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January 2012

A lot that happened in 2011 is worth forgetting. Sovereign debt crisis in Europe moved from periphery to the core, Japan had a natural disaster and the US faced a rating downgrade and economic slowdown. Most of the emerging countries including the BRIC nations saw growth momentum slowing down with no signs of 'decoupling' from the developed world. 'Arab spring' led to dramatic changes in the Geo political situation in the middle east and North Africa. Most of the asset markets witnessed turbulence with investors preferring safe havens like US treasuries and gold. Among the currencies, the flight to safety led to US Dollar Swiss franc and Japanese Yen doing well. Commodities had a poor year with crude oil and gold being exceptions. Though both crude oil and gold were quite volatile and gave up a good part of the gains towards the year end.

The persistent toggle between the risk-on and risk-off trades provided for a nightmarish volatility through the second half – something that the world markets would inherit through the initial part of 2012. Add the variables such as rising rhetoric of people’s opinion, rising regional conflicts in Middle East and Eastern Asia and impending elections in the Top-5 people centric economies.

It was one of the worst year for Indian equity markets with Sensex losing 25%. As the Murphy's law says, "anything that can go wrong, will go wrong".  India was a classic example. Sticky inflation, depreciating currency and rising interest rates coupled with policy inaction and execution failure led to a sever slowdown not envisaged at the beginning of the year. Corporate profitability took a major hit further impacting asset creation. Political situation remained worrisome which put the whole policy making in jeopardy.

Historically, December has been a good month for equity markets though 2011 turned out to be an exception. The rally in November didn't sustain and market fell 4.6% in the month making India one of the worst performing market. 

Markets faced a slew of negative news starting with Economic indicators (IIP, GDP Growth Target, currency, fiscal deficit), government backtracking on FDI in Retail and its inability to get crucial bills passed in the parliament, the Lokpal fiasco and a hasty clearance of the Food Security Bill (that aggravates the fiscal pain). RBI’s dovish outlook on monetary policy provided a small silver lining though. 

Corporate profitability is likely to remain depressed in the near future given the higher input costs, wages, interest rates, steep depreciation in currency and higher competitive intensity. With a hazy outlook and depressed profitability, corporate India seems reluctant to commit new capital locally. Most of the capex has been either stalled, delayed on suspended. The situation will certainly put to test Indian corporates’ wherewithal to navigate this challenging business environment.

The economy can’t afford continuance of sticky Inflation, rising interest rates and a weaker currency. While demand is an addressable issue with marginal stretch from the policy side – it is the governance that needs to step-up its response to the glaring supply gap on most of the input parameters. One can expect a tactical readjustment by polity to get the structural India story back on track sooner. We believe that directional reversal in policy making to be subject to test of political will, on the backdrop of impending state elections is critical for change in the market sentiments.

There exists a possibility of an outlier “blue-swan” of synchronized occurrence of favorable  events like – softened interest rates, global commodities and reversal of the currency slide (they all have high interlinks).

In Today’s pain lies tomorrow’s gain. We expect this period to offer a good opportunity to investors to participate in the long term India story. In this scenario we prefer to focus on bottom up stock picking with core beliefs in terms of quality (business, management, and cash flows), prudence (on cash utilization) and agility (in terms of timing and allocation). We prefer to look for businesses with strong franchise value, large consumption compulsion canvass opportunity and penetration potential. We also remain alert to opportunities that provide tactical returns on Asset plays at attractive valuations and rate sensitives given impending policy response. We recommend investors to maintain the discipline of asset allocation and use the downturn in equity market as an opportunity to gradually build exposure.

The RBI Monetary review in the month of December saw the monetary stance shifting towards addressing the concerns on growth with the RBI indicating that policy actions henceforth would seek to reverse the monetary tightening cycle. The benchmark 10 year bond yields continued its downward trend during the month, trading closer to 8.25% intra month. Bond yields were supported by the change in the monetary stance and continuing OMO program that has reduced the impact of higher government borrowings. The continuing tightness in systemic liquidity resulted in the money market yields trading higher during the month.

We anticipate that the year 2012 could present interesting opportunities for investors in debt funds. The cumulative impact of monetary policy tightening in an environment of tight systemic liquidity has had a moderating impact on key macro-economic variables. Considering the impact on growth and the recent deceleration in inflation, the RBI monetary policy stance has changed. We expect that in the near term, the RBI would be more aggressive in providing liquidity to the markets through OMO’s and an eventual CRR reduction. Long term funds such as the SBI Dynamic Bond fund are well positioned to capture the ensuing broad downward trend in bond yields in the coming year. Overall Bond yields are expected to trade lower from the current levels, considering the concerns on growth and the change in the monetary policy stance. The evolving situation with respect to the fiscal position of the centre and the direction of inflation movements, especially the manufacturing component could keep yields volatile for a while.  Considering the current global risk aversion, funding issues faced by banks and corporates in the Euro zone and slowing domestic economy we recommend selective & limited credit exposure and favor building duration via sovereign bonds. 

We would recommend Dynamic Bond funds for investors with a suitable risk appetite considering the expected volatility in yields. In spite of the downward trend in yields anticipated on account of the broad macroeconomic environment and the change in monetary stance, there would be headwinds such as the pressure on the fiscal and external event driven issues impacting the currency, credit and the rates markets. Dynamic Bond funds have the flexibility to invest across money market, gilts and also corporate bonds. Apart from the flexibility of changing allocations within the debt categories, the dynamic bond fund also has the mandate of aggressively altering the portfolio duration in response to the evolving market dynamics. Currently money markets and short term rates have been elevated on account of the pressure on liquidity. The elevated money market rates also present an opportunity for conservative investors to lock in their investments in accrual debt products such as FMP’s even as ultra-short term funds continue to be attractive destination for very short term cash. Short to medium term debt funds are attractively positioned in the current environment. The higher money market and short term yields provide a high accrual, and at the same time these funds are positioned to benefit from the downward trend in yields in the coming year.

Navneet Munot 
CIO – SBI Funds Management Private Limited
(Mutual funds investments are subject to market risks, please read the scheme Information document carefully before investing.)

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