September, 2020

Nifty-50 gained 2.8% in the month of August with out-performance by the mid and small-caps. The rally was characterized by beta outperformance - metals index gained 13%, followed by realty +11% and banks +9%. Some of the Covid battered stocks like PVR rallied as well. Bharti Airtel (-8%), Ultratech Cement (-5%) and Hindustan Unilever (-4%) were the top losers amongst the large-caps. FPIs bought US$6.4 bn worth of equities for the month while DIIs sold US$1.5 bn - domestic mutual funds saw outflows.
RBI maintained its accommodative stance in the MPC meet and announced a slew of measures such as loan restructuring, increase in LTV for gold loans etc. However the sticky bond yields (July CPI was higher than expected at 6.93%) and rising stock prices have made the relative equity valuations less attractive at the margin. US central bank shifted its policy framework to focus more on economic growth than inflation keeping the global liquidity context favorable for equities.
The government continues to push for local manufacturing through PLI schemes and also banned the import of 101 defense items. Broadly commentary from companies remains positive - even in the financials where retail borrowers appear to be behaving better than expected. Capital goods / industrial stocks have not participated much in the post Covid rally and select names could be beneficiaries of an uptick in investments besides the mid-cap specialty chemical and pharma oriented names.
IT spending has also been resilient and given the faster recovery of global economies compared to India, export oriented sectors are likely to see stronger revenue traction compared to higher end domestic consumption such as cars. Two wheeler demand is likely to be strong till the festive season.
Strategy: While a 7-10% correction in markets cannot be ruled out, a tough ask is when. We don't see any meaningful corrections on the cards and hence one should stay invested and add more on dips as a correction will be a part of a larger upward trend.
We continue to maintain an "equal-weight" allocation to equities and recommend investors to have allocations in-line with their strategic level. Those who are currently under-invested can stagger deployment over 6 months in fortnightly tranches considering the significant rally markets have seen from the lows.
Market cap orientation remains at minimum 60% large-cap and we believe its best to look at opportunities on a bottom-up basis given that the mid-cap universe has its share of high quality business models (consumer discretionary) and sectors which have growth tailwinds (chemicals etc.)

► Recent data suggests that the CDGR* of Covid cases in India continues to decline week on week.
► Positive cases as a proportion of total tests remained flattish at 8.6% as of August 30, 2020
► The proportion of cases in the rural areas is increasing; in general, the spread of the virus is increasing, with the top 10 districts now contributing only 32% of cases vs 44% earlier
► The recovery rate has increased to 76.6% as of August 30, 2020 from 65.8% on August 02, 2020
► The fatality rate has also remained under control, remaining relatively low compared to other major Covid-19 affected countries

► Most of the indicators show that the economic activity is still well below the pre Covid period
► Electricity consumption gap widened to 10% over the seven day period ending August 26
► Daily average e-waybills generated over the past week were the highest since the end of March
► Daily average import duty collections remained lower in August compared to July
► Since the domestic flights were allowed, the number of departures and the number of passengers has increased at a very slow pace
► Petrol consumption in June was already back to March 2020 level High speed diesel consumption in June was above the March 2020 level
► There was no meaningful change in excess time spent at residence, or the number of visits to workplaces However, number of visits to grocery stores improved over the past 7 days
► There was an increase in traffic congestion levels in Mumbai, New Delhi Pune Traffic congestion levels remained unchanged in Bengaluru for a fourth consecutive week
► Car and two wheeler registrations in July were both around two thirds of FY 20 average
► The daily average of property registrations in Maharashtra in August is higher than the daily average of March 2020 and was ~84% of FY 19 daily average
► Estimated unemployment level fell back below 8% as per CMIE survey July saw a notable increase in number of new companies registered, compared to June

Huge Monetary stimulus by CBs: The Balance sheet (ECB+US Fed+BOJ) expansion since Feb has been of the magnitude which took 6 years before Feb

The stimulus by Central Banks post the Covid outbreak has easily dwarfed the response post GFC in terms of both scale & timing

10-yr Govt Bond Yields have fallen: Central Banks have resorted to cutting rates, especially US Fed, so as to provide stimulus to the economy

► The Federal Reserve announced a major policy shift few days earlier, saying that it is willing to allow inflation to run hotter than normal in order to support the labor market and broader economy
► In a move that Chairman Jerome Powell called a "robust updating" of Fed policy, the central bank formally agreed to a policy of "average inflation targeting". That means it will allow inflation to run "moderately" above the Fed's 2% goal "for some time" following periods when it has run below that objective
► "Many would find it counterintuitive that the Fed would want to push up inflation," Powell said. "However, inflation that is persistently too low can pose serious risks to the economy."

