'You can love me or hate me, but you can't ignore me' seems to be our venerable Prime Minister's mantra these days. By pulling the plug on OHD currency notes of Rs. 500 and Rs. 1000 denominations, PM Modi has undoubtedly ruffled some feathers amidst the elite and not so elite alike. While the jury is still out on the expected impact and eventual outcome of this bold move, it's actual execution is no doubt going to be a serious challenge. The question on the minds of many mutual fund investors is: should this move impact my investment policy or strategy in any way? The short answer is: yes. Here's how and why.
It's shouldn't come as a surprise to you to know that there's a lot of unaccounted for money floating about in the system today, fuelling what can be best termed as a 'parallel economy'. Reasonable estimates peg this figure to be in the range of Rs 17-20 Trillion (17-20 lakh crore).
Modi's shock therapy is likely to catalyse a sizeable chunk of this money and draw it into the banking system. Experts predict that the quantum of money that will actually flow into the system over the next few weeks may hit a volume of 5 lakh crore or more.
The sudden demonetization move is sure to have a negative short term impact on the economy; essentially, it's going to instantly dry out a significant chunk of liquidity from the market. We're likely to witness a corrosive impact of this move in the corporate results for the next few quarters, as trade gets impacted.
Here's where things get interesting: 5 lakh crore is a lot of money; it's equivalent to almost 6 months of fresh deposits that the entire banking system witnesses in our country, on average. Credit demand is likely to remain muted for the next few quarters, as companies are by and large, underutilizing their existing capacity. In such a situation, a lot of this money will chase G-Sec's, essentially bringing down yields even further in the next 6-12 months (just when you thought they couldn't get any lower!). The 10-year G-Sec yield plummeted 14 basis points yesterday - this is a good thing for bond holders, by the way. Long story short - long term debt funds are likely to rally.
The demonetization move is also likely to increase the chances of rate cuts by the RBI. Once the short-term pain subsides (and once Trump's trade policies become a bit less opaque), significantly reduced interest rates and improvements in credit offtake are likely to create a significant positive impact on corporate results, as a whole. This will eventually lend a fillip to stock prices.
Don't get me wrong - I'm not advising you to go lock, stock and barrel into equities just yet. Unforeseen global risks persist, as do questions on the general overvaluation of both stocks and bonds in India. However, this move does justify a minor tweak in your overall asset allocation, to the tune of 10-15% more into equities compared to your current investment policy.
To sum up, here's what you need to do as an investor. Switch one year moneys from FD's and shorter duration debt funds such as liquid funds into longer duration debt funds such as long term funds and GILT funds. Increase your overall portfolio allocation to equity funds by 10-15 per cent, but in a staggered manner via a 3-6 month STP (Systematic Transfer Plan). Choose a 50:50 mix of top ranked blue chip and mid cap funds for this increased allocation. A parting word of advice: be prepared for significant volatility over the coming months, and do not attempt to time the market while changing your asset allocation; you'll be sure to burn your fingers in doing so.
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