From the Ring. Will the second half of 2019 be a redux of H2 2018?

A stronger-than-expected mandate for the incumbent government boosted the sentiment towards risky assets, with both the Nifty and the Nifty Midcap 100 rising about 10 per cent, respectively, from May 2019 to early June 2019.

However, post hitting a new all-time high, the Nifty has come under pressure, especially post the Budget, as the sentiment deteriorates amid continuing liquidity concerns regarding non-banking finance companies (NBFCs) and worries about challenging economic growth.

The Nifty and the Nifty Midcap 100 have fallen 8 per cent and 15 per cent, respectively, since early June 2019.

The fears are reminiscent of H2 (second half) 2018. The Nifty rose about 13 per cent from May 2018 to August 2018, hitting the then all-time high. The Nifty Midcap 100 also rose about 7 per cent during that period. However, credit and liquidity concerns regarding NBFCs and the possible risk of contagion triggered a sharp bout of volatility, with the Nifty falling about 15 per cent over the next two months. The Nifty Midcap 100 fell about 18 per cent over the same period.

Investors are worried about the possibility of a similar or a more severe bout of volatility in H2 2019.

How is it different now?

In our view, the key difference between the two periods is monetary policy, both in India and the rest of the world.

In 2018, the RBI had embarked on a tightening cycle, raising rates by 50 bps to 6.5 per cent, as inflation stayed above its medium-term target of 4 per cent amid elevated core inflation and a surge in crude oil prices.

The bond market, then, was pricing in the likelihood of further rate hikes over the next 12 months. In 2019, it has been the reverse, with the RBI switching to a more dovish stance, lowering policy rates by 75 bps to 5.75 per cent till date, with the expectations of more policy easing because of benign growth-inflation dynamics.

Also, the RBI has also stepped up its liquidity support to the market through forex swaps and open-market operations (OMOs). This has turned system liquidity to surplus, compared with the deficit that was prevalent in H2 2018.

Globally, central banks have turned dovish lately, especially the US Federal Reserve, which has cut policy rates in H2 2019 compared with increasing policy rates in H2 2018. Compared with 2018, today’s macroeconomic background looks a bit healthier. Inflation and trade deficit are lower than what they were in 2018, which has resulted in lower bond yields and rupee stability. However, growth indicators are lower than the 2018 period, but they still suggest expansion ahead.

What should investors do?

In our view, macro fundamentals are still supportive, as prior fiscal and monetary policy easing is likely to boost growth in the coming months. However, in the short-term, markets are likely to be volatile as the government prioritises fiscal consolidation over stimulus amid a slowing economy.

We prefer bonds over traditional assets (cash, gold and equities) given the government’s return to a fiscal consolidation path, benign inflation, likely monetary policy easing and still attractive valuations.

Within bonds, we prefer short-maturity bonds over medium- and long-maturity bonds and see opportunities in corporate bonds but prefer higher-rated bonds amid a still elevated credit-risk environment.

Recent correction has made valuations better for equities as earnings continue to recover.

Overall, diversification remains the key in volatile times. Clients should ensure consistency with one’s appetite for risk, and include investments that would help offset losses in riskier assets.

The writers are MD and Head, and Chief Investment Strategist, Standard Chartered Wealth Management, India

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