DAILY VOICE | Devang Kakkad of Equirus Wealth highlights 4 key risks to current bull run on D-Street

A) 2021 started on a positive note with declining COVID cases, increased flows from global investors, and a pro-growth budget. However, concerns surrounding rising global yields and sharper than expected second wave dented the positive sentiments in April & May.

COVID cases peaked in early May and continued to see a significant reduction through the latter half of the month. Unlike the first wave, the second wave was compressed in time and therefore is expected to have a lesser impact on economic activity both from a time duration and magnitude perspective.

Not surprisingly, the up move in Indian equities has been led by pro-economy segments with Financials, smallcaps, and services in particular outperforming.

Other supportive trends at play include moderating global yields, weakening dollar,, and Emerging Market Equities finding a bid again with global investors.

The ongoing result season has been strong as expected with the Nifty companies having reported so far suggesting nearly 18% and 40% year-on-year growth in sales and operating profits respectively off a weak base.

In a year when the economy contracted by 7.3% on a real basis and 3% even in nominal terms, growth in earnings is quite remarkable and supports the thesis that corporate profits to GDP in India may finally be reverting higher after having plunged to multi-year lows.

The volatility witnessed since the start of 2021 is best served by staying invested rather than trying to time the markets. The near-term uncertainties notwithstanding, the long-term outlook for equities continues to remain intact.

We continue to recommend equity investments as per risk profile and recommend a staggered approach to equity investment – through a 3 to 6 months Systematic Transfer Plan (STP).

SIP, which is based on the dual concepts of rupee cost averaging and the power of compounding, remains the most time-tested approach for long-term wealth creation.

Q) Which are the key risks the Indian market faces amid the Bull Run?

A) We foresee 4 broad key risks for the ongoing Bull Run:

a) COVID – While the second COVID wave seems broadly in control, there were increased fatalities in the second wave. Overall, the lingering effect of the second wave is still impacting the investor sentiment and economy. While people and businesses are increasingly adapting to pandemic working conditions, the impending third wave of the Covid wave (if any) continues to remain the foremost risk.

b) Vaccination – As per the Bloomberg Vaccination tracker on June 7, 2021, only 13.5% of the Indian population was vaccinated with first dose and a meagre 3.4% of the population is fully vaccinated. Vaccine shortage and vaccine hesitancy both will be key risks to watch out for.

c) Monsoon – Rural economy has been the backbone of the Indian economy throughout last year. Increased sales in two-wheelers or paints were largely attributed to consumption in rural areas. With the second COVID wave, the rural economy got severely impacted. Normal Monsoon in many ways is a prerequisite for the Indian economy to grow.

d) Commodity prices – They continue to consolidate their first-quarter recovery. Nearly all commodity prices rallied in Q1’2021, continuing their marked rebound since late 2020. Almost all commodity prices now exceed their pre-pandemic levels, and those of some commodities, notably metals, are well above their previous levels. Rising commodities prices will exert significant inflationary pressures for the economy and input cost pressures for companies and may dent robust earnings growth expectations.

Q) What is your take on RBI policy? How long can RBI keep interest rates low?

A) RBI’s June Monetary Policy announcement is in line with market expectation, ticking all the right boxes. RBI’s announcement of another operation under Government Securities Acquisition Programme (G-SAP) 1.0 for purchase of G-Secs of INR 40,000 Crore to be conducted on June 17, 2021.

Monetary Policy also indicated G-SAP 2.0 in Q2:2021-22 and conducting purchase operations of INR 1.20 Lakh Crore is expected to support the market.

With multiple reiterations by RBI of maintaining adequate liquidity and ongoing interventions through OMOs, G-SAP and others, we continue with our expectations of interest rates remaining low for foreseeable future and continue with our preference for a low duration and ultra-short-term bonds to minimize interest rate risk and volatility.

Q) Any contra trade with respect to sectors which you think could play in the next 6-12 months?

A) As evident from May month and YTD 2021 performance, we are witnessing a smart sector rotation. The rally in capital goods/utilities sectors started off with the government’s thrust on the whole CAPEX related theme in this year’s annual union budget.

With a focus on economic revival, GDP is expected to bounce back strongly, and the infrastructure sector will play an important role. Also, relatively cheaper valuations supported the rally in these segments.

Given the uptrend and sectorial rotation, investors will be best rewarded with a diversified portfolio instead of sector concentration. For investors who are keen for thematic investments, the infrastructure sector will be our foremost recommendation.

Investors with a 3-year time horizon and appetite for intermittent volatility could evaluate infrastructure mutual funds.

Q) Will crude above $70 or $80/bbl hurt the economy and markets? Which sectors are likely to get impacted the most?

A) Crude oil prices recovered sharply from their COVID-19 slump, driven by increasing demand as well as continued production restraint by OPEC and its partners (OPEC+). 2021 YTD, Crude oil prices have increased by 38.8% (as of 4th June 2021).

The price of Brent crude oil briefly reached US$70/barrel in early March after OPEC+ announced production cuts through April.

Most economists expect the crude oil prices to stay elevated around US$60/barrel largely driven by a pick-up in demand as the economic recovery gains momentum and vaccinations become more widely available, particularly in advanced economies.

Back home, with petrol prices hovering near the 100 Rupee mark and in few metro cities crossing the 100 Rupee poses upside risks to the inflation outlook. An increase in Crude Oil prices beyond US$ 75 will exert pressure either on Government to reduce taxes and thereby dent the overall fiscal deficit or lead to inflationary pressures in the economy.

In both scenarios, growth estimates will certainly be impacted. An increase in fuel prices means an increase in logistics costs for companies across sectors. Sectors that are likely to get more impacted include consumer discretionary, consumer staples, and auto and auto ancillary.

Q) Do you see demand revival by Diwali?

A) Contingent to COVID being in control, we do expect demand revival by Diwali. We expect demand revival on 2 counts – replacement demand, as well as pent-up demand from COVID, induced lock-downs.

Rural demand may continue to remain robust given the expectation of normal monsoons and the agriculture sector being least impacted by COVID.

Urban demand is expected to pick up with an increased pace of vaccination and improvement in overall consumer sentiment.

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