Time to Embrace Vaccine and Volatility with Equal Aplomb
Markets have been rallying globally and investors continued to make merry as liquidity drove markets to higher highs. After rising 3% in January, 2021, SENSEX rallied another 6% in February, 2021 and hovered close to the 50,000 mark. In recent times, bond yields (especially in US) have started playing spoilsport with global markets. Will “rising bond yields” become the new cuss words for investors globally or is it just a passing trend. We reckon investors will have to embrace volatility with as much confidence as getting the vaccine shot in the coming few weeks or months.
PSU stocks – an unlikely set of stocks have started rallying in recent times
These were boosted by the FM’s announcement in the recent Budget regarding privatization and divestment of some of its crown jewels. After PM Modi stated that “Government has no business to be in business”, divestment has emerged as a new theme for investors. Should you load up your portfolio with PSUs or continue to remain cautious. We delve more on this topic.
And lastly, in our section “Food for thought”, check out some cool learnings from cricket that you can apply to equity investing. There are some uncanny resemblances between cricket and good investing habits. Take the recent examples – after losing the first Test Match against Australia, India managed to clinch the Test Series down under. Against England too, after losing the first Test, India won the series 3-1. As they say, “Haarke jeetne wale ko Baazigar kehte hain”!! The Nifty too after losing the first round of battle to the virus in Feb-Mar 2020 has bounced back and is displaying renewed confidence in same period of 2021.
Investors Yielding to Pressure
Stock markets suffered a scare close to the end of February, 2021 and early March, 2021. The reason? Rising bond yields in US markets. Bond markets and equity markets, usually move in opposite directions in the short term while the same is not true over a longer period. Hence, equity markets got somewhat worried when the yield on 10-year US treasuries suddenly saw a spike.
The spike that spooked
US 10-year Treasury yields moved up dramatically since the month of February, 2021. From 1.08% on 1st February, 2021, yields moved up to 1.40% on 28th February, 2021, a rise of 32bps in a matter of 23 trading sessions. The biggest spike came on 25th February, 2021, when the yield went up 16bps in a single trading session. Equity markets, tumbled heavily on 25th and 26th February, 2021. Back home, the 10-yr Indian bond yields also moved up 16bps in February, 2021.
So does it mean that bond yields sprung a surprise in February, 2021? Not really. A closer look at the bond yield charts for 10 year US Government bonds reveal it has been rising month-on-month since July 2020.
As seen above, bond yields have been inching upwards in India and USA, albeit for different reasons. But before that, let us take a look at why interest rates had been artificially kept low for quite some time.
The backdrop of low interest rates
Central Banks the world over have been holding rates low for quite some now. This was prompted by the need to push economic growth rates higher as all economic activities came to a standstill at the peak of the COVID-19 pandemic. As per a survey held by Bloomberg in the current calendar year, no major Central Bank in the world is expected to hike interest rates in CY2021. The survey covered 90% of the world economy. According to the survey, China, India, Russia and Mexico are among those predicted to cut their benchmarks even further.
Central Banks the world over are of the view that interest rates have to be kept low till economic recovery takes firm shape. The trajectory of V shaped recovery may be interspersed with volatility given some economies are seeing a second or a third wave. Hence, banks are preferring to keep rates low, as they feel that ensuing inflation could be an easier issue to solve than rising unemployment.
India too opened its taps in order to stimulate the economy and support its vulnerable sections. One needs to understand that this is not the same RBI that dealt with the Global Financial Crisis of 2008. Back then, forex reserves were around $200bn and currently, they are at $585bn. Hence, the ability of the RBI to deal with any shocks or sudden outflows is much higher. The RBI Governor too has laid out clearly that it will focus on growth in near term while trying to keep bond yields in check.
Too low for too long….does it actually help
It has been widely debated whether artificially low interest rates actually push growth
Why did bond yields move up?
As history has shown, sustained periods of low interest rate regimes tend to flare inflation. Economies across the globe are showing faster-than-expected recovery in manufacturing and spending. More and more people are now able to put fear of infection behind them as vaccination picks up pace. All this is expected to result in resurgence in growth and a return of inflation, thus forcing Central banks to raise policy rates. All these expectations have begun to build up among market participants and hence interest rates spiked. According to economists, movements in bond markets precede policy rate announcements and hence current bond spikes could be an indicator of Central Bank action going ahead.
What’s the scene back home?
Indian equities, too suffered a scare when bond yields suddenly spiked.
- There is a whopping Rs. 70.5Lcr of G-Secs outstanding and on top of it, Government plans to borrow Rs. 12Lcr from the market. If yields go up, this could burden the Government further, with higher interest payments.
- Food and commodity prices have been climbing steadily over past few months.
- Higher bond yields results in select institutional investors shifting from equities to bonds.
Speed breakers in the expressway journey; No reason to fret
Inflation is no doubt, trending up – metals, oil, gold, everything has become costlier. However, we are yet to identify if this rise in prices is a structural inflation trend or transient one. The world is beginning to come out of a “once-in-a-century” crisis. Supply chains are still disrupted at many places and that is also the reason for select commodities prices rising.
A look at the last mega bull run in 2004-08 reveals that a major part of it happened even as the benchmark yields went up from 5% to 9%, thus corroborating the point that rising yields may be a dampener in short term but not in the long term.
Does the current spike in bond yields signal the end of the current equity market run? Definitely Not. Consider it as speed breakers in the journey towards a recovery followed by growth.
