The Alpha Investor, April 2020 | Issue #6| Finpeg

The Alpha Investor Issue #6, April 2020

A tale of two opposite forces!

INSIDE THIS ISSUE Dear Investor,

1. Cover Story When we were putting together last month’s issue, we had thought that when we sit down for this month’s issue, it will be from our office. 2. Indian Markets Unfortunately, that did not happen. We continue to be locked down. 3. Indian Macro If March was a month of unprecedented volatility, April was a month 4. Global Markets of a sharp V-shaped rebound in stock markets fueled by mega fiscal and monetary stimulus. 5. Global Macro In this issue, we take stock of where we are and what are the forces 6. Performance Data driving the equity markets and which force is likely to win in the near term. We also discuss India’s economic response to COVID-19 in our macro theme section. Happy reading! Shubham Satyarth Co-founder, Finpeg

Put together

Smart solutions for smart money

The Alpha Investor | Issue# 6

The Alpha Investor, April 2020 | Issue #6| Finpeg

What’s Inside?

A TALE OF TWO OPPOSITE FORCES ...... - 3 -

FORCE 1: UNPRECEDENTED MEASURES BY THE FED ...... - 3 - FORCE 2: THE ECONOMIC GRAVITY ...... - 5 - WHO WILL WIN THIS BATTLE? ...... - 7 - INDIAN MARKETS – A V-SHAPED REBOUND IN APRIL ...... - 8 - 1. EQUITY MARKET WRAP FOR THE MONTH ...... - 8 - 2. EQUITY MARKET VALUATIONS ...... - 10 - 3. DEBT MARKET WRAP FOR THE MONTH ...... - 11 - 4. WHAT HAPPENED WITH FRANKLIN DEBT FUNDS? ...... - 12 - 5. WHAT IS THE “SMART” MONEY DOING? ...... - 13 - ECONOMY – TO GET A LOT WORSE BEFORE IT GETS BETTER ...... - 14 - 1. SUMMARY AND OUTLOOK ...... - 14 - 2. GDP AND THE ECONOMY ...... - 15 - 3. INFLATION AND MONETARY POLICY ...... - 16 - 4. EXCHANGE RATE – STABLE DURING THE MONTH ...... - 17 - GLOBAL MARKETS – A SYNCHRONIZED BOUNCE BACK ...... - 18 - 1. GLOBAL EQUITY MARKETS ...... - 18 - 2. GLOBAL DEBT MARKETS ...... - 19 - 3. DOLLAR AND GOLD ...... - 20 - GLOBAL MACRO ...... - 21 -

1. GLOBAL MACRO SNAPSHOT ...... - 21 - 2. INDIA’S ECONOMIC RESPONSE TO COVID-19 ...... - 23 - PERFORMANCE DATA ...... - 26 -

1. BEST PERFORMING EQUITY MUTUAL FUNDS IN APRIL 2020 ...... - 26 - 2. BEST AND WORST PERFORMING NIFTY STOCKS IN APRIL 2020 ...... - 27 -

- 2 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

A tale of two opposite forces

What a fascinating couple of Months we have had! Fascinating in terms of how the markets have behaved and not in terms of what the humankind has had to endure during this pandemic.

In our previous issue, we discussed how March was a complete mayhem. Volatility, across almost all asset classes, rose to levels rarely seen in history. If you had to describe March in just one word, that word would be “volatile”.

And if April has to be described in a single word, it has to be “Fed”.

Our regular readers would know that Fed stands for the Federal Reserve Bank (USA’s Central Bank).

So why was it all about the Fed? Well, nothing else changed fundamentally. If anything, it got worse. And yet, markets across the world had their best month in recent memory. NIFTY 50 was up 14.6% in April. US benchmark index S&P 500 was up 12.7%.

So, what has been driving this rally? It’s the Fed. During the month of April, US Central Bank announced measures that were not used even during the Global Financial Crisis of 2008. We discuss in detail:

Force 1: Unprecedented measures by the Fed

To say that Fed has gone “all in” to tackle this crisis would be an understatement. In all essence, it’s a whatever-it-takes approach to keep the markets from melting down.

Exhibit 1 below tracks the timeline of Fed action (so far) during this crisis.

Exhibit 1: Timeline of Fed action during this crisis

Source: CNBC, Finpeg Research

- 3 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

As can be seen, Fed has essentially thrown the kitchen sink in this battle. The action on April 9th generated a lot of furor and, the Fed, for the first time in history, decided to venture into junk bond territory. Some analysts have even termed it illegal. Well, it is not our place to opine on the legality or morality of Fed’s action. For us, it is what it is – a full blown bazooka to counter the market meltdown.

As expected, Fed’s action did have an impact. Markets calmed down, volatility reduced across the board, credit spread narrowed and equity markets rallied (Exhibit 2-5).

One quick observation that we would like to make about volatility is that if we look at Exhibit 2 and 3, we realize that implied volatility came down sharply but realized volatility still remains at elevated levels. This means that market participants are expecting volatility to be much lower going forward as compared to what was actually realized in April. This could be interpreted in either way - as a sign of bullishness or a sign of complacency.

Exhibit 2: Implied volatility of S&P came down Exhibit 3: Implied volatility of NIFTY also came sharply in April down Relaized and Implied volatility (VIX) of S&P 500 Relaized and Implied volatility (VIX) of S&P 500 90.00 90.00 80.00 80.00 70.00 70.00

60.00 60.00

50.00 50.00 40.00 40.00

30.00 30.00

20.00 20.00 10.00 10.00 0.00 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0.00 /0 /0 /0 /0 /0 /0 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 05 05 05 05 05 05 05 05 05 05 05 05 05 05 05 05 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 6/ 03-Mar-09 03-Mar-10 03-Mar-11 03-Mar-12 03-Mar-13 03-Mar-14 03-Mar-15 03-Mar-16 03-Mar-17 03-Mar-18 03-Mar-19 03-Mar-20 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 Implied Volatility 30-Day Realized Volatility Implied Volatility 30-Day Realized Volatility

Source: Bloomberg, Finpeg Source: NSE

Exhibit 4: Bond spreads came down from their highs Exhibit 5: …and Equity markets rallied and rallied in March really hard Corporate Bond Option-Adjusted Spreads NIFTY and S&P 500 in 2020 YTD 25.00 13000.00 3600.00 3400.00 12000.00 20.00 3200.00 11000.00 3000.00 15.00 10000.00 2800.00

2600.00 9000.00 10.00 2400.00

8000.00 2200.00 5.00 7000.00 2000.00 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 ------r- r- r- r- r- r- r- r- r- an an an an an eb eb eb eb a a a a p p p p p -J -J -J -J -J -F -F -F -F M M M M -A -A -A -A -A 1 8 5 2 9 5 2 9 6 4- 1- 8- 5- 1 8 5 2 9 0 0 1 2 2 0 1 1 2 0 1 1 2 0 0 1 2 2

0.00

4 0 4

NIFTY S&P 500

1 0

BBB AAA High Yield

Source: NSE, Bloomberg Source: FRED

Why bother with US Fed and S&P 500 when we have to invest in India

We get this question a lot. Why do we focus so much on the US Fed, S&P 500 and global equity markets when we have to invest in India?

Before I answer this, would urge to look back at Exhibit 5 above once again. It charts the movement of S&P 500 and NIFTY in 2020. Now imagine if the chart was not labeled. Could you tell which line is NIFTY and which one is S&P 500. I guess not.

- 4 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

And there lies the answer. While there is no denying the fact that in the long term, country’s own fundamentals play a pivotal role in domestic stock market returns, in the near to medium term, it’s the liquidity and global sentiments that have a huge impact on the markets. Especially the US markets. What happens in US reverberates through the rest of the world. Do you think that if US markets were to fall by 20% in next few months, NIFTY will be immune?

