• We remain apprehensive of a gradual rate rise as we move through the year. We remain apprehensive of rising commodity prices-induced inflation and a gradual normalization in the economy leading to the rate rise.
• 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.
• The phenomenon of a persistent steep yield curve and a negative real interest rate regime may be a catalyst for a detrimental effect on all asset classes, and the probability of all central banks moving towards a calibrated normalization approach may dominate the movement of all asset classes in the future.

Indian markets continued its positive trajectory with mid and small cap indices taking leadership role during the month. The markets continue to remain driven by the increasing retail participation in equity markets, both directly as well as through mutual fund schemes. Among large sectors in market; Commodities, Energy and Auto outperformed Nifty while all other sectors underperformed Nifty.

However, globally the equity markets changed track with US markets having an average 5 percent decline across key indices. On an incremental basis, the news flow on economy has started becoming negative driven by supply-side constraints. Many countries are reporting supply issues driven by a combination of factors -- whether it is the lack of chips availability, logistics issues, lack of labour availability, power supply etc. This is not only driving cost inflation, but also impacting demand and in turn hurting economy on both fronts. Some unexpected headwinds emerged during the month on energy front with coal, oil, natural gas witnessing a sharp surge in demand as well as prices. As supply cannot rise up to match the demand, the immediate outcome is shortage; hurting the economy further. Reports surfaced of China restricting power supply to industries due to shortage of coal at thermal plants.

On US Federal Reserve policy, a clear message about road map towards tapering of bond purchases (which was done to give stimulus to US economy) and rate hike came out post the Fed meeting. The indicative time for tapering is from November, 2021, till mid-2022. This is slightly quicker than general consensus and can be a dampener for financial markets, as along with tapering, headwinds of supply as well as energy prices remain important variables to monitor.

It has been a tough call to decode what has been the key driver of global risk appetite for equity assets, whether it’s the comfort of liquidity infusion or low rates or signs of economic recovery since Covid outbreak. Next 6 months may provide some clarity on whether liquidity or low rates drive investor behaviour.

In India’s context, while quite a few macro-economic indicators remain positive (GST, income tax collection), the policy front too remains vibrant with reforms being on the underlying agenda. Air India’s privatisation has reached final stage with financial bids being submitted by two bidders. If and when Air India is actually privatised, this could well be a big moment in India’s drive for reducing government involvement in commercial activities. Also, it may pave the way for many other PSUs being privatised. One unexpected headwind has emerged on energy price front as India’s import dependency is quite high and can alter the current account dynamics and value of Indian rupee vis-a-vis global currencies.

The policy action in US on both monetary and fiscal front remain key economic variables that can drive market sentiments as majority of the gains in markets have accrued on the back of valuations rising due to lower interest rates. We await US’s fiscal policy response.

The result season for Q2FY22 commences this month and we continue to monitor signals from economy and corporates about economic normalisation during Q3 festive season, especially in light of the global supply disruptions.

While the power of asset allocation to equity in past 12-15 months has been seen, it is time for investors to focus on asset allocation and risk management. A disciplined approach helps especially when markets and economy are witnessing quite a few headwinds. Alternate approach is to have a longer time frame while investing.

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

For investments in debt oriented products:

• Our view is that interest rates may gradually rise
• We believe that the investors with a shorter horizon of 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 cap fund as well.