Any correction, whenever it comes, is also be opportunity for investors sitting on cash. Higher or lower bond yields, there is no denying the fact that structurally, we are among the better placed economies in the world. A reform-led Government improves our prospects even further. Volatility will be a part of the journey we will travel in the upcoming quarters just as it was during 2004-08 when Nifty corrected 4 times by over 12% and ultimately continued its upward march. There is a whopping Rs. 70.5Lcr of G-Secs outstanding and on top of it, Government plans to borrow Rs. 12Lcr from the market. If yields go up, this could burden the Government further, with higher interest payments. Food and commodity prices have been climbing steadily over past few months. Higher bond yields results in select institutional investors shifting from equities to bonds. What’s the scene back home Speed breakers in the expressway journey; No reason to fret
PSU stocks – Back in favor or early to call a trend
Over the past few trading sessions, PSUs stocks have been rising steadily. The BSE PSU Index and CPSE ETF have beaten SENSEX returns by a wide margin over the past month. PSUs for long have been shunned by long term investors owing to several issues plaguing them for years together. Will it change now; read on.
FM sets the tone for “de-sarkarization” in Budget 2021
In her Budget speech, the Finance Minister announced that Government will sell stake in numerous PSUs, starting FY22. While a lot of companies will be “privatized”, Government will retain bare minimum presence in four strategic sectors:
According to the Government, firms that are expected to be privatized in FY22 are BPCL, Air India, Shipping Corporation of India, Container Corporation of India, IDBI Bank, BEML, Pawan Hans. Two public sector banks and one general insurance company will also be taken up for privatization. The IPO of Life Insurance Corporation India will also be completed in FY22. On the whole, the Government set a divestment target of Rs. 1.75lakh cr for FY22, much higher than Rs. 1.05lakh cr in FY20 and Rs. 0.8lakh cr in FY19.
PM reiterates FMs’ stand
Prime Minister Narendra Modi highlighted that “the Government has no business to be in business”, during a
recent meeting organized by the Department of Investment and Public Asset Management (DIPAM). DIPAM is a Government body that is mandated with facilitating monetization of non-core assets of government CPSEs under strategic disinvestment or closure and enemy property of value of Rs. 100cr and above. DIPAM has a framework for monetizing non-core assets.
According to the PM, “It is the government\’s duty to support enterprises and businesses. But it is not essential that it should own and run enterprises. There was a different time when public sector enterprises were established and the needs were also different”.
These announcements were enough to fire PSU stocks.
Investors were delighted with these announcements and this sent PSU stocks in a tizzy. Several PSUs have rallied significantly since then, much higher than the broader market.
Emboldened by the announcement, both the PSU-related stock indices rallied ahead of SENSEX since Budget 2021. Out of the total 72 stocks that make up the BSE CPSE and BSE PSU indices, 60 outperformed the SENSEX since Budget 2021.
What does history suggest?
While PSUs have been buzzing currently, history suggests something very different. Historically, PSU stocks have not performed to the mark. The wealth creation track record of PSU stocks has been very poor, as seen in the table below:
So what is the reason for this under-performance?
- Lack of accountability by top management, resulting in poor financial performance
- Large employee liabilities due to heavy work-force and pressure tactics by worker unions
- Complacency by some PSUs given their monopolistic nature
- Loan disbursement to certain unworthy accounts (by PSU banks) under pressure from various lobbies and loan waivers granted
- Frequent ETF / OFS had led to steadily increasing supply of PSU equity in the market, depressing return ratios and EPS for these companies
- Most PSUs are in fields which are capex intensive. In last few years, investors have been latched on to the “India consumption story” rather than the “India capex story”. Hence, consumer facing companies have been preferred over capex intensive companies.
Investors look at PSU stocks for higher dividend yields and as “higher-yielding FDs”. However, even that trait is not common to all stocks and hence some filtering is necessary.
Is the Government getting its act together?
The current Government has been working towards improving efficiencies at PSUs, since it is betting big on divestment to plug fiscal deficit and boost its revenues. With this end objective, it has taken following steps:
After raising Rs. 1Lcr through Exchange Traded Funds (ETFs) in FY19 and FY20, the Government stopped the practice in FY21, reducing supply of PSU equity to markets.
DIPAM is working on a new structure whereby incentives for PSU executives will be linked to factors such as
Government has prioritized sale of non-core assets to begin with, which will help boost return ratios of PSUs making their balance sheets lighter.Most PSUs are debt-free or have very low debt, hence rise in interest rates will not impact much.
Lack of accountability by top management, resulting in poor financial performance Large employee liabilities due to heavy work-force and pressure tactics by worker unions Complacency by some PSUs given their monopolistic nature Loan disbursement to certain unworthy accounts (by PSU banks) under pressure from various lobbies and loan waivers granted Frequent ETF / OFS had led to steadily increasing supply of PSU equity in the market, depressing return ratios and EPS for these companies Most PSUs are in fields which are capex intensive. In last few years, investors have been latched on to the “India consumption story” rather than the “India capex story”. Hence, consumer facing companies have been preferred over capex intensive companies
Is it time to add PSU stocks to your portfolio?
Should one buy aggressively into PSU basket? We believe it can at best be a tactical play wherein some investment can be done with a medium term view and stakes raised over a period of time, once confidence builds in. While the Government is taking several measures to improve performance and processes at these companies, it will take some times before PSUs can shed years of inefficiency, complacency and poor capital allocation. Also there could be opposition from worker unions and reluctance from top management. Most PSUs have access to some of the most lucrative assets, monopoly-like position in their field of operations, debt-free balance sheets and high dividend pay-out. There are some potential Hindustan Zinc’s waiting to be privatized where value unlocking can be done. The PSU divestment/stripping non core assets theme is definitely not going to fizzle away soon.
Food for thought – Cricket as a style of equity investing
There are some amazing similarities between a cricket team and your portfolio! Why not take lessons from your biggest passion and apply them to your investments, to your benefit? Click here to read more about it.