Equity: Go light on risk-taking
In the year gone by, the Indian stock market didn’t just climb the wall of worry put up by Covid-19, it effortlessly pole-vaulted over it. The consolidated earnings of Nifty 50 companies shrank by 17 per cent, but this didn’t stop the index from closing the year with a 14 per cent gain. Therefore, the question for Indian stock investors to worry about today is not whether markets are expensive, but about how overvalued they are and how to handle a correction.
To assess the extent to which market valuations have run ahead of fundamentals, one can use history as a guide.
Going by history, the two previous bull markets (see table) saw the Nifty 50 PE topping out at 24-28 times on trailing consolidated earnings. The big crashes that followed saw the PE bottoming out at 11-12 times. (While the official Nifty 50 PE is calculated on the standalone earnings, we’ve used PE based on consolidated earnings here, sourced from Bloomberg).
In the ongoing bull market though, the Nifty 50 PE, after crossing 24 in 2017, remained high for three years until March 2020, when a material correction of 37 per cent unfolded, levelling it to 17 times. But the rebound since then has been swift and the rally from March has seen the Nifty 50 PE go back to 35 times by December 2020, against its long-term average of 18 times. This suggests that a correction, if it unfolds, can be deep.
But two factors can set a floor to a correction. First is the shape of earnings recovery for the Nifty 50 firms. Unlike previous bull markets where Nifty 50 valuations were bid higher on double-digit profit growth, Nifty 50 firms’ profits have been flattish in the last five years. This offers scope for the Nifty PE to moderate through a bounce-back in earnings.
Presently, India’s analyst community expects consolidated earnings of Nifty firms to shoot up to ₹490 by December 2020 and another 37 per cent (₹671) by December 2021. But with actual earnings at ₹401 by November, this appears a little too optimistic, given that the demand outlook for India Inc is clouded and the unusual cost savings that propped September are unlikely to sustain. Taking analyst projections with a pinch of salt, expecting flat earnings for 2020 and a 10 per cent growth for next year, we’d be left with earnings estimates of about ₹440 and ₹484 for 2020 and 2021. Applying a PE of 18-19 to the 2021 earnings, the ballpark fair value for the Nifty would be at about 8700-9000. A stronger profit recovery would raise this level.
A second factor is liquidity flows. For much of the past decade, the ultra-low interest rate policies of central banks that were intent on stimulating their economies have fuelled high stock valuations. In 2020, while domestic investors and institutions were net sellers in stocks, FPI flows continued to flood in. Therefore, hints from central banks on pausing stimulus or normalising rates may be the key trigger to a correction. Whether such news will materialise in 2021 is anybody’s guess, with the banks even recently reiterating their resolve to continue with stimuli.
The above factors suggest taking a middle path to de-risk your equity portfolio. Take out any money you need within three years from equities, book profits on your most expensive holdings and rebalance to lower equity allocations. This can help you participate in a continuing rally without worrying too much about a crash.
Where opportunities lie
Irrespective of index levels, the stock markets usually do offer pockets of opportunity for bottom-up investors. So, where do these lie for 2021?
One, the broader market today offers more opportunities for bargain-hunting than the Nifty 50 or Sensex baskets. The recent leg of the post-March rally has been driven by furious FPI (foreign portfolio investor) buying, accompanied by domestic institutions selling. FPIs have a great affinity for passive index investing, while domestic institutions like to cherry-pick mid- and small-cap names. A break-down of valuations (see table) shows that while just nine of the Nifty 50 stocks trade at a PE below 15, 111 of the Nifty 500 stocks trade below this PE today, suggesting bargains.
Two, stocks from hitherto underperforming sectors such as cyclicals, corporate banks, realty, PSUs, energy and utilities may offer more promise in 2021 than the so-called defensive pack. Given the Covid uncertainty, investors in 2020 flocked to defensive sectors seen to be benefiting from the pandemic or from the pent-up demand immediately after it. The BSE indices on healthcare (up 60 per cent for CY2020), IT (up 57 per cent), consumer durables (up 20 per cent), basic materials (up 26 per cent) were big outperformers for the year.