Regarding relationship with Fed, we had covered this in greater detail in our issue – The Fed is the only real game in town.

Just to re-emphasize the relationship of Indian stock markets with Fed’s action, would like to present Exhibit 6 that tracks Fed’s balance sheet w.r.t NIFTY.

Exhibit 6: Relationship between Fed’s balance sheet Exhibit 7: …and Fed has gone nuclear with its and NIFTY 50 balance sheet expansion aka liquidity injection Fed Asset Size (USD bn) 7

6 Fed goes nuclear

5 4 3 2

0 04/03 04/04 04/05 04/06 04/07 04/08 04/09 04/10 04/11 04/12 04/13 04/14 04/15 04/16 04/17 04/18 04/19 04/20

Source: FRED, NSE Source: FRED

There we have it. As can be seen from Exhibit 7, Fed has really come in big. The pace of Balance Sheet expansion (liquidity injection) is simply unprecedented.

To put things in perspective, during the Financial Crisis of 2008 that led to QE 1 which was followed by QE2 and QE3 all the way up to October 2014, Fed’s balance sheet expanded from roughly USD 0.8 tn to USD 4.4 tn. That’s an increase of USD 3.6 tn in almost 6 years. In contrast, the balance sheet Relatio has expanded by almost USD 2.5 tn in just 2 months!

So yes, Force 1 (Fed) is big, powerful and in full swing.

Force 2: The Economic Gravity

Fed (Force 1) is trying to push the markets up, but there is an equally strong (if not more) and opposite force that is trying to pull it down – the force of economic gravity.

The global economy (and trade) is collapsing and the impact is likely to be long lasting. In terms of scale, it should be worse than 2008 and could even be as bad as the Great Depression of 1929. The range of outcomes is simply too large but even the best-case outcome is scary.

Truth is, no one knows the complete magnitude of this impact. Most Economists will come up with forecasts, but they are just that – forecasts. No one has a way to model the impact of shutting down the entire World (or most of it) for 2-3 months. Because something like this has never happened before.

- 5 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

But everyone agrees on one thing – it will be bad. And the data coming out is already giving a clue to how bad things are and will be. Some examples:

• US Q1 GDP contracted by -4.8% (QoQ SA). And US went into true lockdown only in the last 10-15 days of March. Imagine what Q2 will look like. • India’s April manufacturing PMI collapsed to 27.4, lowest reading ever. We had to change the scale on my chart in Exhibit 8 to make the April data visible. • The story was similar in the rest of the world. US manufacturing PMI collapsed to 36.1 and EU collapsed to 33.4 (Exhibit 9). • Domestic car sales in the month of April was ZERO. Yes, you read that right. Now show me an economic model that factors for such extreme outcome.

Exhibit 8: India’s manufacturing and services PMI Exhibit 9: The story was similar for rest of the world registered their lowest ever reading as PMIs across the board collapsed Markit Manufacturing & Services Purchasing Managers Index Manufacturing PMI of DM 65 65.00 57.5 60.00 55 55.00 50.00 45 45.00 35 40.00 35.00

25 30.00 25.00 15

20.00

c u

A O

5 A

2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7 8 8 8 8 9 9 9 9 0

2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 0

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2

------

t t t t t t t t

r c r c r c r c r c r c r c r c r

n g b n g b n g b n g b n g b n g b n g b n g b

c c c c c c c c

e e e e e e e e

p p p p p p p p

p US Manufacturing PMI Germany Manufacturing PMI

u u e u u e u u e u u e u u e u u e u u e u u e

J O J O J O J O J O J O J O J O

A D F A D F A D F A D F A D F A D F A D F A D F A

A A A A A A A A Manufacturing PMI Services PMI Japan Manufacturing PMI Eurozone Manufacturing PMI

Source: Investing.com Source: Tradingeconomics

These data points are just some examples to give you a picture of what is happening and what is likely to happen going forward. Mind you, these are just the direct first order impact of the shutdown. We have not even talked about (maybe because no one knows) the ripple effects of this disruption – the second, third and fourth order impacts.

We do know there will be massive unemployment (Exhibit 10,11), but we do not know the extent to which it will damage consumption. We know that there will be defaults and bankruptcies, but again we do not know the scale. We had covered various economic scenarios that could play out in our last issue.

Exhibit 10: Sharpest collapse US nonfarm Payroll Exhibit 11: Initial jobless claims in US spiked to data in April levels never seen before MoM change in Non Farm Payroll ('000) Initial Jobless Claims USA 5000 7000000

6000000

0 0 1 1 2 3 3 4 4 5 5 6 7 7 8 8 9 0 0 1 1 2 2 3 4 4 5 5 6 7 7 8 8 9 9

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

9 4 1 6 1 8 3 0 5 2 7 2 9 4 1 6 1 8 3 0 5 2 7 2 9 4 1 6 1 8 3 0 5 2

2 5000000

0 0 1 0 0 0 0 1 0 1 0 0 0 0 1 0 0 0 0 1 0 1 0 0 0 0 1 0 0 0 0 1 0 1 0 -5000 4000000 3000000 -10000 2000000 -15000 1000000

-20000 0 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 07 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 1- 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 7- 9- 1- 3- 5- 7- 9- 1- 3- 5- 7- 9- 1- 3- 5- 7- 9- 1- 3- 5- 7- 9- 1- 3- 5- 7- 9- 96 96 97 97 97 97 97 98 98 98 98 98 99 99 99 99 99 00 00 00 00 00 01 01 01 01 01 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 -25000

Source: FRED Source: FRED

- 6 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

And what if this entire episode leads to social unrest and/or geopolitical upheaval? We are already seeing signs of hostility towards China and signs of street protests against the lockdown (in USA). We have already witnessed a big crisis with migrant labors in India.

What we can conclude amidst this scenario of uncertainty is that things are bad today. And they are likely to get worse before they get better, at least for the real economy. And therefore, the force of economic gravity is real and is pretty strong.

Who will win this battle?

I hope by now you would have realized that the 2 forces we have talked about are trying to pull the markets in the opposite directions. Fed’s actions are trying to pull it up while economic gravity is trying to pull it down (and hence the use of term “gravity”).

Who will win this battle? Well, again, no one really knows. Both are equally strong forces. While the first part of the battle (till 23rd March) was won by Economic gravity, Fed had the upper hand for the next 20-25 days.

Since then, it has been a fascinating tug-of-war as the markets have remained range bound in the second half of April – neither breaking out, nor melting down. It like watching magnetic levitation.

From a portfolio perspective, what this means is that we should not position fully for only one of the outcomes. That is, we should not go 100% into equity betting on Fed to win. Nor should we go 0% equity betting on gravity to win.

Exhibit 12: Fed vs Economic Gravity

Source: Bloomberg, NSE

- 7 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Indian Markets – A V-shaped rebound in April

1. Equity Market wrap for the month

Table 1: Index Returns as of 30th April, 2020

1 Month 3 Months 6 Months 1 Year Year to date

NIFTY 14.68% -17.57% -16.99% -16.07% -19.07%

NIFTY Mid Cap 15.36% -25.03% -19.72% -23.14% -21.05%

BSE Small Cap 15.54% -24.31% -18.12% -24.09% -18.96%

NIFTY Auto 24.73% -27.02% -30.16% -29.33% -28.12%

NIFTY Bank 12.49% -30.16% -28.38% -27.65% -32.92%

NIFTY FMCG 4.94% -6.84% -11.29% -5.50% -5.18%

NIFTY IT 10.54% -12.61% -9.33% -15.55% -10.26%

NIFTY Pharma 29.97% 14.60% 18.39% -0.80% 15.91%

Banks have been worst hit

As can be seen from table above, Banks have been worst hit during this crash with NIFTY Bank Index down 33% YTD as against NIFTY which is down 19% YTD. Even the bounce in April was lower for the banks with NIFTY Bank up 12.5% as against 14.7% rally in NIFTY

Small and mid-caps have faced the bigger brunt of this crash as they are down 24.3% and 25% in the last 3 months as against NIFTY which is down 17.6% in last 3 months.