FIIs selling was brutal in the month of March taking out about ~INR 62000 crs from the equity market. They have come back strongly into Indian equities since May. Flows to emerging markets, including India, can remain strong if USD weakening continues due to negative real rate expectations

Equity mutual funds witnessed the first month of net outflows in July after 4 years; while SIP inflow was again below INR 8000 crs level possibly driven by profit booking

Schemes for pharma and medical devices sectors: Production Linked Incentive (PLI) schemes are paving the way for setting up of bulk-drugs and medical-devices parks in India

• For bulk-drug manufacturing: Incentives would be given to a maximum 136 manufacturers for six years as a fixed percentage of their domestic sales. For fermentation-based products, incentive rate is 20% for the first four years, 15% for the fifth year, and 5% for the sixth year. For chemically synthesized products, it is 10% for all six years. The scheme is applicable for greenfield projects with a threshold investment limit of Rs 0.2-4.0 bn. Incentives will start from FY23 for chemically synthesized products, from FY24 for fermentation-based products. Total financial outlay is Rs 69.4 bn.
• For creating three bulk-drug parks in India: Grant-in-aid at 90% of the project cost in north-east and hilly states, 70% in others. Maximum grant for one bulk drug park limited to Rs 10 bn. Total financial outlay is Rs 30 bn.
• For promoting domestic medical devices manufacturing: Financial incentives on sales to a maximum of 28 selected applicants for five years. Incentives rate is 5% of sales of domestically manufactured medical devices starting from FY22. Total financial outlay is Rs 3.4 bn

PLI scheme for mobile phones and electronic manufacturing

• For promoting domestic mobile manufacturing: Production-linked incentive scheme (PLI) for mobile manufacturing comes with 4-6% incentives spread over 5 years with a minimum investment of Rs 2 bn spread over three years by any domestic company. This is for mobile phones priced below Rs 15k (ex-factory). In addition, similar incentives are there for mobile components but with an investment of Rs 1 bn.
• Similar incentives are there for international companies manufacturing in India, while investment outlay for them is Rs 10 bn over the same period.

Tax breaks, fiscal incentives and regulatory reforms for the agrochemical sector

• Reports do indicate that Niti Aayog, Agriculture Ministry and Commerce Ministry have sought suggestions from industry to prepare a roadmap for self-reliance in agro-chemicals space.
• The Indian agrochemical industry has the potential to double in 5 years to $11 bn, however, it is currently heavily dependent on imports from other countries. India imports agrochemicals worth over Rs 30 bn from China
• These reports indicate that fiscal incentives like corporate tax exemption for new units, reduction in GST rates, incentives for R&D have been sought besides plug-and-play industrial parks and wider reforms in Insecticide Act and Pesticides Management Bill, 2020. The industry has pressed for lowering of the GST rate from 12% to 5% for agrochemicals, in line with the rate of seeds and fertilisers

Import embargo to push indigenisation in defence manufacturing

• Import embargo (planned during 2020-24) on 101 defence items will boost indigenisation of defence production; more items would be identified progressively.
• Bifurcation of capital procurement budget for FY21 between domestic and foreign routes: A separate budget head has been created with a financial outlay of Rs 520 bn for domestic procurement in FY21.

► Valuations are near or above the medium term averages based on most of the metrics. But with low rates globally, such valuations can sustain.
► Considering the potential threat to GDP growth, FY21 & FY22 earnings could be at risk.

