Market Update
Macro Economic Review
April saw consolidation post the meaningful moves seen in equities and fixed income markets for March. Sensex was up 0.93%, 10 year government bonds yields were up 5 bps and INR weakened 0.6% against USD. The market moves were largely symptomatic of the Foreign Portfolio Investor (FPI) flows – with $1.6bn in equity FPI inflows and $2.1bn of debt FPI outflows. General election’s kicked-off during the month with roughly 65% of the seats under considerations seeing voting done. Preliminary reports indicate circa 55-60% voter turn-out, broadly similar to 2014 general elections.
One of the key events of April was RBI’s monetary policy committee (MPC) meeting on 4th April in which MPC decided to cut repo rates by 25 bps to 6%. Monetary stance was left unchanged to neutral and in its commentary, RBI highlighted some upside risks to inflation from weaker monsoon, higher fuel prices and higher fiscal deficit. This resulted in the 10 year bonds selling off 7-8 bps since the market was positioned for more dovish stance from RBI, which did not come forth. The Treasury department also released 2019-2020 borrowing calendar, which was higher than expected and was front loaded. Combination of these things steepened the curve with 10 year rates selling off. Liquidity remained tight throughout the month. To help reduce the liquidity tightness, RBI conducted $5bn of 3 year FX swap, which saw strong bids worth $16 bn. Towards the end of the month, RBI also announced INR 25,000 crores worth of Open Market Operations (OMOs) to be conducted in May. This somewhat helped to improve systemic liquidity and 10 year yields rallied a subdued 4-5 bps.
March inflation figures saw the headline Consumer Price Index (CPI) increase to 2.86% from 2.6% in February. However, this number was broadly in line with consensus expectations for an increase to 2.9%. Core inflation softened a touch to 5% vs 5.3% in the previous month. Brent crude oil jumped up to $75 on intra-day as US waivers given to certain countries for buying Iranian oil ended and that raised supply concerns. Oil finally stabilized around $72 for end of April, up 6.5% for April.
Industrial Production figures for February came in at very low 0.1% vs 1.4% in previous month. Vehicle sales figures for April were also poor with across the board decline in commercial and passenger vehicle sales for the month. April composite Purchasing Manager’s Index (PMI) dropped to 51.7 from 52.7. All these figures are pointing towards further slow-down in GDP growth for Q1 and potentially Q2.
Trade figures for March showed that trade deficit widened on back of higher Oil and Gold imports. Exports showed a healthy rise and helped to limit the trade deficit. FY19 current account deficit came in at 2.2% of GDP.
March month GST collections were strong and came in at INR 1.13 lakh crore. However, the average monthly run-rate of INR 93,000 crores for FY 2019 was below the required rate of 110,000 crores to meet fiscal deficit target. Monthly average for FY 2020 is budgeted at 125,000 crores for meeting fiscal deficit target.
On the global front, US stock markets rose to all-time highs following robust corporate earnings and a dovish FED. US 10 year yields increased 10 bps in April to 2.5% as fears of US slow-down recede. China aggregate financing increased by $430bn in March taking YTD figure to $1.2 trillion or 43% of last year’s total. This is one of the key reasons markets have positively reassessed risks of global slow-down and preliminary global PMI numbers are showing green shoots.
Overall, April has seen a moderation in growth with inflation still below 3%. Forward looking indicators are pointing to slowing down of growth momentum. Higher oil prices may start to put pressure on the current account deficit. System liquidity remains tight but is expected to improve post elections as government spends its built-up cash balances. Global slow-down fears have receded in post robust earnings growth in US and stimulus in China. However, the key focus will be on the upcoming general elections’ results on 23rd May.
Equity Market
Indian markets (Sensex +1%) had a volatile month as Lok Sabha elections, crude and global geopolitical developments weighed on investor sentiment. On the global front, turmoil in Venezuela, coupled with US announcing an end to waivers on Iranian oil imports lead to crude oil spiking up during the month amidst supply concerns. US-Sino trade talks made some progress in the latest round of negotiations between the 2 countries while on the Brexit news-flow, EU extended the deadline for UK’s departure until 31 Oct from 29 Mar. On the domestic front, Lok Sabha (LS) elections took centre stage as 4 of 7 polling phases were completed in the month, with mixed trends in voter turnouts being seen across states. INR saw some pressure in the month, hitting 70/$ as well as global macro developments were in focus. RBI’s policy review kept its stance unchanged while cutting down rates by another 25bps. India Meteorological Department (IMD) came out with its annual monsoon forecast of a near-normal monsoon, which was starkly different from Skymet’s forecast of a 55% probability of below normal monsoons. In terms of Economic indicators, barring consumer credit growth, most other indicators like auto sales, consumer durable production and air passenger growth continue to weaken sharply. The markets will continue to take cues from the remainder of Q4 earnings and 17th LS election results besides developments around US-China trade discussions.
