The Corona Conundrum

[This was originally published on 3rd March, 2020 as part of our newsletter to indicate shift in portfolio strategy]

The financial markets have been in turmoil over the past few weeks. With the result season over, budget digested and medium term credit policy in place, the market lacks much motivation to resist the selling pressure emanating from global nervousness. The outbreak of Coronavirus has occurred at a time when the domestic and global economies were facing a slowdown. This has threatened to become a global pandemic causing massive supply chain disruption in global trade and commerce. Consequently, the deflationary pressure in the global markets has increased leading to higher demand for safe haven assets like US Dollar, US Treasuries and Gold. Most global central bankers which had already begun to moderate their policy stance in 2019 itself are now prompted to further enhance the monetary stimulusvia rate cuts and QE. Fiscal packages to contain the impact of Coronavirus from various nations will be attempted to normalize the economic situation.

RBI has implemented a paradigm shift in its policy regime. After experimenting with the monetary policy for few years, it has now reverted to management of comprehensive credit policy with supporting growth as the primary objective. The latest policy tools brought into use by RBI (Long Term Repo Operation or LTRO alike ECB) and postponement of Gilt maturities through operation twist (alike Fed) have added significant monetary stimulus to the financial system. LTRO has virtually pegged the short term cost of funds for banks to the current repo rate of 5.15%. Operation twist has reduced the amount of gross borrowing by the government through postponement of maturities and it has eased the long term borrowing cost for corporate by keeping benchmark yields under check. For a change the transmission of policy is accelerated and effective

These two events warrants investment strategy and asset allocation review. In our model, we were working with 50% equities, 25% Debt and 25% Gold allocation. Persistent downward pressure on yields shall keep both the bonds and equities buoyed. The recent correction in stock prices has given us an opportunity to shift more money to equities given the valuation level is much more comfortable at current benchmark indices level. We are hence recommending 75% equities, 20% debt and 5% to Gold. We remain positive on Gold given the accommodative monetary policy stance of Central banks, but the sharp run up in the metal and sharp fall in equities make the latter more attractive from a return stand point of view.

Within equities, we continue to remain overweight on IT, Insurance and Agri inputs. We introduce new weightage of non-lending financials in the form of allocation into AMCs and Depositories. At some point in time in the coming year, the real estate shall also attract buoyancy, given poor yields and abundant liquidity. Real estate rentals have already seen a sharp rise over the last two months. We believe this provides an exciting opportunity in Commercial real estate stocks as well. We also remain equal weight on producers where the pricing power has made a comeback in the past couple of months chiefly cement and FMCG.