ALL WAS WELL AND THEN THE SKIES FELL: THE MAKING OF A CRISIS – REGIONAL EPIDEMIC TO A GLOBAL PANDEMIC

The coronavirus contagion disease spread dangerously, making WHO give it an official name ‘Covid-19’ and recognize it as ‘high risk’ to public health. The total infected cases are now closer to 95,000 in 84 countries with global fatality rate higher at 3.4% vs ~25,000 cases in 24 countries and 2% fatality in early-Feb.The alarming rise in daily new cases and deaths outside of China has rightly led to global recession fears. Most concerning countries have been South Korea, Italy and Iran where the virus transmission has been quicker and US where the fatality rate has been higher at 6.9%. The virus has disrupted routine life activity due to factory shutdowns, travel bans, school closures and mass public event cancellations – even handshakes. The power of social media in amplifying news (good/bad) today relative to SARS (2002), MERS (2012) is un-precedented as almost half of the world’s population is on social platforms. As every dark cloud has a silver lining, even in this case, China ‘getting back to work’ and Singapore (close Asian neighbour) not reporting a single death does give some relief. While the World has moved to a zone of unusual alarm from unusual calm, let’s focus on asset allocations and NOT PANIC. Some may also say ‘hope for a warmer weather’ as flus typically can’t survive it.

GLOBAL EQUITIES: WHIPLASH; REMAIN TACTICALLY OVERWEIGHT ON EMS

Volatility made a comeback and how. Daily index moves (up/down) are making new records as if jolting investors out of the deep slumber with respect to complacency about Covid-19’s economic impact. The CBOE Volatility Index (also known as fear gauge) more than doubled in just the last week of Feb-20 and reached levels last seen in 2011 during Eurozone sovereign crisis. China, being the epicenter, saw its equity index crash in earlyFeb and as virus gripped rest of the World by Feb-end, it led to global equity melt-down, thus, reversing partial gains from the preceding equity melt-up. OECD has revised 2020 World GDP estimates further down to 2.4% from earlier Nov-2019 projection of 2.9% with a scary bear case scenario of 1.5%.

Though, Covid-19 emerged in China, which is the largest emerging market (EM), valuations are attractive on Market Cap-to-GDP and Price-to-Book basis for EMs relative to DMs. CDS spreads and fund manager positioning also lend support. Remain Overweight on EMs against the Strategic Allocation to EM.

GLOBAL FIXED INCOME: RACE TO THE BOTTOM

Asset markets are an outcome of economics and emotions, but fear can make people do crazy things, including valuing assets. Though, G7 Central Bank chiefs and Finance Ministers promised coordinated efforts to fight Covid-19, only the US Fed announced an emergency 50bps cut (effective 2 rate cuts of 25bps each). But even the Fed was unsure how the cut was going to stabilize supply chains and cure the deadly virus. Extreme risk-aversion & more rate cuts have led to further drop in sovereign bond yields and risk of inverted yield curves, especially in US due to its safe-haven appeal (US 10Yr dipped below 1% for first time). Central Banks will stay accommodative in 2020 till spread of the virus is contained and global growth recovery is seen.

GLOBAL COMMODITIES: NO FLOOR FOR OIL; STAY OVERWEIGHT ON GOLD

China contributes greatly to commodity consumption, but with Covid-19 pandemic fallout, demand disruption is seen not just in China but all regions. Both the dry and wet freight indices have spiraled down as trade activity has been strictly curtailed. Oil fell 27% YTD to below $50 as concerns rose about first demand decline since 2009 and stalling negotiations between OPEC & Russia on further supply cuts. Again, as if apocalypse is upon us, investors flocked to Gold. We believe it is prudent to be slight OW on Gold to protect against any such end-of-world events, though valuations are expensive.

INDIA MACRO: ONE CAN ARGUE FOR IT, BUT WORST IS NOT BEHIND

3QFY20 GDP at 4.7% was in-line with expectations but still at 27-quarter low as CSO revised the 2QFY20 GDP upwards from 4.5% to 5.1%. Thus, growth continues to be on a downward trajectory while new challenges to recovery have arisen CSO did maintain the FY20 GDP estimate at 5%, though FY19 GDP numbers (annual & quarterly) were revised down which indirectly means lower growth than previously forecasted. Such constant revisions not only lead to questioning the authenticity of current Govt. data but also lack of confidence in past data. Industry reported de-growth which was offset by Agriculture and Services sector. Gross Fixed Capital Formation (proxy for Investments) cracked to 26.1% of GDP (more than decade low) from 29.1% YoY thus limiting GDP growth. Exports have also deteriorated in face of global economic slowdown. So, only Consumption has provided support, and within that too, Govt. has again played a major role.

