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June 2013

“Sell in May and go away” is a cliché but for global markets, it turned out to be true again as environment has turned volatile given the uncertainty over the sustenance of growth recovery. Treasury yields surged as US Fed hinted towards reversal of quantitative easing program. Economic indicators in key developed economies threw mixed picture. Global commodity prices remained range-bound. “Abenomics” in Japan has stolen the show from Europe for the foreseeable future. We feel ‘Abenomics’ is the biggest experiment in the monetary and fiscal history as Bank of Japan is likely to print more money than the US Fed while the Japanese economy is one third the size of US. The government debt as percentage of GDP is over 200% and they are planning to increase fiscal deficit as percentage of GDP. Through currency weakness Japan would try to export its deflation and would impact competitiveness of other Asian economies with long term repercussions. Japan is also embarking on a serious reform program to boost growth, however, we must keep in mind that given the magnitude of leverage, the journey would not be smooth. What’s happening in the ‘land of rising sun’ would have a big shadow on rest of the world.

The policy environment in India remains challenging. The government received a setback on account of resignations of its key ministers under disparate allegations of inapt influence of power. Due to curtailment of Budget session, key legislations like National Food security bill and land acquisition bill could not be passed. However the cabinet did approve cut down in fertilizer subsidy. As we ink this piece, the monsoon has hit Indian shores of Kerala and is expected to be normal as per IMD. The window of opportunity for the government to push the reforms envelope is now getting narrower. Thus far, it has managed to tide over the tight rope walk of reducing subsidies with fuel price increases on prior committed timelines.

Economic data on growth and Inflation remained mixed. The GDP print for 4QFY at 4.8% was in line with expectations. Centre's fiscal deficit at 4.9% of GDP in 2012-13, against 5.2% pegged in the revised estimate was a positive surprise. The IIP also improved to 2.5% (prev. month ~0.5%) due to better performance of manufacturing and power sector coupled with higher output of capital goods. Core as well as headline inflation maintained the downward trajectory.

The strengthening of USD on the back of US Fed’s comments of tapering of QE had its ripples on the rupee. Despite strong FII flows, the currency weakened to a 11 month lows as it traded above 56/$.

FIIs have been buyers again in the month of May with accelerated net inflows of ~$3.8bn (+$15.2bn YTD). The domestic institutions in the same period have been net sellers $2.2bn (-$9bn) – mainly with redemptions in the insurance sector. In an environment where economic data points seem to be bottoming out, domestic redemptions remain critical to market direction.

The current earnings season does remain mixed. Over the results season, the consensus has revised down FY2013 growth estimates in six out of ten sectors. Financials and materials have witnessed downward growth revisions while Healthcare and Industrials the most upward growth revisions. The street now estimates earnings growth of 14% and 15% for FY14E and FY15E respectively. The results have also thrown-in interesting divergences within sector. There exist early signs of corporate actions to repair operations, assets, balance sheets and even management models – a key building block before corporate growth kicks in.

The market has been resilient to almost every adverse data point. The market also absorbed “offer for sale” of around ~ $700 million caused by the SEBI regulation on deadline for meeting the 25% minimum public shareholding norm for all listed companies.

India is at among the preferred value zone when it comes to options for an international investor – in terms of the sheer depth and the breadth of investable palette, the medium term attractiveness on relative valuations (at ~14.5xFY14E) and long term structural growth drivers. However, given the vulnerability of markets on external flows, any volatility in the global markets would impact India disproportionately.

We remain dedicated to bottom up stock picking focusing on the business quality (business model, earnings, management and cash-flows), remodeling (resources, operations, balance sheet) and valuations.

Bond yields declined further as macro economic data points released post the policy review printed much softer than market expectations. The WPI data for April 13 registered a y-o-y growth of 4.89% as compared to market estimates of 5.45% and previous month growth of 5.96%. The retail inflation index, the CPI which had been relatively sticky printed at 9.39% y-o-y for April 13 as against the estimates of 9.74% and the previous month reading of 10.39%. The inflation readings provided comfort in terms of fall in sequential growth as well as reduced pricing power as evidenced by declining core inflation. Soft data points on inflation and continuing moderation in gold and international crude prices kept market sentiments upbeat, with anticipation of additional easing in policy rates in spite of a rather circumspect RBI policy guidance. The benchmark bond yield based on old 10-year paper moved lower by around 30bps during the month and closed at 7.44%, with an intra month low close to 7.30%. The RBI issued the new 10-year benchmark bond during the month at a cut off yield of 7.16%. AAA corporate bond yields moved lower in line with the sovereign curve movements with the 5-10 year yields moving lower by 30-35 bps.

Largely positive trends on the evolution of inflation have guided market sentiments in the recent past with the market largely ignoring the trade deficit data for the month of April 13. The Q4 GDP data, which was in line with estimates, cautionary comments from the RBI governor regarding the risks to retail inflation and external sector and INR weakness led to markets retracing some of the gains over the last week of the month. The new benchmark 10-year yield closed at 7.24% and the old benchmark at 7.44%, with the AAA PSU corporate yield curve being largely flat in the 3-10 yr space at around 8.15%-8.18%.

The RBI monetary policy response to address the moderation in growth has been constrained by the multiple challenges emanating from the risks on inflation, fiscal deficit and the current account deficit. The moderation in inflation and fiscal adjustments especially on the pricing of diesel has opened up the scope for monetary policy to support growth revival in a limited way, even as the external sector challenges continue. We anticipate a gradual improvement in the external sector accounts driven by incremental slowdown in both oil and gold imports and improving export competitiveness even as the near term dependence on capital flows is likely to continue. Soft macro data, reduced pricing power and negative output gap provide leeway for additional policy rate cuts. The extent and sequencing of the same would be largely guided by incoming data, providing near term market volatility.

We have been maintaining higher duration, with periodic profit taking as market positioning and momentum driven by soft data, has favored such a strategy.

Navneet Munot

(Mutual funds investments are subject to market risks, read all scheme related documents carefully.)