• FOMC outcome, MPC meeting, elevated CPI Print, Release of minutes of MPC meeting, special OMO announcement and devolvement of benchmark 10 Yr G-Sec were key events in the month of August 20 - which kept markets more volatile as compared to last couple of months.
• MPC kept the policy repo rate unchanged at 4% while maintaining the accommodative stance. While the decision of status quo was on expected, however, the policy decision did not bring any comfort to the market participants with regard to the supply pressures in the market.
• The CPI print of 6.93% shocked the market as higher than expected inflation reading muted the chances of a policy repo rate cut in the October MPC meeting.
• The hawkish commentary of the members in the MPC minutes and highlighting risks of higher inflation going forward, led to sharp rise in yields.
• The market witnessed one of the largest amount of devolvement by RBI till date with INR 17,984 Crs being devolved in the benchmark 10 year government security, indicating RBI's discomfort with higher yields. Further, HTM hiked for banks and special OMO announcement by RBI two tranches, led to softening of yields.
• The bond market (G-Sec and corporate) surged by 25-35 bps in August realigning to their self-inferred guidance of the RBI minutes before retracing back post RBI measures.

• 1QFY21 real GDP growth effectively set the trough for FY2021E. While activity levels have been improving, even factoring in a gradual improvement across most sectors, GDP growth for FY2021 is expected to be ~ -10% to -14%.
• Domestic economy will likely face adverse inflation-growth dynamics over the next six months. Even as growth remains muted, elevated inflation risks restrict policy actions through rate cuts and/or incremental liquidity easing. This has started to weigh on bond markets and could impede incremental monetary transmission
• Despite deteriorating fiscal outlook, the bonds markets had been holding up rather well till July backed by (1) easing policy rates, (2) dovish MPC willing to weigh growth over inflation, (3) huge liquidity surplus, and (4) hopes of additional RBI measures. However, the fatigue built-up in the bond market post MPC minutes and subsequent reaction by RBI though various measures to ease the financial market disruptions - point towards continuous RBI support requirement.
• The RBI measures along with the devolvement of the 10-year auction indicate RBI's discomfort with higher yields, which could impede transmission and adversely impact the already weak economy. RBI is keen to use other tools to avert dislocations in financial markets. However, after the recent measures, the toolbox is slowly shrinking.
• Directionally, it looks like a range bound yield play across the curve. Short end being supported by surplus liquidity and low policy rate while long end likely being anchored/ capped by RBI policy support. In all this, 6 to 9 Yr segment on G Sec curve looks attractively valued with higher carry in a benign policy rate environment. Corporate bond spreads looks extremely compressed with some PSU bonds getting traded close to illiquid G-sec of same tenor.

• We remain at one of the lowest policy rate environment as of now. While rates are likely to remain benign in foreseeable future, inflation and fiscal dynamics over a period of time could act as trigger for reversal.
• Continue to suggest "Keep it simple" framework for fixed income allocations - in a range bound yield and cautious credit environment. Anchor return expectation at around 5% - 6% centric for debt allocation.
• Core debt allocation should continue to flow in combination of passive roll downs funds/ Bharat Bond Funds, active short term funds, banking & PSU funds and corporate bond funds, although at slower pace.
• Long term debt allocations can continue to be allocated to long-end passive roll down funds, again at slower pace. Heavy anticipated SDL borrowings in next couple of quarters along with compressed spread in corporate bonds may offer better entry points going ahead. We suggest a 50:50 staggered deployment strategy in two tranches (~25 bps apart) for fresh monies.
• We continue to prefer arbitrage funds for an investment horizon of 6 months to 12 months albeit with higher volatility in short term.

The spread compression on short end yield is meaningful as a result of huge demand from mutual funds. However, purely on fundamentals, valuations look extremely rich for short term corporate bonds for now.

3Y AAA PSU offers 28 bps Spread over G-Sec against long term avg. of 68 bps

10Y AAA PSU offers 74 bps Spread over G-Sec against long term avg. of 81 bps

Term spreads over Repo for 3 Yr PSU have dropped below long term average due to recent rally in 3-4 months and expected to stay low due to abundant banking system liquidity. The long end term spreads stay moderated due to regular RBI interventions

3 Y AAA PSU spread of 100 over Repo is below the long term average of 134

10 Y AAA PSU spread of 270 over Repo is higher than the long term avg. of 176

▮	Indicative Return Guidance across Investment Options

Arbitrage funds can be looked at from a 6 months to 1 year perspective.
All rates are tentative pre-tax estimates based on yields as of 31st August 2020.
These are only indicative results and the actual returns may differ depending on underlying schemes, tenure of holding etc.

▮	Recommended Debt Funds' Performances