Exhibit 13: Mid and small caps were hammered Exhibit 14: Small and mid-caps have been more than large cap hammered more than the large caps Index performance since Jan 2018 Absolute Returns of Indian Indices 24000.00 14000.00 -19.0% -21.1% YTD 22000.00 12000.00 -19.0%

20000.00 -24.1% 10000.00 -23.1% 1 Year -16.1% 18000.00 8000.00 -18.1% -19.7% 6 Month 16000.00 -17.0% 6000.00 14000.00 -24.5% -25.0% 3 Month 4000.00 -17.8% 12000.00 15.5% 10000.00 2000.00 1 Month 15.4% 14.7%

8000.00 0.00 2.9%

2 2

2 1 Week

- -

- 4.1%

e a

p 5.9%

- -

0 0 0 -40% -30% -20% -10% 0% 10% 20% NIFTY Mid Cap 100 BSE Small Cap NIFTY50 BSE Small Cap Nifty Midcap 100 NIFTY 50

Source: BSE and NSE Source: NSE

- 8 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Exhibit 15: Index performance with common base Exhibit 16: Index performance with common base since Jan 2018 till Sep 2019 since Sep 2019 till April 2020 Relative Index Performance with common base since Jan 2018 - Sep 2019 Relative Index Performance with commoan base since Sep 2019 1200 1200.00

1100 1100.00 1000 1000.00 900

900.00 800

700 800.00

600 700.00 500 8 8 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 n b r r y n l g p ct v c n b r r y n l g p Ja e a p a u Ju u e o e Ja e a p a u Ju u e - -F M -A M -J 2- -A -S -O -N -D - -F M -A M -J 2- -A -S 600.00 2 2 2- 2 2- 2 0 2 2 2 2 2 2 2 2- 2 2- 2 0 2 2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 19-Sep-19 19-Oct-19 19-Nov-19 19-Dec-19 19-Jan-20 19-Feb-20 19-Mar-20 19-Apr-20 NIFTY NIFTY Mid Cap 100 BSE Small Cap NIFTY NIFTY Mid Cap 100 BSE Small Cap

Source: BSE and NSE Source: BSE and NSE

The rebound that we have seen since lows on March 23rd has been fairly broad based with 37 out of 50 stocks in NIFTY 50 advancing (Exhibit 17).

Also, as of month end on 30th April, NIFTY 50 was very close to breaching it’s 50 DMA resistance level (Exhibit 18)

Exhibit 17: A broad-based rebound in the month of Exhibit 18: NIFTY inching closer to its 50 day moving April average

Source: NSE Source: NSE

Exhibit 19: NIFTY 50 vs percentage of stocks above Exhibit 20: NIFTY 50 vs percentage of stocks above their 200 day moving average their 50 day moving average

Source: NSE Source: NSE

- 9 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

2. Equity Market Valuations

Correction from all-time highs have made valuations look attractive especially in the broader market space. Although, NIFTY (on a trailing PE basis) is now trading slightly above its historical average (Exhibit 21), If we look at the PE ratio of NIFTY 50 Equal Weight Index (where all 50 stocks have same weight unlike NIFTY 50 which is weighted by market capitalization), we find that valuations are close to 1 standard deviations below historical average (Exhibit 18).

However, we should take these valuation numbers with a pinch of salt for following reasons:

1. These numbers are based on trailing 12-month (TTM) earnings. With the impact of COVID- 19, we are sure that there will be a fairly sharp negative impact on EPS of almost all Companies. TTM valuations do not factor that impact. 2. Last 2 cycle ends (major market corrections) of 2000 and 2008 saw market bottom at NIFTY PE of 10.9 and 10.7. This time, the bottom was 17.2 on 23rd March. Nowhere close to where we landed the previous 2 times. 3. Valuations in itself are not a great indicator of short-term movement in the market (great indicator to predict long-term returns). As discussed in our cover story, near term movement will be guided by the two opposing forces. Will economic gravity bring valuations to levels seen in previous 2 cycle ends (2000 and 2008) or will Central Bank intervention continue to keep valuations elevated? Remains to be seen.

Exhibit 21: NIFTY inched above its historical average Exhibit 22: NIFTY Equal Weight Index is still 1SD by the end of the month below historical average NIFTY PE NIFTY 50 Equal Weight PE 29 28

24 23

19 18 14 13 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -0 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -2 b b b b b b b b b b b b b b b b b b b b b Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe Fe 8- 8- 8- 8- 9- 8- 8- 8- 9- 8- 8- 8- 9- 8- 8- 8- 9- 8- 8- 8- 9- 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 8 30-Apr-10 30-Apr-11 30-Apr-12 30-Apr-13 30-Apr-14 30-Apr-15 30-Apr-16 30-Apr-17 30-Apr-18 30-Apr-19 30-Apr-20 P/E Average 1SD 2SD P/E Average Plus 1SD Plus 2SD Minus 1SD Minus 2SD

Source: NSE Source: NSE

Exhibit 23: Mid Cap valuations still below historical Exhibit 24: BSE Small cap index is trading 1 SD average and remains attractive below its historical average PB NIFTY Midcap 150 PE BSE Small Cap P/B 3 57 2.8 2.6 47 2.4 2.2 37 2 1.8 27 1.6

1.4 17 1.2

A A A P/E Average 1 SD 2 SD PB Average Plus 1 SD Plus 2 SD Minus 1 SD Minus 2 SD

Source: NSE Source: BSE

- 10 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

3. Debt Market wrap for the month

10-year GSEC yields fell marginally by 2 bps during the month of April. Interestingly, the shorter end of the curve, 3M bill fell by 61 bps during April. This has made India’s yield curve steepest we have seen since 2009. While shorter end has benefited from RBI’s rate cuts and liquidity injection, the longer end has not fallen due to concern over rising fiscal deficit and potential ratings downgrade.

We believe that inflation could be on a downward trajectory as energy prices have collapsed and so has the near-term demand. In our view, there is likely to be more rate cuts in the coming months by the RBI and bonds should continue do well.

But there is other side of this argument as well. As a response to COVID-19 crisis, the Government will have to drastically increase spending to support individuals and businesses. At the same time, Government revenues will take a hit (in form of lower tax receipts). This means that fiscal deficit will go through the roof. Higher deficit generally leads to increase in bond yields as Government fills the deficit through issuance of bonds (increasing supply). Another fallout could be a rating downgrade by credit rating agencies which could see Indian G-Sec yields going up. We discuss this in detail in our macro theme section – India’s Economic response to COVID-19.

