Market Update
Macro Economic Review
The upward trajectory in consumer price index (CPI) continued in June ‘18 with inflation touching a high of 5% from 4.28% in Mar ’18, prompting RBI to once again raise the repo rate by 25 bps to 6.5% - its second consecutive hike this fiscal. The RBI, apparently, took note of the glaring macro concerns that can have critical bearing on inflation, namely, uncertainty in global financial market - especially escalating trade tensions, persistent volatility in crude oil prices, uptick in household’s inflation expectations and uneven (regional) distribution of monsoon thus far. The rise in CPI last month was led by sharp increase in core inflation that rose to a 4-year high to 6.45%. The wholesale price index (WPI) also rose to a multi-year high of 5.77%, largely led by laggard impact in passing down the higher crude oil prices, an uptick in cotton prices and in electricity tariffs, as well as higher inflation in manufactured products.
The recently concluded 4th round of Goods & Services Tax (GST) rationalization saw the GST council reduce tax rates on 88 items, which is expected to somewhat ease the inflationary pressures in due course. However, reduction of tax rates could also have a bearing on government’s tax revenues and can weigh on government’s road map for fiscal consolidation going forward.
The Index of Industrial Production (IIP) for the month May ’18 registered a growth of 3.2% year on year (y-o-y), which was subdued when compared with 4.8% y-o-y growth clocked in April ’18, largely due to weakness in the manufacturing sector (2.8% vs. 5.3% last month) despite the mining (5.7% vs. 4% last month) and electricity (4.2% vs. 2%) sectors registering growth. However, the overall economic activity, in the month of June ’18, remained stable, as reflected by key lead indicators. Auto sales, aided by GST, remained strong with 42% y-o-y growth in commercial vehicles, 22% y-o-y growth in two-wheelers and 38% in passenger vehicles. Cement production too improved at 13.2% y-o-y vs. 5.2% y-o-y in May ’18 while port traffic growth improved to 7% y-o-y in Jun ’18 vs. 3% in the previous month. Besides, at the aggregate level, capacity utilization in manufacturing sector, based on the latest RBI survey, also improved marginally to 75.2% in Q4FY’18 from 74.1% in Q3 FY ’18.
Trade deficit in the month of June ‘18 widened to $16.6 billion despite a strong 17.6 % growth in exports, as imports were driven up by a strong rise in oil imports, highest since Sep 2014 at US$ 12.7billion and offsetting any benefit from US$ 1billion worth of lower gold imports. Going forward, we expect consumption-centric imports to rise in FY19, as higher government spending will boost household spending. Escalation in global trade protectionism and rising commodity prices also pose upside risks to India’s trade deficit, not only to the Current Account Deficit (CAD) but also on the weakening currency.
Despite a high commodity price scenario and its impact on inflation and GDP posing threat, the headline growth numbers continue to hold steady. In fact, a good monsoon and buoyancy in rural economy aided by Minimum Support Price (MSP) increase could keep the economy running at a stable pace going ahead. Meanwhile, with rise in the commodity prices steadily waning, any moderation in the commodity prices could positively catalyze the already steady economic growth.
Equity Market
An encouraging beginning to the earnings’ season helped boost market sentiments last month that saw Indian equities rise by ~6% over previous month. While midcaps and small caps trailed the large cap index, they did stage a recovery from their recent lows during the month. Besides recovery in the monsoon rains from its previous month’s deficiency also helped uplift the market mood somewhat during the month. The India Meteorological Department (IMD) has now reported that ~74% of country has received normal rainfall. However, there is still a deficiency of ~ 4%. Southern & central India have been witnessing good rains, but east & northeast have witnessed deficient rainfall. Going forward, we expect the market to take cues from the RBI’s stance on interest rates and remainder of Q1 FY19 earnings’ season.
On the macro front, MSP announcement early in the month followed by GST rationalisation for several items also helped lift consumer sentiment. However, the increase in loading limits for medium and heavy commercial vehicles (CVs) took the industry by surprise and runs the risk of potentially reducing the demand for new commercial vehicles in near term. Sector wise, BSE Oil & Gas (+10%), BSE FMCG (+7%) and Bankex (+6%) gained the most while BSE metals index (-3%) was the only index to close in red. As far as fund flows are concerned, domestic mutual funds remained buyers for the 7th straight month albeit with significant contraction in net inflows. FIIs too were net buyers albeit of low quantum.
Earnings season for 1QFY19 has trended well thus far, with about two-thirds of the universe, that have reported earnings till date, showing revenue and operating earnings growth of ~20% each this quarter. Strengthening earnings’ recovery will likely remain a key to markets sustaining current valuations and overcoming likely resistance due to macro worries, emergent risks of inflation and interest rates and a busy political calendar.
In the given backdrop, 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. The recent sharp fall in mid and small cap stocks and as anticipated by us now for a while, has added to overall market volatility but has also expanded investment opportunities given steep valuation corrections. 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), in its recently concluded second bimonthly policy review, raised the repo rate once again by 25 bps to 6.5%. The two successive rate hikes from the MPC have been well received in the market, which was expecting the rate hikes and had already priced in the same in the bond prices. Since the actions of the MPC are generally guided by the economic data, the post policy reactions in the market were largely expected and the bond yields had accordingly started to move lower over the last couple of months.
The headline CPI inflation has remained contained under 5% and hereafter is expected to move lower towards 4% due to the supportive base of last year. This benign forecast on inflation has taken off some selling pressure from the market. The 10-year benchmark in fact has moved lower by about 25bps from the peak of 8% last seen in early June’18. With some moderation in the international oil prices and the apparently measured impact of the rise in the minimum support prices for agricultural commodities, the headline inflation is expected to remain contained in near future.
Notwithstanding escalating trade tensions, which is now an evolving risk for global economies, , domestic currency (INR) has started to show some stability after some initial bouts of volatility until about a couple of months back. The foreign investor flows into debt has also become positive in the month of July ‘18 after 5 months of net selling. Moreover, interventions in the currency market from the RBI continue to stay put in a bid to contain the volatility in the market. About 5% of the forex reserves have been used by RBI so far from April’18 to stem volatility.
Monsoon, this year, which took off well in time, has however eased somewhat thereafter and there is an overall deficit of 10% rainfall compared to the normal across country thus far. This may or may not put pressure on the agricultural prices depending on the intervention from the government.
The GST collections are marginally lower than the expected collections and may put some pressure on the fiscal targets, which will be known by the end of FY ‘19. Meanwhile the borrowing calendar for the next 6 months beginning Oct’18 is expected to be heavier than the first 6 months. This may or may not put pressure on the bond yields depending on the quantum of Open Market Operations (OMO) announced by the RBI to infuse the durable liquidity in the market.
The bond yields appear to have priced in ~ 50-75bps further rate hike after the initial 50bps rate hike.
In the absence of an immediate rate hike threat (maybe at least till the next 2-3 quarters) the bond yields may slowly move lower depending on the quantum of OMO announced by RBI.
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 expected to take cognizance of developing inflation and growth dynamics.
Last Updated: 15th August 2018
Next Update On: 15th September 2018
Update Frequency: Once Every Month
