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Investment Strategy

Jul 10, 2024

• Dichotomy of headline data persists in the US.
• Global equity markets remain buoyant, led by the US technology sector.
• We maintain a neutral stance on Indian equity due to elevated valuations.
• We prefer duration in the Indian bond market, given favourable supply-demand dynamics.

The McKelvey Rule

For the past few months, we have regularly highlighted the dichotomy of headline data between headline data from the US and underlying trends. One of the key variables suggesting economic strength has been the tightness in the labour market. Recently, the US Bureau of Labor Statistics published a report based on actual census data from 1.6 million employers, which revealed a net loss of 192,000 jobs in 3Q CY2023, contrasting sharply with earlier estimates of a gain of 640,000 jobs. This is material because the job loss number triggers the McKelvey rule, which has a 100% record of predicting recessions. As per the rule, the recession would have started in October 2023, but the National Bureau of Economic Research (NBER), the official agency that declares recession, is known to often have a lag of over a year in acknowledging recessions.

This explains why the recent Fed Chair Powell’s speech post the FOMC conference referenced Fed’s dual mandate (inflation and employment) after keeping inflation as the centre point of many policy discussions thus far. Interestingly, considering recessions since 1945 have typically lasted less than a year on average, if the McKelvey rule proves accurate once again, we may be nearing the end of the downturn.

In a noteworthy divergence from the Fed’s decision, the ECB cut rates by 25bps last month. The decision came after the Swiss and Swedish central banks had already cut rates and hence may not be as bold as many analysts initially considered it to be. The ECB’s approach to cutting rates is expected to be more gradual compared to previous cycles, leading analysts to not expect another cut in the upcoming July meeting.

Global Market Update

Global equity markets continued their positive trend in June, marking another month of gains. Year-to-date, global equities have surged more than 10%. U.S. equities, driven by robust performances in the technology sector, have maintained their dominant position. However, both Europe and Japan lagged last month and over the past quarter. This can be attributed to surprise elections in France and a slowdown in domestic growth in Japan, which have impacted their respective equity markets.

Source: Bloomberg, Sanctum Wealth. Above returns are price returns in local currency terms

Global bond markets have shown little change in recent months, with yields mostly remaining within a narrow range despite fluctuations amid the uncertainty surrounding US Fed rate cuts.

India Market Update

After a bit of a wobble following surprise election results, Indian equities ended last month with strong gains. Market fears of an unstable government seem to have been squashed, with the BJP retaining all the major ministries despite a coalition government. The market, including us, views this as a continuation of policies, which has led the equity markets higher. While public sector companies have recovered most of the losses seen post-election results, they underperformed the market last month as investors expect the government to focus more on supporting consumption. Banks, especially private banks, were among the best performers last month.

Source: Bloomberg, Sanctum Wealth
The above returns are price returns

Indian bond yields have been largely range-bound with the RBI still in a wait-and-watch stage. FPI inflows into Indian bonds continue at a steady pace as the index inclusion begins. To recall, the index inclusion is at a rate of about 1% weight every month starting on 28th June 2024 and ending on 31st March 2025. Additionally, record dividends by the RBI also came as a positive surprise.

Tactical Asset Allocation | Quarterly Asset Pairs Review

Our proprietary asset pair model plays a critical role in shaping our tactical asset allocation decisions and designing our model portfolios. This allows us to focus on fundamental factors amidst market noise. When we did this exercise last month the scores across asset pairs remained largely unchanged. Currently, the scores slightly favour equities, particularly large caps over midcaps. Additionally, we prefer long-term bonds over short-term bonds, while maintaining a neutral stance on other asset pairs.

Equities vs Bonds

Macro, earnings are supportive, but valuations are expensive.

India’s economic growth remains robust despite uneven global growth. There seem to be no signs of a slowdown, with India’s PMI numbers consistently near 60, ranking among the highest globally. Key indicators such as GST collections, IIP, non-food import growth, and auto sales also display stability. Additionally, external macroeconomic fundamentals like stable currency, trade balance, and current account deficit remain healthy.

In recent years, India’s growth has been driven by investment rather than consumption, reflecting a deliberate strategy by the government. This approach focuses on supporting sectors like infrastructure and industrial development to spur future economic expansion. However, recent election outcomes indicate potential voter discontent, prompting expectations that the government may look to bolster consumption in the upcoming budget while continuing to maintain emphasis on capital expenditure.

PMI indicates sustained economic growth

Q4FY24 earnings met expectations

Source: Bloomberg, Sanctum Wealth

Corporate earnings for Q4FY24 met expectations, driven primarily by Financials and Auto sectors. Nifty reported a robust earnings growth of 11.6% yoy, outpacing revenue growth, which remained modest at 6.6%yoy. Healthy operating margins, supported by operating leverage and favourable commodity prices, contributed to the strong earnings. For the FY2024, Nifty earnings surged by 26%, while revenue growth remained in single digits. Looking ahead, Nifty earnings are anticipated to maintain a healthy growth trajectory of approximately 15% over the next two years, despite expectations of continued single-digit sales growth. PSU banks, Utilities and Private banks saw upgrades to FY25 earnings while Chemicals, Technology and Consumer sectors saw downgrades.

Indian equities expensive

DIIs buying more than offsetting FII selling

Source: Bloomberg, Sanctum Wealth

Foreign institutional investors (FIIs) turned net buyers in June after being net sellers in April and May. Domestic Institutional Investors (DIIs) have been buyers for eleven consecutive months. Year-to-date, DIIs have bought approximately USD 29bn, while FIIs have sold around USD 2bn.

