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August 2014

July  marked completion of 2-months of the new government  at  the centre. The  markets continued to give thumbs up to the new policy regime. The benchmark index closed nearly 2% higher over the month. Year-to- date, India remains one of the best performing markets in the emerging markets peer set. 

 The  new  government’s  first  budget  rightly  focused  on  the  four  pillars  of  the  future  India  strategy  –  fiscal prudence,  ease  of  doing  business,  attract  financial  savings  to  asset  creation  and  give  escape  velocity  to infrastructure  development.  Local  macro  indicators  were  mostly  constructive.  The  monthly  economic

indicators reflected an improvement, both in industrial production as well as inflation. The monsoon picked up after a weak June, though still being below average.

 Thus  far,  government  has sent  right  messages  in  terms of  its  intents  and  priorities.  Decisions  pertaining  to controlling  inflation,  expedite  decision  making  by  abolishing  all  EGoM,  bringing  special  focus  on  creating manufacturing competencies and steps to ensure steady flow of credit to infrastructure and housing sector are positive. Tough decisions like raising railway fares and continuing with fuel price hikes have been taken.

The prime minister continues to work towards creating a more cohesive and co-operative climate within the SAARC region with a long term objective of making it a strong economic union. Also rather than talking big, the focus is to set the ball rolling on execution and further fuel the economic positive reflexivity. 

 The  external  backdrop  remained  mixed.  Policy  developments  in  China  were  encouraging.  Geo-political developments  in  the  Middle  East  adversely  impacted  investor  risk  appetite.  The  US  Federal  reserve continues  to  taper  the  quantitative  easing  (QE)  while  guiding  for  an  extended  period  of  near-zero  interest rates. We believe that if the current trend of improvement in  the labour market and uptick in CPI continue then expectations on US interest rates may undergo a change. 

 The  FII  flows  continue  to  be  positive,  with  domestic  investors  turning  buyers  in  the  last  couple of  months.  With the recent run up, the market is now trading at about 17x FY15E, which is marginally above the 10-year historic  average.  The  consensus  estimates  continue  to  witness  marginal  upgrades.  The  2-year  forward earnings growth remains at around 15% CAGR.

 Mid-cap valuations too have improved and are now trading above the 10-year average. The recent catch up in  this  segment  has  brought  the  mid  cap  valuations  at  premium  to  large  caps.  The  market  is  certainly factoring a higher growth expectations from the mid cap space  now. We  expect  this gap to continue  given that mid cap corporates would remain a larger beneficiaries of the positive  reflexivity in the economy. We also expect earnings upgrades to follow across the spectrum, with a larger dispersion in mid-caps as we go forward.

 Going  forward,  we  need  to  watch  out  for  progress  of  1Q  FY15  earnings  season,  progress  of  monsoon  and Government’s action on the ground. We expect Prime minister to announce his vision and blueprint on the economy as part of his Independence Day address on August 15th.  The risk factors to watch out are – shift in  global  liquidity  and  interest  rate  expectations,  surge  of  equity  supply  on-shore  and  geo-political developments.  Emerging  market  investors  have  been  substantially  overweight  on  India  given  the  relative attractiveness but any signs of improvement in outlook on China may lead to shift in incremental flows as a tactical trade given the valuation gap. 

 We re-iterate that India is in a sustained long term bull run on the back of slow but stabilizing macro, revival in corporate earnings growth, reasonable valuations and improving liquidity both from the foreign as well as domestic investors. Having said that, we expect the market to consolidate its recent gains  in the near term as  it  absorb  the  current  earning  season  and  management  commentary  and  concurrent  large  equity issuances.  We  expect  the  market  to  reward  patient  and  disciplined  investing.  To  capture  the  emerging opportunities,  we  have  enhanced  breadth  of  our  investible  universe  to  benefit  from  the  opportunity  that exists  down  the  cap  curve  for  the  similar  quality.  We  maintain  our  focus  on  bottom  up  stock  picking  for generating alpha. 

 Even  as  the  RBI  maintained  status  quo  on  policy  rates  which  was  widely  anticipated,  the  accompanying statement  has  been  perceived  to  be  more  hawkish  as  against  a  somewhat  neutral/dovish  undertone perceived  in  the  June  review.  The  reduction  in  SLR  and  the  accompanying  cut  in  HTM  holdings  are  part  of the gradual measures designed to reduce the regulatory pre-emptions on banking system to provide space for  credit  growth  as  the  economy  starts  to  recover.  With  credit  demand  remaining  weaker  and  the government maintaining its fiscal consolidation targets, the timing of the same cannot be disputed. The RBI, while  acknowledging  the  recent  deceleration  in  inflation  momentum,  has  provided  a  more  cautious guidance  on  the  6%  CPI  target  by  January  2016  citing  upside  risks  to  the  same.  The  near  term  negative market reaction can be attributed to the lack of any additional liquidity enhancing measures or a relaxation in daily CRR maintenance as also the higher stress  given on the 6%  CPI target, even as the  RBI went ahead with an SLR cut.

 Overall  the  policy  indicates  that  the  RBI  is  firmly  focused  on  containing  inflation  expectations  as  per  their medium  term  glide  path.  This  reinforces  expectations  of  an  elongated  pause  in  policy  rates,  while  firmly ruling out any near term monetary easing driven by recent CPI moderation. The RBI’s cautious guidance also reflects  the  central  bank’s  assessment  of  a  more  lower  output  gap  which  could  result  in  near  term  price pressures  as  demand  and business  confidence  picks  up,  with  supply  side  responses  likely to  act  with  a  lag.

Overall the RBI is likely to adopt a more cautious stance as the economy transits from a high inflation, supply constrained, low  growth trajectory to an environment  where  growth impulses revive with gradual inflation deceleration  and  execution  of  supply  side  measures  by  the  government.  On  the  liquidity  front,  recent buildup of government cash balances has been cited as the reason for volatility in overnight rates. The RBI is likely  to  consider  additional  term  repo  auctions,  with  modulation  in  both  the  tenor  and  timing  to consistently maintain the rates in alignment with the policy rates stance. 

 We  have  been  maintaining  a  moderately  higher  duration  with  a  more  medium  term  view  on  rates.  At  the same  time,  we  would  continue  to  tactically  keep  higher  cash  allocations  to  take  advantage  of  market volatility.  A  steady  moderation  in  CPI  driven  by  both  government  actions  and  a  vigilant  monetary  stance, would also provide more confidence of an eventual policy easing sometime over the next year.

Regards,
Navneet Munot

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

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