By Sunil Sharma
While acknowledging that forward earnings can be like a mirage in the desert, the forward earnings yield differential between bonds and equities has moved to levels historically associated with attractive returns for equities. On a trailing basis, the measure remains in neutral territory. The trailing price-to-sales ratio is a purer approach based on top-line and is also approaching levels historically associated with attractive equity environments, at roughly a standard deviation below the 10-year average.
Large-cap vs mid-cap
Equity research analysts appear to be finding cheer at mid-cap companies, that isn’t readily apparent to the macro investor community. The forward P/E ratio for mid-caps has declined below its long term average, while the forward P/E ratio for large caps remains above its average. Further, the EPS revisions data demonstrates an uptrend since late last year in midcap earnings revisions, while revisions for the Nifty 50 remain largely static. Mid-caps appear to be witnessing improving momentum relative to large caps.
Corporate bonds vs G-Secs
The spread between the 10-year G-sec yield and the repo rate has compressed meaningfully. However, the spread between corporate bonds and G-secs has widened over the past few weeks, as the government bond has moved lower, tracking short term rates. Corporate bond yields have moved lower, but by less, therefore leading to spreads increasing to historically high levels. The spread between G-sec yields and AAA yields remains consistent across the short and long end of the curve. Therefore, there is no advantage that appears evident in the short or long end.
Equities: Domestic recovery underway
Just as we were beginning to wonder if investors are adequately positioned domestically for positive economic news flow, the attack on the Saudi fields brings crude back into the equation. Oil importers are likely to be affected, as are companies with raw material imports, and oil derivative imports. Should the move on crude sustain, margins are likely to be impacted, yet again for sections of the market. The weakness in the rupee should it unfold would be immediately attractive for IT, pharma. Our views on equities remain unchanged, except that the risks in the short term now appear elevated with respect to crude. It is difficult to get a handle on the potential impact and bears monitoring, but we expect the situation to self-correct in coming days/weeks. Portfolios constructed to deal with multiple outcomes rather than a specific view remain preferable. These would include quality growth, capital protected strategies,
long-short, Gold and Silver, global diversification, and tactical hedging.
Fixed Income: Oil can add to fiscal pressure
A spike in the price of crude could impact yields in the short term, adding to fiscal pressures for an already fiscally constrained government. In the short term, the impact is likely to be absorbed by international oil reserves; should the situation remain unresolved for an extended length of time, the impact on the global economy could be tangible.
A diversified portfolio of AAA-rated, highest quality, corporate bonds, banking and PSU bond funds, short, medium-term bonds, low to moderate duration remains our preferred positioning. Fresh money allocations would be best-advised post the stabilisation of the situation in Saudi Arabia.
(The writer is chief investment officer, Sanctum Wealth Management. Edited excerpts from Sanctum Wealth Management’s Investment Strategy)