But if a genuine economic recovery does takes shape, it is more likely to be led by cyclicals such as utilities, energy, oil and gas, cement and corporate lenders, apart from PSUs. The recent upturn in the global commodity cycle also suggests a stronger profit outlook for commodity processors and a weaker one for users of these inputs. These are also the segments where stocks are still available at reasonable valuations.
Three, investors may also need to watch for the comeback of the long-dead value and dividend-yield styles of investing. With earnings growth hard to come by, the bull market of the last decade has been led by companies seen to deliver predictable growth. This has led to high valuations for ‘growth’ companies with low debt, high cash flows and shareholder returns. But with investors increasingly running out of reasonably priced options in this space, there’s evidence that they’re turning to companies with lower earnings visibility, but high dividend yield or cheap PE of late.
Until the end of 2019, the MSCI India Value Index, with a 10-year CAGR of 4.94 per cent, struggled to keep up with the MSCI India Growth Index’s return of 8.57 per cent. But 2020 proved to be a year in which value stocks took a decisive lead — the MSCI India Value Index gained 22 per cent for the year compared with an 8.5 per cent gain in the Growth index.
After the pole-vault, 2021 promises to be a precarious year that is best navigated with caution. Go light on risk-taking. Reduce your equity allocations and don’t pay sky-high valuations for stocks.
Gold: Bulls will continue to rule
The year 2020 was terrific for gold as it produced a 28 per cent return.
The spot price of gold on the Multi Commodity Exchange ended the year at ₹50,005 versus the previous year’s close of ₹39,076. This is the second highest calendar-year gain in the last decade, the highest being 32 per cent in 2011. The yellow metal produced a notable return of nearly 24 per cent in 2019, thereby giving back to back double-digit gains. The annualised return over the last five years stands at 12.4 per cent, outperforming the Nifty 50’s 11.3 per cent.
The past two years have been specially good for the yellow metal. While concerns about slow global growth triggered the price rally in 2019, Covid-19 and its response from central banks across the globe helped bullion sail through 2020.
What’s in store
Monetary injection by the central banks, a big driving factor for gold lately, cannot continue forever. Covid fears are also diminishing with the development of viable vaccines. Even the new strain of virus, which is believed to be more contagious, has not really shaken things up.
Hence, these factors are not expected to play a major role in influencing gold prices in 2021. Factors such as inflation, economic expansion, currency movement, et al, may take over as drivers.
Risk-off sentiment, which usually helps gold rally, can wane as economies across the globe return to normalcy, with better growth leading to higher incomes. Should this happen, the lead role in demand, which has been played by investments last year, can be taken over by jewellery demand — traditionally a big driver for gold.
Economic expansion taking shape and the ultra-low rate policies, too, can fuel higher levels of inflation. Gold as a natural hedge against inflation can benefit from this.
All this points to the price of gold staying sluggish in the short run, but firming up in 2021. Technical indicators suggest that in the next one year, targets of ₹56,000 are attainable, with ₹60,000 or ₹65,000 possible over the next two-three years.
If you would like to own gold as a hedge against inflation risks, sovereign Gold Bonds (SGBs) issued by the RBI, and gold exchange-traded funds (ETFs) offered by mutual fund houses should be your preferred options.
SGBs are issued in units of one gram and there is an additional sense of safety since the RBI is involved. They carry an interest of 2.5 per cent per annum with a minimum five-year lock- in. Selling SGBs early in secondary markets can be a sore point given low liquidity.
Gold ETFs are offered in units and for every unit issued, there’s an equivalent value of physical gold bought by the fund. While it may not carry interest like in SGBs, ETFs are available on tap and liquid.