Table 2: Returns of Gilt and Medium to Long duration Funds

Scheme Name 1M 3M 6M YTD 1Y IDFC Bond Fund 1.58% 1.64% 3.99% 3.21% 10.02%

ICICI Prudential Bond Fund 2.89% 2.03% 5.20% 4.06% 12.41%

HSBC Debt Fund 3.49% 3.30% 5.66% 5.12% 12.92%

IDFC G Sec Fund 5.26% 5.48% 9.60% 7.91% 18.71%

DSP Govt Sec Fund 5.15% 6.22% 9.18% 8.16% 18.32%

Nippon India Gilt Securities Fund 4.99% 5.08% 8.51% 7.25% 17.37%

Exhibit 25: 10-year GSEC yields fell in the month of Exhibit 26: 10-year Bharat Bond Index has March by 20bps outperformed 3-year index Indian GSEC yields Bharat Bond Index 1080

12.00 1060

10.00 1040

1020 8.00

1000 6.00 980 4.00 960 2.00

940

9 0 0 1 2 3 3 4 5 6 6 7 8 9 9 0 1 2 2 3 4 5 5 6 7 8 8 9 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 2 9

0 0 0 0

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / 0 0 0 0 0 0 0 0 0 0 0

2 2 2 2 2 2 2 2 2 20 20 20 20 2 2 2 2 2 2

2 1 8 5 2 1 8 5 2 1 8 5 2 1 8 5 2 1 8 5 2 1 8 5 2 1 8 5 5 ------r- r- r- r- r- -

n n n n n b b b b ar ar ar ar ay

0 1 0 0 0 1 0 0 0 1 0 0 0 1 0 0 0 1 0 0 0 1 0 0 0 1 0 0 0 a a a a a e e e e p p p p p -J -J -J -J -J -F -F -F -F M M M M -A -A -A -A -A M 1 8 5 2 9 5 2 9 6 4- 1- 8- 5- 1 8 5 2 9 6- 0 0 1 2 2 0 1 1 2 0 1 1 2 0 0 1 2 2 0 GSEC10Y GSEC3M Bharat Bond 2023 Bharat Bond 2030 Source: Bloomberg Source: NSE

- 11 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

4. What happened with Franklin debt funds?

On 23rd April, Franklin India AMC decided to wind up 6 of its debt funds - Franklin India Low Duration Fund, Dynamic Accrual Fund, Credit Risk Fund, Short Term Income Plan, Ultra Short Bond Fund and Income Opportunities Fund.

These funds were shut down and further investments or redemptions in or out of the funds was blocked. In essence, if you were invested in any of these 6 funds, your investment has been locked. You cannot add to your investments in these funds nor can you redeem your existing investments in them.

So, have investors lost all their monies in these funds?

No! In fact, this was a smart step to contain damage. But investors have not actually lost money. Not yet. What Franklin India AMC now aims to do is sell the underlying securities in these 6 schemes. And pass on the amounts to the investors of the funds proportionally. This will take some time.

What prompted Franklin India AMC to do this?

Illiquidity in the lower-rated debt markets. Franklin AMC’s debt funds were particularly famous (among investors aiming for returns) and notorious (among investors who understood the underlying risks).

Franklin AMC took on substantial credit risk to earn slightly higher returns for its debt fund investors. This means it invested in bonds of entities that were not AAA-rated since these offered higher interest rates.

Credit risk is one of the two primary risks in debt funds. This credit risk undertaken worked pretty well since it did not hurt the investors during good times. The entities whose debt these funds held were operating just about fine and were able to service their debt.

However, with the COVID-19 crisis, these entities have started facing cash flow problems and this will only get worse going forward. And as this problem becomes more and more severe, they’ll probably start defaulting on their debt.

If this happens, the investors of Franklin AMC’s debt funds lose! In fact, a number of investors started figuring this out. So, they started to redeem their investments in Franklin AMC’s debt funds and the redemption pressures on these funds increased sharply.

This forced the AMC to sell their good bonds (with liquid market) as they could not offload bad papers due to complete illiquidity in the market for those papers. This increased the percentage allocation of the bad bonds in its portfolio.

Hence, the AMC had to take the decision to lock these funds down. Simply because they would have been unable to meet the redemption demands of the investors!

In our blog Save your mutual fund portfolio from the next Franklin-like debacle, we discuss this in greater detail and offer tips to avoid falling into Franklin like trap in the future.

- 12 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

5. What is the “smart” money doing?

While March was an exodus by FIIs, in April the selling was much more muted. FIIs were net sellers of Rs 6,884 cr in equities, as compared to Rs 61,973 cr in March. In the debt segment, FIIs were net sellers to the tune of Rs 12,552 cr as compared to Rs 60,376 cr in March.

Interestingly, DII (Mutual Funds) that were net buyers in Equity in March turned net sellers in April. DIIs sold Rs 7,154 cr (net) in April as against being net buyers of Rs 26,358 cr in March. DIIs continued to be net buyers in the debt segment buying Rs 3,438 cr in April.

Exhibit 27: Monthly FII/FPI inflows in Equity Exhibit 28: Calendar year FII inflows in Equity and markets Debt markets Monthly FII/FPI Inflows (Equity) Yearly FII/FPI Inflows (lac cr) ₹30,000 2.00 1.59 ₹20,000 1.49 ₹10,000 1.50 1.28 1.13

₹0 0.97 1.01

7 8

9 1.00

- -

-₹10,000 -

a a

a 0.51

e e

e 0.42 0.46

S S

M M -₹20,000 M 0.50 0.35 0.18 0.21 0.26 -₹30,000 -₹40,000 0.00 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 -₹50,000 -0.50 -0.44 -₹60,000 -0.51 -0.55 -0.03 -₹70,000 -1.00 -0.33 -0.48 Average FII Equity Equity Debt -0.82 Source: NSDL Source: NSDL

Exhibit 29: Monthly Domestic Institutional Investors Exhibit 30: Calendar year DII inflows in Equity and (MF) inflows in Equity markets Debt markets

Monthly DII Inflows (Equity) Yealy DII inflows (lac cr) ₹30,000 7.00 6.23 ₹25,000 6.00 5.26 ₹20,000 5.00 4.47 ₹15,000 3.90 4.00 ₹10,000 3.33 3.25 3.00 ₹5,000

₹0 2.00 0.26

4 4 5 5 5 6 6 6 7 7 7 8 8 8 9 9 9 0

4 1.17 1.13

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2

------

r r r r r r r

c g c g c g c g c g c

-₹5,000 g 0.71

e p e p e p e p e p e p

p 1.00 0.49

u u u u u

u 0.48 0.46

A A A A A A

A 0.24

D A D A D A D A D A D -₹10,000 A 0.00 -₹15,000 2014 2015 2016 2017 2018 2019 2020 Average DII Equity Equity Debt

Source: Moneycontrol Source: Moneycontrol

- 13 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Economy – To get a lot worse before it gets better

1. Summary and Outlook

Indian economy was already slowing and deleveraging before COVID-19 hit. In fact, we had been arguing that the slowdown had bottomed by second or third quarter of fiscal 2019-20. Recovery green shoots were already visible in PMI and IIP numbers.

But then COVID-19 happened and all the equations and calculations have been thrown out of the window.

The cost of locking down the country is simply unfathomable. As noted earlier, there is simply no way to model the economic impact of this shutdown because something like this has never ever happened. We mentioned that Indian auto industry sold ZERO passenger cars in April. How do you model such extreme outcomes?

Talking about extreme outcomes, India’s manufacturing PMI plummeted to 27.4 in April (from 51.8 in March). That’s the lowest since the series began 15 years back. And if that was not enough, Services PMI plunged to 5.4! Yes, it’s not a decimal typo. It is indeed 5.4 and NOT 54.

And all this was April. In May, although there has been some resumption of activity, the biggest economic hubs of Mumbai and Delhi still remain in the “red” zone and still remain completely locked down. And from the way case count is progressing, it looks like the month of May will also be a washout.

And if the virus situation goes completely out of control, maybe for the first time in many many years, India economy could face a recession. Yes, you read that right – a recession. Bottomline, we don’t know yet how things will play out.

IMF has projected India’s GDP to grow by just 1.9% in 2020. This could be the slowest growth in last 20 odd years and even 1.9% forecast appears be a little optimistic (at least now).

But, as we keep saying, all is not lost and there is a silver lining.

