• The RBI continues to remain the beacon of hope for the domestic debt markets. The surge in pandemic domestically has also put the markets to believe that the MPC will continue to remain dovish as it would continue to focus on growth and would ignore inflation as a transient phenomenon.
• However, we remain apprehensive of a gradual rate rise as we move through the year. We believe that the markets may stop coat tailing the RBI, and are not ignoring a commodity prices rise induced inflation and a larger borrowing program
• The possibility of a bear flattening of the yield curve exists with long term rates rising lesser than short term rates
• We also believe that AAA credit spreads are very tight and the probability of spreads to increase in the near future remains a distinct possibility
• Liquidity being in sustained surplus mode, the extreme short end of the yield curve may remain stable.

Indian markets continued with the broad-based rally in previous month with the mid- and small-cap indices faring better than Nifty. The broad rationale for the market behaviour is the increasing retail participation in equity markets. From the perspective of institutional investors as well, hopes of cyclical recovery brings earning growth expectations in small and mid-caps. Among large sectors in market; IT, Pharma, FMCG outperformed, while Financials, Energy underperformed Nifty.

Globally, the equity markets continue to remain in positive zone. The market expectations regarding economic recovery is that it is on track, driven by normalization in services activity as US and Europe get vaccinated. Outcome of US Federal Reserve policy meet reiterated Fed’s view of current high inflation being transitory and hence the willingness to accept the current level. Fed policy also signaled marginally quicker tightening versus expectations before the meeting. While the roadmap on expected rate hike is shared by Fed through “dot plot”, the review and dis-continuation of bond purchase (liquidity infusion) is a known unknown.

When the global economy was hit in March 2020, US Fed acted on monetary stimulus to support economy. Majority of central banks across the globe followed with a similar policy action. Once the expectations about Fed plan for taper is known, how other central banks react would be key. In some emerging markets, central banks have already started their path of rate hike to control inflation.

We would monitor policy action by RBI in India’s context. While higher bond yields can act as headwinds to the equity markets through higher cost of equity, policy action on withdrawing liquidity support can impact the economic growth and portfolio construct. Historical experiences suggest that monetary easing supports mid and small-cap segments in general, while tightening hurts these segments. Primary rationale being that many small and mid-cap companies are capital starved and easy liquidity helps them in business activities. Definitely, this applies more to companies that rely on external financing and to that extent company specific analysis continues to remain the primary driver of portfolio construct.

On Covid front, while US and Europe are ahead on vaccination as a % of population, Indian government is moving on track for Dec 2021 target of getting substantial population vaccinated. India vaccinated over 8 million citizens on a single day in June and while we write this, India has overtaken in terms of total vaccinations done. As supply dynamics improve through new vaccines, domestic as well as global, the normalization of activities will pick pace.

Globally, the monetary policy response to inflation in post-vaccinated economy remains the focus area for financial markets. The key reason being that ultra-low interest rates have led investors to look at higher valuations as a new normal. The investor reaction to higher policy rates would be a true test of the sustainability of higher valuations. Specific to US, the fiscal support by way of direct payment and unemployment benefits comes to an end on September 6th 2021. Policy decision on further continuation is also a variable that is likely to influence consumer demand and economic growth in US.

The result season for Q1FY22 would be interesting to follow for management commentary for FY22. In a way, the current year is likely to replicate FY21 wherein post the Covid disturbance in Q1 the economy normalised during the festive season in Q3. There are already demands for some fresh measures to support MSMEs and Lenders, with policy makers announcing extension of credit guarantees.

While the power of asset allocation to equity in past 12-15 months has been seen, it is equally, if not more important to realize the power of market cycles in terms of capitalizations. What started as a large-cap driven recovery, passed leadership baton to mid-cap and then to small-caps. The economic cycle of growth and corporate earnings, navigate across market capitalization, driven by policy actions on both fiscal and monetary front. We believe this re-emphasises the need to be flexible in choosing companies across market capitalizations. Yes, there are clearly Risks (Uncertainty) in Markets and its relationship with expected Returns. Large Cap, Mid Cap and Small Cap as a segment, play a critical role in portfolio construction for investors and they may choose to manage it themselves or choose to entrust to funds who have the flexible approach.

Investors with lumpsum investments could have an asset allocation strategy (equity as a % of portfolio) to try and benefit from greed and fear phases. Alternatively, the strategy is to really stick to longer term outlook rather than focusing on 1-2 years volatility. However, for investors with SIP investments such phases are not so relevant as investor is still in accumulation phase for wealth creation over the 5-7 years. SIP may be a good alternate to avoid the behavioural traps during the extreme phases of markets. We maintain that investors use SIP as part of core investment philosophy and use the lumpsum route to top-up on their SIPs in fearful times amid market volatility.

For investments in debt oriented products:

• We believe that the investors with a shorter investment horizon may continue investments in ultra-short term and low duration funds
• For a medium to long term investment horizon and with a suitable risk appetite, an allocation to short term fund and dynamic bond fund merits attention.

For investments in equity oriented products:

• Our view is that volatility may continue and SIP may be a good way to increase equity market allocations
• Investors looking to invest for a medium to long period, can consider SIPs or STPs into focused, multicap or hybrid funds based on risk appetite.
• Investors looking for a better return opportunity and with a suitable risk appetite, may consider part allocation in mid capfundas well.