Market Update
Macro Economic Review
The 7.7% growth in the economic activity (GDP) for the March ’18 quarter, the highest since 1Q FY ’17, came in as a positive surprise even as the GDP for the full year FY ’18 was recorded at 6.7%. Manufacturing growth at 9.1% in 4Q was strong and in-line with the trend over last couple of quarters while construction growth of 11.5% propelled industrial growth to 8.8%. This improvement reflects at buoyancy in the housing and infrastructure schemes of the government, which also has a positive bearing on employment numbers as the construction sector is one of the largest non-farm employer in the country. Meanwhile, the exceptional growth in the gross fixed capital formation continues, with a 14.4% growth in 4Q. However, the sharp deceleration in growth in trade, hotels, transport & communications and financial services’ industries in 4Q (6.8%) has dragged down overall services growth to 7.7%.
The Index of Industrial Production (IIP) for the month of March 2018 slowed to 4.4%, but the high frequency indicators continued to hold stable, Accordingly, Passenger vehicle sales grew by 7.5% while the two-wheeler sales were also strong at 17% year on year (YoY). Investment indicators like credit growth and commercial vehicle sales also portray healthy growth thus far. Also, the India Meteorological Department (IMD’s) forecast of a normal monsoon (at 97% of the long period average), the third consecutive normal monsoon for the country, augurs well for the economy, especially the rural economy. A normal monsoon could in fact off-set some of the upside risks to Consumer Price Index (CPI) inflation, that has begun to spiral following a sharp rise in global crude oil prices. The CPI inflation rose to 4.58% from 4.28% in March 2018 while the core inflation (CPI ex-food ex-fuel) inched up further to 5.9%YoY from 5.4% in March 2018 and the wholesale price index (WPI) rose to 3.18% on the back of rising crude oil and food prices. Besides, there is also an emergence of demand side pressure on the core inflation in addition to the current adjustments in housing inflation due to the 7th pay commission hikes. The upside risks to inflation also prompted the Monetary Policy Committee (MPC) to hike the repo rate to 6.25% in its latest round of monetary policy review, through it upheld its neutral stance on the policy in the wake of ongoing uptick in economic and investment activity.
April ‘18 trade deficit remained unchanged at $13.7bn, while exports expanded 5.2% YoY led by growth in engineering goods (17%), drugs and pharma (14%). Imports growth slowed further to 4.6% (lower than previous 7.1%). We do not expect any quick improvement in the trade deficit until the international prices of metals and oil continue to hover around the present levels or move higher. However, we do see some pressure on the Balance of Payment (BoP) if the higher oil price and portfolio outflow risks hit the economy simultaneously, exacerbating the pressure on the currency. This is the key event to watch out for over the next six months.
All said, despite high commodity prices and its impact on inflation and GDP posing threat, the headline growth numbers continue to be steady and a good monsoon and buoyancy in rural economy could keep the overall economy running at good pace.
Equity Market
The equity market, taking a pause from its previous month’s rally, ended the month May ’18 on a rather flat note. Recent political develeopment coupled with concerns pertaining to crude oil and currency kept the markets on the edge. Besides, in a key event last month, Morgan Stanley Capital International (MSCI), in its half yearly rebalancing exercise, lowered India’s weight in the MSCI EM Index by ~14bp.
The market performance this month was largely led by Private Sector Banks (+8%) and PSU Banks (+4%) while Cement (-10%), Telecom (-8%), Healthcare (-8%), Real Estate (-8%) and Auto (-5%) sectors underperformed. Also, Midcaps (down 6.8% in May) underperformed the Nifty and now also lag Nifty on a trailing 12-month basis (8% return v/s Nifty’s 12%).
In a surprising turn of events, select midcap companies taught investor focus following abrupt resignations by their auditors. The sentiments, subsequently, rubbed off to the entire midcap space. In terms of flows, FIIs were net sellers for the second month in a row while domestic funds continued to see net buying.
Meanwhile, the RBI, taking cognizance of the sporadic rise in the global crude oil prices and its potential upside risk to inflation, increased the repo rate by 25 bps to 6.25% in its second bimonthly policy review of FY 2018-19, after a pause of over 4 years. The move was however already factored in by the market, as reflected by the hardening bond yields ahead of the policy review, and the impact of rate hike on equity market too was thus largely neutral.