The biggest silver lining is the collapse in oil prices. Lower oil prices augur well for Indian economy overall. India’s biggest import is oil and if that import bill goes down, it brings along tremendous savings to the Government. Lower oil prices are best thing that can happen to Indian economy from a macro perspective.

Another big factor could be policy response. In our view, such kind of crises forces the government to take on drastic reform measures which have very long-lasting impact on the economy (1991 is an example). There is a very high probability that something similar would happen this time around as well. And this is playing out. We have seen some big-ticket labor reforms being carried out in states to attract foreign manufacturers looking to move out of China.

Therefore, we believe that once all this is over and we go through that slow and painful process of rebuilding and recovery, there will be a lot going on for the economy.

- 14 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

2. GDP and the economy

GDP print for third quarter of the fiscal is not out yet but we know that the numbers will not be great. And if 3Q numbers will be bad, 4Q numbers will be nightmarish. In all likelihood, we could see negative growth in the 4th quarter of this fiscal.

Why negative? Well let’s start with PMI data for April (exhibit 32). The numbers don’t make for a very happy reading. India’s manufacturing PMI collapsed to 27.4 in April (from 51.8 in March). That’s the lowest since the series began 15 years back. And if that was not enough, Services PMI plunged to 5.4. The impact on services was expected to be worse than manufacturing because the lockdown has impacted service-based industries much more. But 5.4 is beyond imagination.

What do you do when you get a chart like Exhibit 32? We had to alter the scale completely to make the chart fit. So much so that the chart gives you an illusion that before April, the PMIs were pretty stable and flat across all these years. Obviously, that is not the case.

Maybe from 2021, when we present charts, we will have to eliminate 2020 data points just to avoid this illusion.

IIP accelerated to 4.5% in the month of February in line with our earlier thesis of growth recovery starting 4Q of the last fiscal. But then, things are obviously very different now. Expect a sharp drop in IIP numbers for March and April.

Exhibit 31: Real GDP growth likely to go negative in Exhibit 32: Service PMI plunged to a record low of 4th quarter of FY20 5.4 in the month of April. Markit Manufacturing & Services Purchasing Managers Index Quarterly GDP Growth 65 14 57.5 55 12 10 45 8 35 6 4 25 2 15

1 1

1 5

/ /

0 0 0 Manufacturing PMI Services PMI Average Real GDP Growth

Source:MOSPI Source:Investing.com

Exhibit 33: IIP accelerated to 4.5% in pre COVID Exhibit 34: YoY change in IIP growth turned positive world in February in January

IIP Growth Monthly YoY change in IIP growth 25 25.00 20.00 20 15.00 15 10.00 10 5.00

0.00

8 9 9 0 0 1 1 2 3 3 4 4 5 6 6 7 7 8 8 9 0

5 7

0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

-5.00 0

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

/ / / / / / / / / / / / / / / / / / / / / /

6 1 8 3 0 5 2 7 2 9 4 1 6 1 8 3 0 5 2 7 2

0 -10.00 1

1 0 0 0 0 1 0 1 0 0 0 0 1 0 0 0 0 1 0 1 0 0

7 7 8 8 9 0 0 1 1 2 2 3 4 4 5 5 6 7 7 8 8 9 9

0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 -15.00

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

-5 2

/ / / / / / / / / / / / / / / / / / / / / / / /

2 9 4 1 6 1 8 3 0 5 2 7 2 9 4 1 6 1 8 3 0 5 2

0 0 0 1 0 0 0 0 1 0 1 0 0 0 0 1 0 0 0 0 1 0 1 0 -20.00 -10 -25.00 Average IIP Growth -30.00

Source:MOSPI Source:MOSPI

- 15 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

3. Inflation and monetary policy

Inflation (or lack of it) will be one positive thing to come out of this crisis. Commodities and oil have been crashing (Exhibit 36 and 37) and the prices will likely remain muted in coming months as well as demand remains subdued.

Retail inflation (as measured by CPI) declined to 5.91% in March 2020 (from 6.58% in February). WPI also declined to 1.0% in March from 2.26%% in January. Inflation is likely to go down further not just on back of falling energy and commodity prices but also due to overall lack of demand in the economy.

Lower inflation allows RBI to get more aggressive with its monetary policy stance. We already saw a 75 bps cut in the last week of March. Don’t be surprised if we see more in coming months. As RBI brings down the interest rate, bond yields are likely to fall making a good case for owning Government bonds.

But there is other side of this argument as well. As a response to COVID-19 crisis, the Government will have to drastically increase spending to support individuals and business. At the same time, Government revenues will take a hit (in form of lower tax receipts). This means that fiscal deficit will go through the roof. Higher deficit generally leads to increase in bond yields as Government fills the deficit through issuance of bonds (increasing supply). Another fallout could be a rating downgrade by credit rating agencies which could see Indian G-Sec yields going up. We discuss this in detail in our macro theme section.

Exhibit 35: Both retail and wholesale inflation Exhibit 36: Commodity prices have crashed as world cooled off in March 2020 demand is hit by COVID-19 S&P GSCI Indian Inflation Rate 800 20.00 700

15.00 600

10.00 500 5.00 400

0.00 300

1 1

/ /

-5.00 / 200

0 0 0 -10.00 100 CPI Change (YoY) WPI Change (YoY) 0 07/05/10 07/05/11 07/05/12 07/05/13 07/05/14 07/05/15 07/05/16 07/05/17 07/05/18 07/05/19

Source: CEIC, Finpeg Research Source: Bloomberg

Exhibit 37: Crude prices have literally collapsed on Exhibit 38: RBI cut rep rate by 75 bps in the last back of muted demand and price war week of March 2020 RBI Repo Rate WTI Crude (USD/barrel) 10.00% 160 9.00% 140 120 8.00% 100 7.00% 80 60 6.00% 40 20 5.00% 0

4.00%

0 0 1 2 3 4 5 6 7 8 9 0 1 1 2 3 4 5 6 7 8 9 0

6 6 6 7 7 8 8 8 9 1 1 1 2 2 3 3 3 4 6 6 6 7 7 8 8 8 9

0 5

0 4 5 9 0

0 0 0 0 1 1 1 1 1 1 1 1

0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 2

0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2

------

l l l

r t r t r t

/ / / / / / / / / / / / / / / / / / / / / /

v c r v c r v c r

n n p b y g n n p b y g n n p b y

u c u c u c

p e a p e a p e a

a o a a o a a o a

1 2 1 0 9 8 7 6 5 4 3 2 1 2 1 0 9 8 7 6 5 4 3

u e e J u u e e J u u e e J

J J J

J A O J A O J A O

S F D S F D S F D

N A N A N

M M M

0 1 1 1 0 0 0 0 0 0 0 0 0 1 1 1 0 0 0 0 0 0 0

M M M

Source: MacroTrends, Finpeg Research Source: Reserve Bank of India

- 16 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

4. Exchange Rate – Stable during the month

INR depreciated by 0.5% in the month of April as risk-on mode returned in the market and FII outflow ebbed. As we have noted earlier, there is a strong negative correlation of NIFTY movement with INR deprecation in the short term (owing to FII flows).

Roughly at the time markets bottomed (23rd March), INR had depreciated by almost 7% before bouncing back as stock markets also rallied. This simply shows how INR, in the short term, is driven by portfolio flows.

