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Equity Strategy: ‘Deploy derivative-based portfolio hedging strategy to protect gains made so far’

Equity Strategy: ‘Deploy derivative-based portfolio hedging strategy to protect gains made so far’
July 21
09:02 2021

There is no doubt that global GDP will see a sharp recovery in 2021 from the troughs of pandemic ravaged 2020. But, the strong resurgence is expected to continue well beyond pre-COVID levels into 2022.

Substantial fiscal stimulus, near-zero interest rates, and significant spurt in household savings act as tailwinds. Delta/+ variant, which is behind the current spike in cases in UK/Indonesia, could move across borders to create more havoc.

Though hospital admissions have not grown as much, and it seems jabs have played their part, nothing can be left to chance when dealing with an invisible and ever-mutating enemy.

Growth will vary across countries depending on policy support, vaccine stocks and rollout strategy, and GDP composition.

Developed Markets (DM) have seen better-than-expected growth with the US at the helm. Deployment of EUR 750bn recovery fund could now see Europe taking the lead. Within Asia, China’s pace could slow down with others catching up.

Global Equities: Inflation-Growth Dynamics Hold Key

US May inflation – CPI/core-CPI/PCE – whichever measure one looks at surprised hugely on the upside with readings at multi-year/decade highs. The second jolt came from the US Fed’s mid-June policy which sounded slightly hawkish.

VIX saw a knee-jerk reaction, but investors soon anchored to the more positive bits. The Fed Chair calmed the nerves by saying the dot-plot shows independent members’ views and not the central bank’s guidance.

The US Fed also construed the inflation spike to be transitory and driven more by base effects and one-offs. EPS growth has been better than expected for 1HCY21 with high growth forecasted for CY22 as well.

The global household savings surplus is also expected to lead to pent-up demand for services. On the contrary, if inflation turns out to be sticky and growth recovery dissipates, central banks could reign in liquidity to address asset price reflation and elevated valuations might not sustain.

Hence, prudent asset allocation and quality investing are critical. We prefer to have a tactical Overweight stance on EU/Japan (Cyclical and Value) and stay Neutral US/Asia ex-Japan.

At the same time, this tactical trade would have to be closed if excess liquidity is reduced as Growth would start looking attractive again.

India Macro: Recovery Dependent on Vaccination Strategy, Budget Execution And Normal Monsoons

Central Government took up the responsibility of vaccine procurement for the States after revising its policy on 21-Jun-2021, and we saw the inoculation drive gathering steam once again.

However, with just ~20% population having received at least one dose of the vaccine, there is a long way to go. Hence, the Central and State governments must work in sync to scale up the pace and size of the vaccination drives to reduce the impact and fatality of any potential third waves.

Successful execution of the Union Budget proposals on the capex spending front is required to boost GDP growth, generate employment, and lend confidence to the private sector to undertake new projects.

The 2nd Covid wave negatively impacted high-frequency macro indicators like PMI, auto sales, e-way bills, freight movement, power and fuel consumption, GST, and toll collections in the month of May.

However, as infections declined and mobility restrictions were eased, the recent data for June and July have shown sequential improvements though still lower than levels seen in 1QCY21. Another bright spot was the highest ever quarterly exports at $ 95bn in 2QCY21 which bodes well for the overall manufacturing sector.

Monsoons were above average for June but have been below average in July (so far). Distribution was also unequal leading to delay in sowing of Kharif crops.

Though, agriculture now constitutes only a small % of GDP, it provides employment to many and drives rural consumption. Hence, good monsoons always aid economic growth and would be an important element in recovery going ahead.

India Equities: Volatility has faded for now but could spike in case of a potential 3rd wave

The moderation in COVID-2.0 infections supported investor sentiments even as hawkish tone from Fed, Oil price rise, and INR weakness impacted. Confidence can be gauged by the 50% fall in India VIX from 25 (at peak of 2nd wave) to 12 now and the number of IPOs hitting primary markets.

Most of the offerings have been OFS exits to promoters and PE funds which raised capital in 1HCY21 equal to the whole of CY20. Ten more IPOs are lined up in Jul-21, with CY21 total IPOs and fundraise expected to eclipse CY17.

The frenetic pace of issuances raises concerns around market participants euphoria. We prefer Equity over Bonds primarily driven by low VIX, steady FII and SIP flows, inflation risks, and healthy earnings growth.

Within Equities, we prefer Mid-caps over Large caps led by relatively better valuations, more robust domestic flows, high retail participation, and higher forward EPS upgrades.

Given that reversal from the market, bottom is complete, value to growth rotation could start playing out soon, complemented by EPS upgrades.

However, one should be mindful that sentiments can turn sour if a potential third wave erupts, and inflation turns out to be persistent than transitory.

Investors wary of taking additional equity exposure at this juncture can execute a derivative-based portfolio hedging strategy to protect the gains made so far.

We believe this to be a better option than moving into cash entirely and waiting for opportunities to deploy on corrections. Time in the markets is more important than timing the markets.

INDIA FIXED INCOME: CRACKS ARE APPEARING

Just like everywhere else, inflation spooked bond investors in India too. Headline CPI came in at 6.3% for 2 consecutive months. It was sharply above consensus estimates for May led by core CPI and food prices though inline for June.

The RBI survey also highlights consumers’ elevated current inflation perception and expectations 3M/1Y out. MPC minutes too spoke about concerns on this front.

But, RBI’s actions indicate they are obsessed with keeping yields stable at low levels to avoid interest costs from swelling for the largest borrower – GOI. Repeated bond auction devolvement, cancellations, change in methodology all point towards the same.

Yields across the curve have moved up sharply in last two weeks. We like top-quality corporate issuances/funds and short-duration investments for debt allocations while avoiding G-Secs and the long end of the curve.

(The author is CIO, Validus Wealth)

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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