Calendar 2018 waves us goodbye and leaves in its wake volatility, surprises and indigestion for the gluttons in the mid and small cap space. A course correction maybe in order. Let us look at it from a sum of the parts perspective:
Commodities (hard assets): It constitutes the raw material component in corporate reports. Prices of these will be determined by a combination of demand and supply and the currency peg. While we are staring at pro-cyclicality in the hard assets space (when the real economy and financial market trends are positively correlated), industrials are likely to stay range-bound, boosted perhaps by weakening fiat currency levels. Since currencies and hard asset prices are inversely correlated, weaker currency translates into stronger hard asset values and vice versa.
Fixed income: Budget 2018 clearly tilted the dice in favour of fixed income, especially bank deposits. By levying long-term capital gains (LTCG) of 10 percent on equities and raising the tax exemption threshold of bank interest income from Rs 10,000 per annum to Rs 50,000 per annum from FY 2018-19, investors’ money is clearly biased in favour of fixed income via fixed deposits. For sure, the higher exemption applies to senior citizens only, but historically, they are the biggest investors in bank deposits anyway. The upside to investing in bank deposits is that your investment does not fluctuate with the markets. The higher the volatility in the equity markets, the more I expect capital flight to fixed income markets.
Currencies: The US needs a strong dollar to manage its external debt. USA goes to polls in 2020. As per the ‘Presidential election cycle’, the currency and equity markets tend to firm up in the US approximately 15-18 months ahead of actual elections. Which means around April – June 2019. Coincidently, we will be involved in our own electoral exercise, which will stir the currencies melting pot spiking volatility even higher. Also noteworthy is the fact that our banks are exempt from disclosing mark-to-market losses at one shot on their bond portfolios (available for sale and available for trading G-Secs) in FY2018-19. As we head closer to the next financial year, these concerns will start raising their head again.
The 10-year benchmark bond yields stood at 7.398 percent as on 31 March 2018. Should bond yields trade higher than this figure, the currency can weaken further marginally in the coming year. The probability of a weaker rupee is therefore higher than a stronger rupee. Which means the landed prices of our imports will continue to climb, foreign debt will get progressively expensive to service and redeem. This in turn can raise the WPI (wholesale price index).
Equities: This will be the most slippery asset class among all to predict in 2019. There are multiple triggers to push volatility higher. The post-election budget, bond MTM losses accounted from April 2019 onward by banks, current and fiscal deficits, total figures of farm loans waived and retail inflation, not to mention corporate profitability. An investor/ trader will have to keep his ears glued to the ground to gauge the directions of the capital markets. The US presidential cycle will start playing out in H2 of the calendar year as well.
With the small and mid-cap stocks way off their recent peaks, upthrusts may encounter the routine overhead supply. Sticking to high quality large caps seems to be a safer bet. Further splitting the choice, I would prefer to go with non-discretionary consumption-fuelled stories rather than manufacturing themes. Any hike in interest rates may become a possibility, especially if inflation rears it’s head again (watch oil keenly in 2019) and drive investors further towards relative safety of fixed income instruments.
The one thing that would be treacherous to do would be to resort to linear extrapolation. So avoid the mental math of—if Nifty rose 100 points this week, it will rise 500 points in 5 weeks (extrapolation). Remember, Nifty returns have been approximately 3 percent in calendar 2018. Just as human beings tire out as they climb the steps of a tall structure and tend to slow down with strain, markets too must respond to gravity, selling pressure and limited resources of the bulls. After rallying smartly from 2016 onwards, I think 2019 should be a year of treading cautiously. Alpha (capital appreciation) will surely occur, there is no need to shy away from equity, but just make haste……slowly.
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Updated Date: Jan 14, 2019 19:19:15 IST