Fixed income: Time to keep investment safe and flexible
In its efforts to spur economic growth following the Covid-19 pandemic, the RBI announced a sharp 75-basis point (bps) cut in the repo rate in March 2020, followed by another 40-bps cut in May. With this, the repo rate has come down from 5.15 per cent at the start of the year to 4 per cent now.
In line with this move, large commercial banks slashed their deposit rates by 70-160 bps over the past year or so. Small finance banks (SFBs) followed suit with cuts of 100-150 bps.
Rates on small savings schemes, which are reset quarterly, were slashed by 70-140 bps in the April-June 2020 quarter. Though, since then, rates have been left unchanged for three consecutive quarters. The Government of India 7.75 per cent Savings Bonds were closed for subscription in May 2020 and were replaced in July by the 7.15 per cent Floating Rate Savings Bonds.
Among debt funds, hurt by downgrades and defaults, many credit-risk schemes took a hit this year. While most liquid funds fetched one-year returns of 3.2-4.3 per cent in 2020, those in the short- and medium-duration categories returned 6-11 per cent.
What to pick
With interest rates at historic lows today, investors have been left wanting better investment avenues. With many businesses and the economy yet to fully recover from the impact of the pandemic, capital preservation remains top priority.
At the same time, the interest rate outlook is quite uncertain. While further cuts appear unlikely, so do near- term increases. This suggests investors are better off parking their debt money in products with ready liquidity, short lock-ins or floating rates. We highlight options that score high on returns, safety, ease of exit and tax benefits.
Fixed deposits: Despite the rate cuts, a few fixed deposits, especially from SFBs are offering good rates, at 6 -7 per cent on their one- to two-year FDs. These are particularly attractive for those in the lower tax brackets as interest on FDs is taxed at your income-tax slab rate.
Investors can consider the one-year-to-18-month FD from Equitas SFB, one of the healthier SFBs in terms of governance and capital adequacy. It offers 6.60 per cent per annum (7.10 per cent for senior citizens). Comparable FDs from public sector banks offer 4.9-5.3 per cent, while many from private sector banks offer 5-6 per cent.
Equitas SFB’s gross NPAs were 2.48 per cent and its tier 1 CAR (capital adequacy ratio) was at a comfortable 20 per cent as of September 2020. Investors can also consider DCB Bank’s 700-day FD that offers 6.9 per cent.All bank deposits have a deposit insurance cover of ₹ 5 lakh per bank.
Short-duration debt funds: These funds invest in debt and money market instruments such that the average portfolio maturity is under three years. The last seven years, leading schemes in this category have delivered average one-, three- and five-year rolling returns of 7.9 per cent, 5.0 per cent and 7.7 per cent, respectively. But going forward, returns will be lower given the low coupons on bonds currently.
If you want to play it safe, stick to only high-credit-quality funds. IDFC Bond Fund – Short Term Plan and Canara Robeco Short Duration Fund are two such schemes. As of November 27, 2020, the IDFC fund and the Canara Robeco fund had over 96 per cent and 97 per cent, respectively, of their portfolio in AAA and sovereign debt papers.
If held for over 36 months, long-term capital gains on debt funds is taxed at 20 per cent with indexation benefits, making them more attractive than fixed deposits for those in the higher tax brackets. Short-term capital gains (for investments redeemed within 36 months) are, however, taxed at your income tax slab rate.
Floating Rate Savings Bonds: If liquidity is not a concern, you can invest in the sovereign guarantee-backed Floating Rate Savings Bonds 2020 from the Central government that carry an interest rate of 7.15 per cent per annum currently. The interest rate is reset every six months and is paid half-yearly. The interest income is taxed at your income tax slab rate.
You can buy the bonds from SBI, other nationalised banks and some private sector banks. The only negative — a lock-in period of seven years. However, those 60 and above, are allowed pre-mature encashment after a few years, subject to a penalty of 50 per cent of the last interest payment