Market Update
Macro Economic Review
India’s macro situation continues to remain largely stable but has seen pressure from external factors. The Monetary Policy Committee (MPC) kept key interest rates on hold but changed its stance from “Neutral” to “Calibrated Tightening” sighting lower CPI forecast on lower food inflation. However, the MPC members did express concerns to the inflation forecast arising out of higher oil prices and depreciating rupee. The recent readings from RBI suggests that inflation is the top priority for them and it may not defend the exchange rate through interest rates.
The trade deficit number for September 18 narrowed to US$14bn due to deceleration in both exports (-2.2% YoY from 19.3% Aug) & imports (10.5% from 25.4%) which was a relief, but lower deficit number needs further validation as September month tends to be lumpy based on festive season in India. We believe the government may have to undertake some expenditure level cuts to achieve its gross fiscal deficit target of 3.3% of GDP.
CPI inflation remained unchanged at 3.8, despite a surge in global oil prices & below normal monsoons as food inflation was lower at 1.1% which reflects that Minimum Support prices MSP passthrough has not affected yet, while core inflation (ex- transport) remained elevated at 5.7%.
The IIP data for Aug’18 witnessed some moderation from 6.6% in July to 4.3%. The mining sector production contracted by 0.4 per cent in August compared to a growth of 9.3 per cent in the yearago month. Similarly, the capital goods output growth decelerated to 5 per cent during the month from a 7.3 per cent expansion year ago.
The five crucial states of Madhya Pradesh, Chattisgarh, Rajasthan, Telangana and Mizoram are headed into elections starting mid-Nov with 83 Lok Sabha seats at stake. The outcome of these elections could have an impact of near term policy decision of Central Government.
Equity Market
Indian equities remained weak in October (-5%) due to continued worries around liquidity tightness in the credit markets, fear of defaults, rupee depreciation and a global risk-off. We also saw RBI maintaining a status quo on policy rates contrary to market expectations. On a positive note, India has jumped 23 places to 77th rank in the World Bank’s latest Ease of Doing Business 2019 report. Closer home, Supreme Court’s directive to CERC, paving the way for compensatory tariff hikes for loss making Ultra Mega Power Projects brought some relief to the power sector and its lenders.
In terms of stock performance, most sectors were in the red except for Capital Goods, Utilities and Bankex. BSE Oil & Gas (-10.8%), BSE Auto (-7.4%) were the major losers. On flows, FII selling almost tripled MoM while DII buying continued to pick up meaningfully during the month driven by MFs, while deal activity remained muted. Q2 earnings season has been a mixed bag so far, with broad based recovery in earnings not yet visible. Going forward, five states of MP, Chattisgarh, Rajasthan, Telangana and Mizoram are headed into elections starting mid-Nov (with 83 Lok Sabha seats at stake). Near-term, markets will try to derive cues from this along with developments surrounding liquidity/ refinancing conditions in the fixed income market besides the remainder of the earnings season.
Given the confluence of various global and local events (US mid-terms, India state elections, Brexit, progress on US-China trade talks and middle east geopolitics) and the continuing dilemma of growth vs emergent risks of inflation/interest rates, we expect equity markets to remain in a heightened state of volatility over the next 2-3 months. Incrementally, we do turn constructive on the market from an opportunity standpoint; particularly in the mid and small cap segment given steep valuation corrections in several good quality businesses.
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 do attract our attention.
Fixed Income Market
There have been some dramatic changes in the market position in October’18. The bond yields started to decline due to the following reasons (not in the order of rank):
- Drop in the international oil prices, led by the buildup of inventory and increased supply
- Sustained decline in headline inflation in India
- Stabilization of INR vs USD and EUR
- Monthly calendar of OMO announced by RBI for Oct and then for Nov.
- Contraction in trade deficit
All these above factors led to rise in bond prices, and the 10 year benchmark yield came off from an intra-day high of 8.22% in Oct to closer to 7.80% by the end of the month.
The bond market had started to price in series of additional rate hikes, as the oil prices were climbing and worsened by sharp depreciation in INR. All these led to the belief that RBI MPC (Monetary Policy Committee) members will continue the rate hikes into this quarter. However, the headline inflation data moved lower over the last 2 months despite the rise in oil prices due to sharp drop in the food price inflation component. The CPI was under 4% for the last two months (3.69% and 3.77%), much lower than the forecast. This inflation trend prompted the RBI MPC members to refrain from a rate hike in early Oct, which was till then widely priced in. However, they changed the stance of the policy from neutral to ‘calibrated tightening’ (which was later explained by Urjit Patel as meaning ‘rate reductions were off the table’)
In its last monetary policy review, RBI revised down the March’19 CPI forecast from 4.8% to 4.5%. The follow-through drop in oil prices has started to change the market expectation of a rate hike now since it appears RBI will not be required to hike rates, since inflation is going to remain contained with drop in food price component and now with further drop in oil prices. It has not started to appear that rate hike possibility till March’19 is now a distant possibility. Hence the market is experiencing some relief rally.
The OMO of Rs. 36,000 crore in Oct. and announcement of Rs. 40,000 crore OMO for Nov’18 has improved the market sentiment. The net effect is that total demand is outstripping supply.
The money market at the shorter end is under huge liquidity stress post the default of IL&FS and its group companies in Sept’18 and downgrade of its credit rating to D from AAA in a matter of weeks. Ever since the government had desired that RBI would infuse liquidity into the markets in a targeted manner for the NBFCs and HFCs. However, so far RBI has not relented and only infused liquidity through the OMO route by buying gilts. This has increased the liquidity in the hands of the banks. It is expected that the excess liquidity in the hands of the banks will get onward lent to the corporates including NBFCs and HFCs. However, in the absence of commensurate risk appetite, the flow of liquidity into the affected sector is ebbing, and the credit spreads have widened by over 100bps in the last couple of months.
The drop in oil prices and contraction in trade deficit to under $14bn in Sept’18 from $17.4 bn, previous month improved the sentiment on INR. This has possibly resulted in some net positive flows from foreign investors from the last week of Oct’18 after several months of net outflows.
In the given market conditions, we urge investors to be remain cautious and pick fund duration aligned to their investment horizons. While we do not expect any rate hikes in the next few months, we feel the change in stance to ‘calibrated tightening’ by RBI ties their hand while CPI remains benign. 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 MPC’s rate decision, which is expected to take cognizance of developing inflation and growth dynamics.
Last Updated: 15th October 2018
Next Update On: 15th November 2018
Update Frequency: Once Every Month
