to pay for that growth visibility. Indian economy and markets are precisely at that juncture.
An immediate outcome of this can be that valuations take backseat. Ability/willingness of any investor to overpay (i.e. buying at higher valuations) is a function of -
With a positive demography of over 1.35 billion, India offers one of biggest consumption market as well as an employable youth power to meet global needs as world population is ageing much faster. This has implications not only for economy but also for financial markets as capacity creation and consumption of the same would happen more in India relative to the world. Investors like pension funds looking for that 2030 year investment opportunities are keen to invest in India. CY20 saw the best-ever investments in India (both foreign portfolio investments and foreign direct investments).
Globally the capital is in abundance and looking for growth avenues. Ignoring the brake applied by Covid in CY20, India retains its position among growth leaders in the world economy. India’s economic growth is estimated to make India among top 5 economies in world by 2025 and top 3 economies by 2030. We believe this growth potential will continue to attract capital that is in active search of growth destination.
In addition to this, we also see an interesting opportunity for capital that is in search of passive growth. Over past decade, Global index providers like MSCI & FTSE have emerged as a popular allocator of capital for investors with passive approach to investing. There are ETF’s that track the indices offered by MSCI n FTSE and investors are happy to participate there. We believe that even index providers would be enforced to recognise India’s rising economy and add more weight to India as a country in the global indices. This increase in weight could attract more capital that believes in passive tracking. To highlight, as on 30th November 2020, MSCI Emerging Market Index has India’s weight at 8.09% while China is at 40.72%.
So here we are, long-term attractiveness has been priced in very quickly, thanks to the liquidity. We believe that liquidity while it can be respected, it cannot be trusted to stay forever as it is generated by some action somewhere else in the world. So yes, we need to be watchful in the next 6-12 months, while we should be comfortable with the medium- to long- term investment horizon.
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