We believe there are downside risks to the FY20 GDP growth forecast given Covid-19 entry in India and its likely economic impact as seen elsewhere. Though, current infected cases are few at 28, given the high density of population and lack of basic hygiene and health infrastructure, this can multiply very quickly. But, then, onset of summer can play a natural deterrent.

Other high frequency macro data indicators are also weak and do not point to a bottom yet – 8-core industries index series reported a positive 2.2% YoY growth primarily due to low base but also from rising Coal, Electricity & Steel output. IIP turned back to negative 0.3% vs estimates of +1.7% as value added output remained weak. Even auto volumes showed monthly and yearly decline as manufacturers transition to BS-6 norms. The sustenance of Manufacturing & Services PMI does give some comfort but weakness in other data points stands out stronger. Strong Rabi sowing, decent Agri GVA growth, Govt. focus on rural expenditure and high food inflation bodes well for rural incomes which can restart the consumption cycle

INDIA EQUITIES: FII’S FLEE IN PANIC; TIMING DOES NOT HELP

Back home, India too bore the brunt of the global sell-off compounded by the existing weak macro fundamentals. FII panic driven by Covid-19 spectre led to massive outflows from India too, from both Equity and Debt. But, DIIs – both MFs and non-MFs – did provide strong support. Indian industry too is dependent on China for various raw materials and ancillary components, whose delay in supply can wreak equal havoc as in the case of global industry. Post 3QFY20 results too, the EPS growth estimates were again revised down.

Valuations have corrected and look cheaper when seen from a shorter term (1-5Yr) perspective and relative to bond yields too. But, as we have always stated, one must invest in a gradual manner when faced with uncertainty rather than time the market. Recent sharp spike in volatility should be used to build portfolios. The various risk and return factors goad us to maintain our Neutral stance between Equities and Bonds & Large Caps and Mid Caps

INDIA FIXED INCOME: RBI’S ACTIVE DYNAMISM TO CONTINUE

Knowing very well that it does not have the balance sheet strength to do US and European style Quantitative Easing (QE), RBI has been stealthily using its easing arsenal to still ensure rate cut transmission and durable liquidity. First arrow from its quiver was ‘Operation Twist’ which successfully reduced long end yields. Second was the Long Term Repo Operations (LTROs) for 1Yr & 3Yr tenors up to INR 1 lac crores (announced at 6-Feb-20 meet) which did reduce medium-term yields. Given its inflation-targeting mandate and high headline CPI, RBI has stayed away from cutting rates at Feb meeting but recently did state that it stands ready to take action to preserve market confidence and ensure financial stability and orderly functioning of financial markets.

We believe that softening of yields may not be sustainable, as Public debt-toGDP ratio for India at 69% is much higher than major EM peers. Also, under realisation of revised tax revenues can lead to fiscal slippage. Further, most G-Sec issuances are long-dated securities, which could keep 10Yr G-Sec yields under pressure. For these reasons, our outlook on G-Secs would be one of extreme caution. Credit environment too is still some time away from stability. Hence, we continue to suggest investors to focus on Short to Medium duration funds, PSU & Bank Funds and Corporate Bond Funds

CURRENCY: DOLLAR IS THE FLAVOUR OF THE SEASON; POSITIVE ON USD

China contributes greatly to commodity consumption, but with Covid-19 pandemic fallout, demand disruption is seen not just in China but all regions. Both the dry and wet freight indices have spiraled down as trade activity has been strictly curtailed. Oil fell 27% YTD to below $50 as concerns rose about first demand decline since 2009 and stalling negotiations between OPEC & Russia on further supply cuts. Again, as if apocalypse is upon us, investors flocked to Gold. We believe it is prudent to be slight OW on Gold to protect against any such end-of-world events, though valuations are expensive.