However, concerns remain around valuations. While Indian equities are trading slightly above average in terms of trailing P/E, they are expensive on most other valuation parameters. We believe that most positives are already priced in. Hence, there doesn’t seem to be a trigger in the near term. The next key event is likely to be the union budget, which will be presented when the monsoon session of the Parliament begins in mid-July. Hence, we are cautious in the near-term but over medium to long term we are positive on Indian economy and equity markets.

Large-caps vs Mid-caps

Midcaps more expensive

Mid and small-cap equities continued to outperform large-cap equities in June. Year-to-date, mid and small- caps have outperformed large-caps by more than 10%. This has made mid and small-caps relatively more expensive than large-caps. Relative to their own history, mid and small-caps, are now in the top decile of their valuation history. This leaves very little margin for error, even though the earnings outlook for them is better than that for large-caps.

Midcaps more expensive than large caps

Source: Bloomberg, Sanctum Wealth

Of course, there are still parts of the mid and small-cap segment where value can be found. However, we suggest that investors generally remain underweight in mid and small-caps and overweight in large-caps.

Fixed Income | Corporate vs Government | Short-term vs Long-term

Supply-demand dynamics supportive of duration

India’s core inflation is trending low; however, persistent food inflation has slowed the overall disinflationary process. The RBI also highlighted risks emanating from the recent pick-up in input cost conditions for firms and higher global food prices. We believe the RBI will be vigilant about the progress of the monsoon and its impact on crop sowing too. The RBI governor highlighted that the RBI not only wants to reach the 4% inflation target but also stay there for some time before considering acting on rates. Hence, rate cuts may still be a few months away.

Foreign flows into Indian bonds rising

Government gross borrowing to decline

Source: Bloomberg, Sanctum Wealth

However, we believe the case for duration remains. Demand for government bonds is likely to outstrip supply. The global bond index inclusion will support passive as well as active inflows from Foreign Portfolio Investors (FPIs). We are already seeing the evidence of this. FPIs have bought a significant amount of Indian bonds over the past few months. On the other hand, with lower fiscal deficit target for FY25 and record RBI dividend this year the supply is likely to be much lower. Hence, we suggest adding duration with a 1–3-year investment horizon in mind. However, we do caution against near-term volatility till rate cuts are more visible.

Gold vs Cash

Gold as an insurance

Gold prices have surged significantly in recent months, rising approximately 12% year-to-date and over 20% in the past year in USD terms. This increase has been partly driven by global central banks shifting from US treasuries to gold, notably the Chinese central banks amid concerns over sanctions. While physical demand has been subdued, there has been strong retail investment interest in gold.

Conversely, gold mining supply is anticipated to surpass the previous record highs set in 2018 due to expanded mining activities. Additionally, technical momentum has eased as prices take a pause following the robust rally. Nevertheless, we maintain that gold continues to serve as a hedge against geopolitical tensions and potential spikes in inflation. Demand from central banks and ongoing investment interest are also expected to support the gold prices moving forward.

Overall, we our model is suggesting neutral on gold given the recent run up while corresponding fundamentals have not changed dramatically. However, we have no model for measuring geo-political uncertainty and in a geopolitically sensitive world today, gold allocation is a must.

Central Banks think higher % of reserves will be gold

Source: World Gold Council, 2024 Central Bank Gold Reserves Survey June 2024

Gold prices have rallied sharply

Source: Bloomberg, Sanctum Wealth


India’s strong fundamentals to support the INR

Emerging market currencies have faced pressure against the US Dollar this year, with JP Morgan’s EM foreign exchange index declining by more than 4%. However, the Indian Rupee (INR) has exhibited relative strength and has largely traded within a range against the dollar. India’s robust external balance sheet, characterized by a positive balance of payments, a low current account deficit, and substantial foreign exchange reserves, have supported the INR.

Additionally, concerns over crude oil prices have been limited, aside from brief spikes during periods of potential escalation in Middle East conflicts. Moreover, FPI inflows into debt have outweighed outflows from equity, although moderate foreign direct investment (FDI) inflows have been a concern for the INR. Looking ahead, we anticipate that FDI inflows could improve now that the elections are over.

In conclusion, we expect the INR to maintain its resilience and continue trading within its current range against the USD.

USDINR has been range bound

Crude oil prices pose no immediate concerns

Source: Bloomberg, Sanctum Wealth

Sanctum Multi-Asset Portfolios

We manage our multi-asset portfolios known as SMAPs, which reflect our tactical asset allocation decisions across three profiles: Shield (conservative), Enhancement (balanced), and Generation (aggressive).

Given that our tactical asset allocation remains unchanged, we are not making any major changes to our multi-asset portfolios now. Currently, we maintain an underweight position in midcaps relative to large caps, while holding a marginal overweight position in gold. The negative impact of being underweight in midcaps has been offset by the positive performance of our gold holdings over the last few months.

Private banks in India have not experienced the same level of rally as the broader markets, presenting an attractive valuation opportunity. Moreover, these banks are seeing continued EPS upgrades. Consequently, we are considering increasing our tactical exposure to private banks by reducing our exposure to diversified large cap index.

Overall, the portfolios have performed in line with expectations. Here is an update on the performance of our three multi-asset portfolio strategies:

Performance is calculated using Time Weighted Returns, net of fees and expenses. Returns over one year are compounded annually; returns for less than one year are absolute. Please note that SEBI does not verify the performance information provided above. Please note that past performance is not a guarantee of future performance.
NSE Multi Asset Index 2 composition is 50% Nifty 500, 20% Nifty 50 Arbitrage, 20% Nifty Medium Duration Debt Index, 10% Nifty REITs and InVITs

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