With the eventual roll out of multiple COVID vaccines in parts of the world, there is cause for cautious, broad based optimism. The spread of the new viral strain in the UK and the rising cases in the US are still a cause for concern, but the larger hangover of the virus on the global economy seems to be receding. In India, reduced geo-political risk vis-à-vis China and a stronger than expected bounce back of the economy in Q2FY21 (with an estimated 7.5% contraction) have been key positives. There is hope in the air!
With an estimated USD 20 trillion of fiscal and monetary stimulus undertaken by governments and central banks globally, the world economy has never seen such a glut of liquidity. It is estimated that nearly USD 18 trillion of global assets are in negative interest yielding debt as of date. India has been no exception to this ‘easy money’ economy with multiple liquidity measures announced by the Indian government and the RBI to revive the lockdown hit economy. However, the economy had limited absorption capacity for such a scale of liquidity infusion. Credit offtake, which was already weak pre-Covid on NPA concerns, does not show any significant uptick (5.8% in the quarter ended September 2020 vs 8.1% for the corresponding period last year). Financial institutions, already grappling with legacy NPA issues, became very circumspect vis-à-vis disbursements and became more focussed on asset quality. Thus, while the overall liability costs for most financial institutions has come down significantly (about 250-300 bps on average), they are struggling to find avenues to deploy capital profitably. The problem has been accentuated by negligible private investments during this period and a slowdown in Government spending. Consequently, the RBI currently has over USD 100 billion of liquidity available as on date. An increase in bank deposits (up ~11% YoY), a fall in borrowing costs for AAA corporates below the reverse repo rate and a dip in 10-year government bond yields (down to 5.95% despite high and sticky inflation) are symptomatic of the liquidity overhang. A weak dollar has acted as a catalyst to the liquidity and led to record FDI/FPI flows in emerging markets like India (FDI and net FPI inflows into India are at USD 50 billion and USD 20 billion YTD). Asset classes like gold (up~27% YTD) and public equities (NIFTY is ~13% up YTD and ~81% up from its March 2020 lows) are on a liquidity driven rally which shows no signs of abating.
Despite its increasing frequency, rising ferocity and increasing socialization where even vital government installations are not spared, we believe that cybersecurity is not being assessed by investors as a materially relevant financial risk. Investors must recognize that cybersecurity and data breaches are not simply technology related risks but are highly material business risks that have financial implications for a company's bottom line, can cause brand erosion through reputational damage and also pose legal ramifications with possible lawsuits. This is particularly true for financial services companies.
With the equity market risk premium at an all time low, valuation multiples have expanded in the public markets. The NIFTY is trading at its highest decadal level at ~22x FY22 estimated earnings. A causal effect for the liquidity inflows are expectations of a strong rebound in Q3/Q4 growth this fiscal. While Q2FY21 growth was driven by a combination of pent up and festive demand, agricultural growth and an overall restocking of supply chains, lead indicators (fuel and power consumption, Services PMI and Index of Industrial Production) signal that the growth momentum is likely to continue. The markets also seem to have discounted macro-economic risks like an expanded fiscal deficit, higher debt to GDP ratio and elevated inflation levels. The quantum of private consumption expenditure and government spending in the next few months hold the key to growth in the next 2-3 quarters.
In our discussions with companies, the underlying theme that we are hearing is of cautious revival with demand levels in most businesses reaching/exceeding pre-Covid levels. Unavailability of labour and supply side disruptions (farmers agitation, cyclones in South India) continue to persist as challenges. The services sector seems to be less impacted by this and may post better growth numbers. Most businesses have also utilised this period to rationalise costs, bring in operational efficiencies and pivot their digital strategies. This is leading to higher profitability margins, albeit with a muted growth trajectory.
‘Range’, a book by David Epstein, is a very interesting read on how generalists with a diverse skill set are likely to do better than specialists in most emerging fields in the 21st century.