Exhibit 39: Rupee weakened by 1.2% against the Exhibit 40: Rupee has been depreciated by 5.6% USD in March YTD in 2020 USD INR Annual USD INR (yoy,%) 80 30 22.00 70 25 20 60 17.00 15 50 10 12.00 40 5 7.00 30 0 -5 2.00 20

-10

1 1

10 -3.00 2

0 0

-15 0

0 -20 D

-8.00 T

1 1

4 4

4 -13.00

0 0 0 INR Depreciation Average Annual Depreciation USD/INR USD INR (YoY)

Source: MacroTrends, Finpeg Research Source: MacroTrends, Finpeg Research

Table 3: INR against major currencies (% change, positive number is depreciation)

Currency 1 Month 1 Year Euro (EUR) -1.51 4.56

Canad ian Dollar (CAD) -1.47 3.28 Aus tralian Dollar (AUD) 0.65 -0.54

British Pound (GBP) -1.13 3.44

Singapore Dollar (SGP) -0.53 4.35

Jap anese Yen (JPY) 1.96 12.93

Indonesian Rupiah (IDR) 4.17 2.04 Korean Won (KOW) -1.74 4.38

Thai Baht (THB) 0.47 7.56

Hong Kong Dollar (HKD) -0.27 10.19

Chinese Yuan (CNY) -0.57 5.15

Brazilian Real (BRL) -10.86 -24.64

Source: Economic Times

- 17 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Global Markets – A synchronized bounce back

1. Global Equity Markets

If March was a month of deep red for stocks around the globe, April was quite the opposite. April saw a synchronized bounce back in equities across the world. US benchmark index S&P 500 was up 12.7% in April and is down only 10.6% YTD. In fact, the bounce back was so pronounced that the US tech index NASDAQ is almost flat for 2020 (down only 2.2% YTD as of 30th April).

As discussed earlier, the rally was primarily driven by a whatever-it-takes play by the Central Banks. Plus, promising result from drug Remdesivir (initial trials) for treatment of COVID-19 also buoyed the mood of the market.

So, was March 23rd a secular bottom for equities or is this rally a bull trap? In our previous issue, we had argued that this rally is likely a bull trap. While no one really knows, we still lean towards this rally being a bull trap and expect a next leg down for global equities.

Our stance is primarily driven by (a) deteriorating economic conditions around the world and (b) markets (especially the US markets) are retesting the stretched valuation levels seen in February (in fact above their Feb high valuations at the time of writing this piece).

Table 4: Performance of major indices across the world

Indices 1M 3M 6M 12M YTD S&P 500 12.68% -11.31% -4.12% -1.13% -10.60%

Nasdaq 15.45% -4.40% 7.20% 9.81% -2.23%

Russel 2000 13.66% -20.48% -16.12% -17.63% -21.37%

FTSE 4.04% -20.06% -18.59% -20.45% -22.40%

DAX 9.32% -18.61% -15.58% -12.01% -18.86%

Stoxx 600 6.24% -18.10% -14.30% -13.11% -18.99%

Nikkei 225 6.75% -12.12% -11.92% -9.28% -14.64%

Shanghai Composite 3.99% 4.13% -2.35% -7.33% -7.30%

Hang Seng 4.41% -9.27% -7.59% -17.56% -13.66%

NIFTY 14.68% -17.57% -16.99% -16.07% -19.07%

Source: Bloomberg, Finpeg Research

- 18 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

2. Global Debt Markets

Debt market was much calmer in April as compared to March with US 10-year yield hovering in the range of 0.6% - 0.7% closing the month down 6 bps at 0.64%. German and Japanese yields were also down 12 bps and 5.5 bps respectively.

The next big question on the street right now is if US rates will turn negative like those in Europe and Japan? So far, US Fed has been very clear about not adopting a negative interest rate policy. But the market is signaling something else. Fed Fund Futures market is indicating negative policy rates by Jan 2021. And it is likely that US rates could go negative along the entire curve.

Fed’s action to get involved in the corporate bond market had the desired impact of calming the market and tightening the spreads (Exhibit 44). High-yield spreads came down from highs of 10.9 on 23rd March to close the month of April at 7.63. Similarly, spreads on BBB and AAA rated bonds also came down significantly.

Again, is the worst over for corporate bond market in USA? Just like equities, recent rally would suggest that the worst is indeed over. We however continue to believe that the wave of downgrades and bankruptcies (the second order impact) is just getting started. It’s quite possible that these spreads start expanding again and it might well coincide with the next leg down for equities as well.

Exhibit 41: US 10-year yields collapsed by 46 bps in Exhibit 42: German 10Y GSEC yields increased in March the month of March. US 10Y and 3M GSEC yields 10Y GSEC yields 3.50 6 3.00 5 2.50 4 2.00 3 1.50 2 1.00 1 0.50

0 1

0.00 2

1 2

2 -1

u J

0 M -0.50 M -2 US10Y US3M Germany Japan

Source: Bloomberg Source: Bloomberg

Exhibit 43: US Treasury was almost as volatile as Exhibit 44: Corporate Bond Spread in US over 10Y

the equity markets Treasury US 10-year bond yield in March Corporate Bond Option-Adjusted Spreads 25.00 1.20 1.18

1.10 20.00 1.00

0.90 15.00 0.80 0.70 10.00 0.60

0.50 0.54 5.00

0.40

9 0

- -

- 0.00

7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 0

9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4 0 4

0 0

0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0 1 0

2 2 2 BBB AAA High Yield

Source: FRED Source: Bloomberg

- 19 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

3. Dollar and Gold

It was a calm month for dollar as well with DXY index remaining flat during the month. Dollar squeeze that we witnessed in March when DXY shot up to 102.76 levels seems to have been addressed with Fed opening up swap lines and repo facilities for international Central Banks.

On a trade-weighted basis, dollar (TWEXB) came down during the month by 50 bps. However, on a YTD basis, it has appreciated much more than DXY. Note that biggest components of DXY are Euro and Japanese Yen. Apparently, dollar has not been as strong against these currencies as compared to EM currencies.

Exhibit 45: Dollar index (DXY) was flat while TWEXB Exhibit 46: Dollar has increased much more on a was down 50 bps in April trade weighted basis Dollar Index Dollar Performance

130.00 14.0% 12.6% 120.00 12.0% 7.4% 7.5% 110.00 10.0% 6.7% 100.00 8.0% 6.3% 90.00 6.0% 5.4% 80.00 4.0% 2.6% 70.00 0.1% 1.7% 1.3% 2.0% 0.8%

60.00 0.0%

1 1

/ /

/ 1M 3M 6M YTD 1Y 2Y

5 5

5 -2.0% -0.5%

0 0 0 DXY TWEXB DXY TWEXB

Source: FRED, Bloomberg Source: Bloomberg

Gold continues its run as the best asset class in 2020

After a volatile March, Gold had a great month in April and was up 7% for the month. As Central Bank s across the world went on a printing spree, investors lined up to buy Gold. Interestingly, Gold has been the best performing asset class (when compared to equities) in the last 1 year. In fact, it has performed better than S&P 500 (in USD terms) and NIFTY (in INR terms) since Jan 2000 (Exhibit 48).

We at Finpeg, remain bullish on gold from a medium-term perspective. In our view, rampant printing of USD (as well as other major currencies) by Central Bank s will eventually make gold very attractive w.r.t fiat currencies.

