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June 2012

The Indian equity markets represented by S&P CNX Nifty continued its downslide for the third month in a row and posted negative 6.2% returns in the month of May. The month saw a series of disappointing domestic macroeconomic indicators like low Q4 GDP, high inflation and slowing industrial growth. All global indices ended in red driven by concerns over Greece’s inability to form a government and fragile macroeconomic conditions in the Eurozone. Italian bond yields and their spreads over German bond yields increased as the country was not able to completely auction its sovereign bonds. The spread between the Spanish and the German bond yields touched lifetime high due to concerns over asset quality of Spanish banks.

Foreign Institutional Investors continued selling in the domestic markets due to increased risk aversion. FIIs were net sellers of secondary market equities worth Rs 1,523 cr in May, the second consecutive month of net selling after they sold equities worth Rs 568 cr in April. The rupee touched its life-time low of Rs 56.4 vs. the US dollar and ended at Rs 56.11, down 6.4% m-o-m. Since India is a large importer of crude oil and gold, the depreciated rupee will have an adverse impact on the current account deficit since capital inflows are slow, and will keep inflation at high levels. It will also adversely impact corporate India which has significant amount of foreign currency loans due for repayment over the next few months.

The Q4FY12 and FY12 GDP numbers announced on the last day of the month fuelled fears of slowdown. Q4 GDP growth slipped to a nine-year low of 5.3% dragging the overall FY12 GDP growth to 6.5%, which was significantly lower than advance estimates of 6.9%. The industrial output contracted by 3.5% in March driven by broad slowdown across industry groups. WPI-based inflation was 7.2% in April driven primarily by food inflation, which re-entered double digit zone after a gap of six months.

All domestic sectoral indices ended in red during the month. Auto was the biggest loser with negative 17% returns. This was due to the combined impact of (a) tepid auto sales growth in April, (b) petrol price hike, and (c) Sharp decline in index heavyweight Tata Motors (30% weightage) post disappointing Q4FY12 results. Power index was the second biggest loser for the month with negative 9.9% returns due to poor Q4FY12 results reported by index heavyweights. The metal index posted negative 8.7% due to declining global commodity prices and poor growth outlook given by metal companies for FY13.

The quarterly results season just got over and suggests a sharp deceleration in revenue growth. Margins remained under pressure, although the pace of decline is abating. Consequently, on a reported profit basis, aggregate earnings will probably remain modestly negative for the third consecutive quarter, the drag coming largely from Industrials, consumer discretionary and materials. Interest expense has also risen materially as highlighted by the rising interest-to-ebitda ratio. 

Amidst this environment of gloom, one shouldn’t lose sight of the long term opportunity. The structural India story for which everyone was bullish in India is almost intact. Favorable demographics, rising incomes & consumption levels, high savings, opportunities in infrastructure & outsourcing, robust market infrastructure, all these are still true. There is no denying that macro situation is scary & very close to crisis days of 1991. Global environment couldn’t have been worse. Policy makers have disappointed big time. However aggressive transformation never happens in India out of conviction, politicians deliver them out of compulsion and we are reaching that point. If history is any guide, these are precisely the time when you get great opportunities to accumulate risk assets. From a historical perpective, equity market valuations are reasonable. We continue to focus on bottom up with criticality of quality (earnings, cashflow, business franchise & management) and valuation to the ultimate delivery of long term sustainable returns.