Going forward, we expect the market to be guided by the progress of monsoon rains across the country. Initial indications suggest India is likely to witness the third consecutive normal monsoon season with India Meteorological Department (IMD) forecasting a normal monsoon at 97% of long period average.
A reflection on corporate results so far shows corporate earnings gaining momentum and are likely to support overall market valuations notwithstanding near term macro-challenges. At the latest Q4FY18 result season, aggregate sales of a broad basket of companies grew 15.3% YoY, Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA) rose 9.5% YoY and Profit After Tax (PAT) fell 17.1% YoY. Performance was disproportionately impacted by PSU Banks and Private Corporate Banks, which saw a significant jump in slippages/provisions after the new RBI framework on asset quality (Feb’18). Excluding PSU and Private Corporate Banks, Sales/EBITDA/PAT grew 16.1%/16.5%/17.3%. Nifty aggregate sales grew 15.5% YoY, EBITDA grew 13.1% and PAT grew 5.1%. Excluding PSU and Private Corporate Banks, Nifty PAT growth for the rest of the 47 companies came in at a reasonably healthy 15.6%.
We continue to maintain that the market will likely remain in the mode of re-calibrating recent gains in economic and earnings growth momentum against emergent risks of inflation and higher interest rates for some time and this will likely induce volatility in the market for some time. The recent sharp fall in mid and small cap stocks, as already anticipated by us for quite a while, has added to overall market volatility but has also expanded investment opportunities given steep valuation corrections in select stocks.
Our portfolio approach continues to remain balanced with bottom-up stock selection and sector selection playing an equal role. We believe evidence is emerging on strengthening a pro-cyclical stance and some portfolio shifts to capture a potential industrial/manufacturing recovery are being undertaken. Cyclicals with comfortable balance sheets and attractive valuations or companies with strong franchise value but presently facing growth headwinds continue to attract our attention.
Fixed Income Market
The Monetary Policy Committee (MPC), prompted by the upside risks to inflation in the wake of sharp and sporadic increase in the global crude oil prices, raised the repo rate to 6.25% in its latest bi-monthly monetary policy review, while maintaining its stance as neutral in due consideration of ongoing recovery in the investment activity and economic growth.
Meanwhile, the government, withstanding the pressures to initiate tax cuts in domestic fuel prices, has enabled the pass-through of increasing crude oil prices thereby limiting the impact on fiscal balance. Nevertheless, the volatility in the bond market continues in the wake of upside risks to inflation in the near term, resulting in hardening of bond yields that traded closer to around 7.9% through May ’18.
In fact, the demand for bonds continued to remain muted despite some softness in the crude oil prices towards the end of the month. Also, the domestic currency (INR), that has been under pressure since the beginning of the year, continued its slide against the US Dollar through the month of May ’18. This month, the INR depreciated by ~2.65% against the USD before some retracement from the lows of 68.42 and closed around 1.12% lower. Interestingly the forward premia for 1-year is anchored around 4% for the last 2-3 months.
The April Consumer Price Inflation (CPI) of 4.58% was about 30bps higher than the previous month, but has been under some pressure given the rising oil prices and the threat of higher food inflation given the plan to increase the Minimum Support Price (MSP) to a level of cost plus 50%. The GDP growth data of March ‘18 quarter of 7.7% real growth has been heartening but has failed to discourage the selling spree by foreign portfolio investors (FPIs) in the debt market. The FPIs have sold almost Rs 15,000 crore in April’18 and about Rs 17,000 crore in May ‘18. While the prediction and onset of a normal monsoon has brought in some cheer to the market, the same is yet to reflect in the demand for bonds.
The market, presently, is reeling under the upside risks to inflation and a potential second round of rate hike by the RBI. However, the hardening bond yields have already priced in much of the potential rate hike by the RBI and we expect the bond yields to eventually tread lower as the upside risks to inflation gradually subside.
In the given market conditions, we urge investors to be cautious and pick fund duration aligned to their investment horizons. We do not expect any rate reductions soon but we do hold on to our stance for a need for tighter real rates and endorse efficient allocation of capital and savings/ investment. The market, in due course, is expected to move in sync with the Monetary Policy Committee (MPC’s) rate decision, which is taking cognizance of developing inflation and the economic growth dynamics.
Last Updated: 15th June 2018
Next Update On: 15th July 2018
Update Frequency: Once Every Month