Exhibit 47: Gold has finally woken up from its long Exhibit 48: Gold has been the best performing asset winter slumber class since 2000 both in INR and USD terms Gold Prices (USD/Oz) Gold vs NIFTY vs S&P 500 50.0% 2,000.0 42.0% 1,800.0 40.0% 1,600.0 31.5% 1,400.0 30.0% 1,200.0 1,000.0 20.0% 14.7% 12.7% 800.0 11.2% 12.2% 9.4%9.2% 9.2% 9.5% 7.5% 600.0 The Gold Winter 10.0% 7.0% 5.6% 6.9% 6.6% 3.4% 3.7% 3.5% 400.0 200.0 0.0% 1M 1Y 5Y 10Y Since 2000

0.0 -1.1%

1 2 2 3 4 5 6 7 7 8 9 0 1 2 2 3 4 5 6 7 7 8 9 0

0 -10.0%

0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 2

/ / / / / / / / / / / / / / / / / / / / / / / / /

3 1 1 9 7 5 3 1 1 9 7 5 3 1 1 9 7 5 3 1 1 9 7 5

0 0 0 1 0 0 0 0 0 1 0 0 0 0 0 1 0 0 0 0 0 1 0 0 0 -20.0% -15.9% Gold Gold (USD) S&P 500 Gold (INR) NIFTY

Source: Goldprice.org Source: Investing.com

- 20 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Global Macro

1. Global Macro Snapshot

Table 5: Overview of major and emerging economies

US Germany Japan UK Euro GDP (yoy, 1QCY20) -4.80% 0.40% -0.70% 1.10% -3.80% Inflation (yoy, March 2020) 1.50% 0.80% 0.40% 1.50% 0.40% 10Y Gsec (latest) 0.64% -0.55% -0.01% 0.31% 0.14% Central Bank Rates (latest) 0.25% 0.00% -0.10% 0.22% 0.00%

China Indonesia Brazil GDP (yoy, 1QCY20) -6.80% -2.41% 1.70% Inflation (yoy, Mar 2020) 4.30% 2.67% 3.30% 10Y Gsec (latest) 2.60% 8.10% 7.70% Central Bank Rates (latest) 3.85% 4.50% 3.00%

We have been arguing that the economic impact of virus will be severe. When it all started in China, the argument was that, at worst, it will be a supply chain disruption leading to a supply shock. But as countries around the world started locking down, it fast turned out to be a big demand shock as well.

US reported its GDP numbers and the GDP shrunk by 4.8% (QoQ SAAR) thus marking the end of the longest expansion in the history of US. What’s scarier is the fact that these are 1Q numbers. The actual impact of the shutdown will be visible in the second quarter which could see US economy shrink by an unprecedented number.

Exhibit 50-53 show Manufacturing PMIs for US, Eurozone and China respectively for the month of April. As expected, PMIs crashed to levels previously seen in 2008. What’s interesting in the PMI numbers is the Chinese PMI for April which clocked below 50 indicating that there was actually a contraction in manufacturing activity vis-à-vis March.

Exhibit 50: US manufacturing PMI dipped to 36.1 in Exhibit 49: 1QCY20 marked the end of longest expansionary cycle in US as growth turned negative April

GDP Growth (yoy,%) US Manufacturing PMI 65.00 25.00 8.00 20.00 6.00 60.00 15.00 4.00 55.00 10.00 5.00 2.00 50.00 0.00 0.00 45.00 -5.00 17 17 17 17 18 18 18 18 19 19 19 19 20 CY CY CY CY CY CY CY CY CY CY CY CY CY -10.00 -2.00 Q Q Q Q Q Q Q Q Q Q Q Q Q 40.00 1 2 3 4 1 2 3 4 1 2 3 4 1 -15.00 -4.00 35.00 -20.00 -6.00

30.00 -25.00

3 4 4 4 5 5 5 6 6 6 7 7 7 8 8 8 9 9 9 0

4 5 6 7 8 9 0

1 1 1 1 1 1 1 1 1 1 1 1 1 2

1 1 1 1 1 1 1 1 1 1 1 1 2

------

l l l l l l

t t t t t t t

r r r r r r

n n n n n n n

u c u c u c u c u c u c

-8.00 c

a p a p a p a p a p a p a p

J J J J J J

J J J J J J J

O O O O O O O

A A A A A A A US China Euro Japan US Manufacturing PMI US PMI (yoy change)

Source: TradingEconomics Source: Investing.com

- 21 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Exhibit 51: Eurozone PMI crashed to 33.4 in the Exhibit 52: And absolute plunge in Chinese month of April manufacturing PMI in February Eurozone Manufacturing PMI China Manufacturing PMI 65 15 55.00 10.00 10 53.00 60 5.00 5 51.00 55 0 49.00 0.00 -5 47.00 50 -10 45.00 -5.00 45 -15 43.00 -10.00 41.00 40 -20 39.00 -25 -15.00 35 -30 37.00

30 -35 35.00 -20.00

1 1

M M M China Manufacturing PMI China PMI (yoy change) Eurozone Manufacturing PMI Eurozone PMI (yoy change)

Source: Investing.com Source: Investing.com

Deflationary pressure taking over

As we have been highlighting, we expect a significant moderation in inflation and that seems to be playing out (Exhibit 53). As oil prices have collapsed and an overall demand shock generated in the economy, we believe that we would see strong disinflationary pressure play out in the near term.

With the way things stand right now, it is quite possible to see deflation in the near term in US and Euro Zone countries.

Exhibit 53: Inflation inching down globally as oil and Exhibit 54: US Fed brought the rates down by 150 commodity prices crash bps in 2 back-to-back emergency cuts Global Inflation Rate Fed Fund Rate 6 3 5 2.5 4 2 3 1.5 2 1 1 0.5

0 0

9 0 8 9 9 9 9 9 9 9 9 9 9 9 0 0 0

1 1 1 19 1 1 1 1 1 1 1 1 1 2 2 20

1 2 ------2 l

c n b r r y n g p t v c n b r

/ / e a e a p a u Ju u e c o e a e a /

J F A J S O J F

1 1

D M M A N D M 3

0 0 U.S Germany Japan Eurozone UK China Brazil

Source: Investing.com Source: Bloomberg

- 22 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

2. India’s economic response to COVID-19

India’s economic response to COVID-19 disruption has been pretty muted so far compared to the rest of the world.

While India was ahead of the curve in imposing lockdowns, we are way behind the curve when it comes to economic stimulus. Remember, we have had one of the most stringent lockdowns and one of the most muted economic response so far. Nowhere else in the world did we see a PMI print of 5.4.

Here is what India’s fiscal response been so far:

1. A stimulus package valued at approximately 0.8% of GDP (roughly USD 22 bn). The key elements of the package were: in-kind (food; cooking gas) and cash transfers to lower- income households; insurance coverage for workers in the healthcare sector; and wage support to low-wage workers (in some cases for those still working, and in other cases by easing the criteria for receiving benefits in the event of job loss). 2. Another Rs 15,000 cr to be devoted to health infrastructure, including for testing facilities for COVID-19, personal protective equipment, isolation beds, ICU beds and ventilators.

When we compare this with other countries, this is miniscule. As can be seen, India’s package is the lowest at 0.85% of the GDP.

Exhibit 55: Stimulus committed by various countries as response to COVID-19 (%age of GDP) Stimulus as %age of GDP 25

20.95

15.29 15.27 15

11.38 10.71 10 10 8.02

5.13 5

1.3 1.32 0.85 0 USA Italy China Spain Germany France UK South Korea Japan Australia India

Note: Includes loans and credit guarantees, tax freeze and debt repayment moratorium. Also includes bailout funds and liquidity support Source: EconomicTimes

- 23 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

What’s stopping the Government from going the whole hog?

It’s the fiscal space. As per the latest Bloomberg report, India’s fiscal deficit for FY20 was 4.4% of the GDP (well above budgeted target of 3.8%).

Now consider the formula for Fiscal Deficit as percentage of GDP:

FD = (Government Expenses – Government Revenues)/GDP.

Now consider what will happen in FY2021. Government revenues are essentially taxes. As corporate profitability, consumption and Income levels go down (due to the lockdowns and its after effects), tax receipts will fall drastically. At the same time, the denominator (GDP) is likely to grow at a very low rate or maybe even contract.

So what happens? Your fiscal deficit goes through the roof.

