Back to all items

February 2012

Like every dawn after the darkest night, January 2012 brought with it chilling-fresh dawn. In January, Sensex gained 11.25% and Indian markets were among the Top-3 best performing emerging markets. It rose 19.5% in US Dollar terms as Rupee appreciated 7%. 

The global risk-on trade reappeared on the back of improved set of economic data from US and better news-flow from Europe. Increased likelihood of a continued quantitative easing by the European Central Bank (ECB) and US Federal Reserve’s reassurance of continuation of ultra low interest rates till 2014 also fueled equity gains. European central bank (ECB) has expanded its balance sheet by a whopping 44% in the last 6 months through Long term Repurchase Operations (LTRO). Markets now talk about the great “Euro carry trade” as the correlation between risk assets and Euro has surged. 

India also benefited from the global risk-on trade as Foreign Institutions turned net buyers of US$2bn worth of Indian stocks (when the domestic institutions sold US$1.3bn) and INR/US$ appreciated the most since 1980 in a month. The surge in liquidity, coupled with relative under ownership of Indian equities among large institutions contributed for an unprecedented rally.

Quite a few of the macro news flows further complemented the positive reflexivity of the investing environment – 

  • Headline inflation for December falling below 8% 
  • RBI signaling a start of easing monetary cycle with a CRR cut of 50 bps
  • Fast track task force under Prime Minister Office (PMO) showing urgency on setting a policy turnaround at both macro and micro levels

As things stand the key developments that would set the trend of the market are –

  • The direction of core inflation – we expect this to be softer given the base effect and this will give RBI headroom to ease monetary policy
  • The policy direction – which critically hinges on the interim state election, especially Uttar Pradesh (a state with 20% of India’s population and 15% of seats in the Lower House – Lok Sabha)
  • The fiscal Situation – given a fear of slowdown in revenue collection and burgeoning subsidies, crude oil being a joker in the pack. A surprise outcome from the state elections can create a positive influence here.

Corporate results for 3QFY12E announced so far have been a mixed bag. The worries on margins, impact from Forex fluctuations, asset quality deterioration in case of banks and slowdown in order inflows for infrastructure companies have persisted. We believe the negative trend in earnings downgrade should bottom out in the current quarter. 

The news from the leader of the last rally, i.e. banking, has been lackluster thus far with asset quality concerns coming to the fore. We expect the current phase to continue in the business – something valuations seem to have factored in. The sector has shown some steam in the recent rally, primarily on the back of positive sentiments on the interest rate cycle. Industrial remain sluggish. Some of the marquee consumption plays are showing initial signs of exhaustion.

How fast do things change really in today’s world? Within 25 working days, the market seems to have climbed the initial wall of worries questioning even the structural India story. Market participants seem to be less concerned about policy paralysis, growth prospects and twin deficit (trade and fiscal) now. In this early phase of rally, the beaten down stocks or laggards of the last year have performed better as ‘quality premium’ has shrunk. 

The liquidity has provided the gasping market with enough oxygen to take deep breath. The multiple moving parts of the currency, commodity and capital puzzle – do make it difficult to look far beyond, but as things stand today one can expect them to be range-bound in coming months – Indian market would be no different.

We expect the positive reflexivity to be further fueled after the outcome of state elections, as both micro and macro policies gaining traction (with better clarity for the ruling alliance on its potential partners that it would carry through to next national elections in 2014). 

We are specifically positive on healthcare sector while maintaining our core belief on the “long-term growth story” wresting on the key pillars of – consumption, favorable demographics and investment upturn. Quality remains core to our investing principles, though we remain tactical accomplices in playing the large liquid names where a relative value opportunity exists to participate in. 

Long term yields remained volatile during the month even as the tightness in systemic liquidity kept money market yields in an upward trend. The benchmark 10 year government bond yield moved down by around 40 bps from the previous month leading into the policy review in January as the OMO program supported sentiments in spite of the additional market borrowings announced. The Benchmark yield touched an intraday low of 8.07% post the CRR reduction, but quickly reversed the gains and closed the month at 8.27% as the RBI refrained from announcing OMO post the policy review. The RBI in the third quarter review of monetary policy has shifted the growth-inflation balance of the monetary policy stance to growth. In continuation with the definite shift in the monetary stance in the December review, the RBI cut the CRR to address the structural liquidity shortage in the system and to provide primary liquidity on a more enduring basis. The cut in the CRR is meant to ensure that the current tightness in liquidity does not impair the flow of credit to productive sectors in an environment where the downside risks to growth have magnified. The immediate impact of the CRR cut should moderate the extent of the current tightness in systemic liquidity. The RBI has reduced the fiscal year end GDP estimate to 7% and maintained the estimate of 7% on the year end inflation reading. 

With the CRR reduction signaling the change in the policy stance, the medium term trajectory of policy rates would be conditioned by the fiscal stance as enumerated in the Union Budget in Mid March. The policy review states that based on the current inflation trajectory, including consideration of suppressed inflation, it is premature to begin reducing the policy rate. The RBI has cautioned that in the absence of structural measures to improve the supply side response and fiscal consolidation, the Reserve Bank would be constrained from lowering the policy rate in response to decelerating private consumption and investment spending. This puts the onus on the government to deliver on the fiscal side starting with the forthcoming Union budget. We anticipate that the RBI would be more proactive in ensuring adequate liquidity to the markets given the change in its stance. This would most likely necessitate additional OMO’s or another CRR reduction given the seasonal liquidity pressures in March. In the near term over the next few weeks, the trajectory of bond yields would be dependent on the continuation of the OMO program and its sequencing. In the context of the policy rates having peaked and the reduction in the CRR apart from the moderation witnessed in growth variables, we expect duration funds such as SBI Dynamic Bond fund to provide attractive investment opportunities over the coming year.

We have been recommending investors with risk appetite and investment horizon of over a year to consider the dynamic bond fund which is well positioned to take advantage of the opportunities in the bond market. With the short term corporate bond rates at elevated levels, we recommend short term funds to investors with a moderate risk appetite and an investment horizon of up to 6 months.

Navneet Munot