In terms of sector level performances, the best performing sectors were BSE Infotech (+6.4%), BSE Teck (+4.7%), BSE Metals (+1.4%) while the sectors which were major laggards were BSE Realty (-3.3%), BSE Power (-3.2%), BSE Capital goods (-2.4%) and BSE Bankex (-2.4%). Positive FII interest in India persisted though with inflows moderating significantly, while domestic investors continued to remain sellers in markets. Capital market activity in April was lack-lustre as election uncertainty weighed down on primary markets.
Even as global markets are reflecting anxiety on US growth prospects, our in-house view remains Market Update that of steady expansion with low inflation leading to lesser market volatility than in 2018. Since the last few months, we have been constructive on the Indian equity market from an opportunity standpoint; particularly in the mid and small cap segment given meaningful valuation corrections in several good quality businesses. Recent run-up of market since start of the calendar year and re-emergence of event risks associated with crude oil, nearing of India election result and US-China trade would weigh on markets hereon. We would like to advise clients to recalibrate their near term or short-term return expectations post the recent rally across market cap as valuations have now turned fair from attractive earlier.
Our positive outlook is based on improving macro factors - controlled inflation, stable commodity prices and currency, improving asset quality and credit growth cycle and likely moderation of interest rates. We think the modest improvement seen in corporate earnings last quarter have now got the necessary conditions and building blocks to gather strength in coming quarters, which may be further aided by better consumer sentiment post the election event. We do not rule out time corrections to the market post recent rally but also advise against excessive pessimism given earnings cycle once it improves this year, can well extend into the next couple of years.
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
The month of April’19 has been negative for the rates market. While there was a 25bps repo rate reduction in early April, the bond prices fell since the liquidity position within the banking system remained in deficit. With this second 25bps repo rate reduction the cumulative rate reduction from Feb’19 onwards is 50bps. In the Feb’19 policy, the monetary policy stance has also been changed to neutral from calibrated tightening. RBI also attempted to infuse liquidity through one more 3 year USD INR swap of $ 5 bn (approx. Rs. 35,000 crore) in April’19 but it was not sufficient enough to turn the liquidity within the banking system into surplus.
The FPI inflows with regard to debt investments turned negative with outflows to the tune of INR 15,000 crs in April’19 after being Rs. 14,000 crs positive in March’19. While equity overseas flows were positive in April’19, the combined net flows were negative for the month of April. Hence, the overall liquidity position remained deficit despite successive dollar swaps and Open Market Operations (OMO) g-sec purchases by RBI.
The fears of an excessive borrowing calendar over FY20 and the uncertainty around attaining fiscal targets amidst a general election has weighed on the market sentiment.
Seasonally in the month of April the market is flushed with liquidity since government starts to spend heavily in the first month of the new fiscal, however, this year April we still observe some surplus cash left in the government balances with RBI, and hence the market has remained in deficit.
This negative liquidity position along with a perceived ‘not so dovish’ monetary policy has pushed the bond yields higher over the month of April by 30-50 bps.
So far, the bond yields have not moved in line with the monetary policy actions. Hence the drop in bond yields can be significantly large (close to 40-50 bps) in an event of liquidity infusion if it is sufficient enough to maintain adequate to surplus liquidity levels within the banking system. While another round of repo rate reduction is expected, but the timing of that might be some time in the future as the market awaits the effects of the risks highlighted in the last policy document.
The sudden change in the Fed stance on rate hikes and the subsequent softening in the bond yields in US and Europe have obviously tilted the balance in favour of emerging markets (Ems). While the expected weakening of USD post slowdown in US, and the confusion around Brexit has not pulled down the crude oil prices yet, it remains largely a fundamental possibility over 2019. The possibility of continuation of output reductions by OPEC nations has kept the oil prices elevated but still around 20% lower than the peak of 2018.
Outlook
We think real GDP growth is slowing down on back of slower global growth and slowing domestic consumption. On inflation front, we think headline CPI for CY20 should be comfortably well within 4%. Thus, with growth slowing and real interest rates high, RBI will likely cut rates so as to push through lower rates into the economy. However, drop in repo rate do not guarantee lower borrowing cost and hence we feel RBI will may take actions to infuse liquidity (as and when there is consensus and comfort around the trajectory of CPI data) so as to help lower the deposit rates of the banks enabling them to price their loans cheaper.
Additionally, certain public sector banks, which were under prompt corrective action (PCA framework) have now been remediated and should be able to lend thereby improving availability of credit. The growth of broad money is being keen watched so as to access the effects of incremental credit growth and money supply.
We also think FPI flows into Indian debt to pick up after the general election results if there is a positive outcome on political stability. Thus, we think the path is set for yields and credit spreads to compress, albeit with bouts of volatility. In the given market conditions, we urge investors to start selecting funds in alignment with their investment horizon and selectively longer, depending on their individual risk appetite. Hence some additional duration over the investment horizon should work in favour as the risk return matrix is tilted in favour of lower rates. The risks to this view emanate from higher government borrowing calendar of FY20. However, it may get neutralized through creation of demand for gilts and bonds by infusing liquidity into the system by RBI.
Last Updated: 15th April 2019
Next Update On: 15th May 2019
Update Frequency: Once Every Month