So even before a sizeable stimulus package (Government Expenses), we see that India is already in a bad fiscal space. Now if you add a chunky stimulus to it (Expenses), you further hurt your fiscal deficit.

Is fiscal deficit really bad?

Well, this is one of the most debated topics in the field of Macro Economics. And there are opposing school of thoughts. We don’t want this newsletter to become a lecture in Marco Economics, and hence, we will keep this as simple as possible.

Traditional arguments against running a high fiscal deficit are as follows:

1. If the deficit is financed by printing money (Reserve Bank creating “new” money to buy Government bond), it would lead to more money chasing limited supply of goods that could lead to inflation (or maybe hyper-inflation). There are enough examples of hyper-inflation being cause by reckless money printing. Here are some examples. 2. The other argument is “crowding out” of private investments. If Government finances its deficit via borrowing from the market, it will crowd out the private borrowers (private companies) from the market. Excessive supply of Government securities push up the yields making it costly for private borrowers to borrow money to invest. 3. The third argument for emerging market economies like India is that it will lead to sovereign rating downgrade. A downgrade in rating will mean higher rates not just for the Government debt but also for private borrowers.

All these arguments have merit and we will not focus on discussing the merits of these arguments. What we will do next is evaluate option for the Government and argue why it may not be a bad idea to monetise its deficit (RBI directly financing Government deficit) in this current crisis period.

- 24 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

What should the Government do?

There are number of factors why we feel inflation should not be a concern in the near term:

1. We are living in a deflationary world (at least in the near term). With oil and commodity prices being where they are, we are unlikely to see a surge in Inflation in the near term. 2. Plus, India’s capacity utilisation as of Jan 2020 was just 68.6% (lowest levels seen in last 15 years). At such low capacity utilisation levels, there is enough slack in the system to counter any inflationary demand surge. 3. A behavioural change that will be triggered by the crisis. After every economic crisis, people become cautious and tend to save more than spend. People who lived through the Great Depression of 1930s became the most frugal spenders. The same will be true for us as we emerge out of this crisis. We will realise the importance of building a nest egg and will tend to save more. Again, this will have a disinflationary impact.

While there are number of op-eds with experts opining on a possible course of action, we would like to humbly weigh in as well. In our view, a following approach could be taken:

• A big fiscal stimulus is a must. There is no escaping the fact. • A calibrated deficit monetisation with a clearly laid out plan to get fiscal house in shape over next 3-4 years. The fiscal roadmap is important to calm investors and rating agencies. • Cut down on unnecessary Government spending. However, it should be done with caution so as to not be demand destructive. • Make full use of the oil bonanza. • Do not try to boost revenues by increasing taxes. That will simply be demand destructive and contractionary.

Exhibit 56: Capacity utilization in India stood at 15- Exhibit 57: Global map of S&P credit rating. India is year low level of 68.6% at BBB-

Capacity Utilization (%) 78

75.9 76.1 76 75.2 74.8 74.1 73.8 73.6 74

71.8 72 71.2

70 69.1 68.6 68 66

8 9

M M M

Source: RBI Source: Wikipedia

If you are interested in knowing more about deficits, financing of deficit and debt monetisation, here is an excellent article we recommend - Quantitative Easing, MMT, and Inflation/Deflation: A Primer

- 25 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |

The Alpha Investor, April 2020 | Issue #6| Finpeg

Performance Data

1. Best performing Equity Mutual Funds in April 2020

Best Large Cap Funds April-2020 YTD 1Y Invesco India Largecap Fund 15.7% -14.5% -11.6% Essel Large Cap Equity Fund 15.2% -18.8% -14.9% DSP Top 100 Equity Fund 14.7% -21.5% -14.4%

Best Multi Cap Funds April-2020 YTD 1Y DHFL Pramerica Diversified Equity Fund 17.3% -10.8% -8.7% L&T Equity Fund 15.4% -17.6% -16.1% Aditya Birla SL Equity Fund 14.9% -19.6% -15.2%

Best Mid Cap Funds April-2020 YTD 1Y DHFL Pramerica Midcap Opp Fund 15.9% -7.3% -6.8% Edelweiss Mid Cap Fund 14.7% -15.7% -11.4% SBI Magnum Midcap Fund 14.0% -17.3% -18.0%

Best Small Cap Funds April-2020 YTD 1Y Reliance Small Cap Fund 14.9% -19.9% -21.4% Sundaram Small Cap Fund 12.5% -22.1% -27.5% Union Small Cap Fund 12.4% -14.5% -12.8%

Best Large & Mid Cap Fund April-2020 YTD 1Y UTI Core Equity Fund 15.7% -21.2% -21.3% Mirae Asset Emerging Bluechip 15.4% -15.7% -8.4% Tata Large & Mid Cap Fund 15.2% -16.2% -9.5%

Best Focused Fund April-2020 YTD 1Y Reliance Focused Equity Fund 18.1% -20.5% -20.5% DSP Focus Fund 15.1% -21.9% -13.0% ICICI Pru Focused Equity Fund 14.6% -11.4% -15.5%

Best ELSS Fund April-2020 YTD 1Y IDFC Tax Advt(ELSS) Fund-Reg(G) 16.7% -20.6% -22.6% Mirae Asset Tax Saver Fund-Reg(G) 15.6% -17.1% -10.8% Quantum Tax Saving Fund-Reg(G) 15.3% -20.2% -23.5%

- 26 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

2. Best and worst performing NIFTY stocks in April 2020

Top-10 NIFTY stocks April-2020 YTD 1Y Cipla Ltd. 39.4% 23.9% 4.2% Vedanta Ltd. 38.4% -42.1% -46.8% Hero MotoCorp Ltd. 36.4% -10.9% -15.1% Hindalco Industries Ltd. 36.1% -39.2% -36.4% IndusInd Bank Ltd. 33.3% -68.5% -70.0% Sun Pharmaceutical Industries Ltd. 31.8% 6.9% 2.7% Reliance Industries Ltd. 31.6% -2.9% 4.3% Tata Motors Ltd. 31.2% -49.4% -55.0% Bajaj Auto Ltd. 29.7% -16.7% -13.4% Mahindra & Mahindra Ltd. 28.7% -31.7% -43.2%

Bottom-10 NIFTY stocks April-2020 YTD 1Y Hindustan Unilever Ltd. -4.5% 13.3% 27.4% Tech Mahindra Ltd. -3.4% -28.3% -34.7% State Bank of India -3.2% -43.0% -38.2% Wipro Ltd. -2.9% -22.9% -35.0% Power Grid Corporation of India Ltd. 1.9% -17.1% -14.8% Indian Oil Corporation Ltd. 3.1% -33.1% -46.7% Bajaj Finance Ltd. 4.6% -45.2% -26.0% ITC Ltd. 6.0% -23.5% -40.3% Grasim Industries Ltd. 6.0% -32.0% -43.9% Coal India Ltd. 7.8% -29.9% -41.2%

- 27 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 | The Alpha Investor, April 2020 | Issue #6| Finpeg

Finpeg is a registered trademark of Neam Caps Private Limited. Neam Caps Private Limited is a registered Mutual Fund Distributor with AMFI Registration Number ARN – 113082

NEAM CAPS PRIVATE LTD.

Unit no. 325, C-1, 3rd Floor, Soham Plaza, Manpada, Thane West, Maharashtra – 400607 Email: [email protected] Phone: +91 90829 13729

Plot no. 564-A57, H. No. 1257, Road No. 42, Jubilee Hills, Phase III, Hyderabad, Telangana – 500034 Email: [email protected] Phone: +91 98484 91415

- 28 - THE ALPHA INVESTOR, APRIL 2020 | ISSUE #6 |