Equity Market Review
Indian markets were volatile in the month of May as sentiment remained fragile led by Lok Sabha polling and results along with the ongoing trade war between US-China weighed down
markets. However, a strong mandate to the incumbent government cheered the markets. Nifty and Sensex ended with (+1.5%) and (+1.7%) returns, respectively.
Global equities witnessed a selloff on the back of weak macroeconomic data and trade disputes. The US-China trade tensions re-escalated in May, with trade negotiations breaking down and tariffs raised by both sides. All global indices ended on a negative note in May. Worldwide, FTSE100 was the top performer with (-3.5%), followed by Dow Jones (-6.7%), Euro Stoxx (-6.7%) and Nikkei (-7.4%) returns. Hang Seng was the worst performer with (-9.4%) returns.
MSCI Emerging market underperformed Indian domestic market with (-7.5%) returns. MSCI AWI Index ended with (-6.1%) returns. BSE Mid cap and BSE Small cap indices performed in line with its larger peers. BSE Mid cap and BSE Small cap indices ended with (+1.4%) and (+1.7%) returns, respectively.
Indian markets witnessed heightened volatility in May as equal number of sectors traded with positive and negative bias. Capital goods was top performing sector with (+10.6%) returns. Real Estate (+9.6%), Banking (+5.8%), Oil & Gas (+2.5%) and Power (+2.1%) outperformed Nifty. Consumer Staples (-2.1%), Auto (-2.1%), IT (-3%) and Metals (-6.6%) underperformed Nifty. Healthcare was the worst performing sector with (-7.4%) returns.
FII continued with its buying momentum in May with inflows of $1.2 bn, taking YTD total to $11 bn. Domestic investors turned buyers with inflows of $705 mn after three months of selling. Domestic mutual funds turned buyers with inflows of $735 mn after two months of selling. Insurance companies were sellers to the extent of $30 mn in month of May. YTD, DII outflows were at $1.7 bn. Mutual Funds are equity buyers at $305 mn while insurance funds were net equity sellers at $2 bn.
IIP for the month of March slowed to 21-month low as growth in industrial activity contracted by 0.1% on continued slowdown in manufacturing sector. In terms of industries 12 of 23 industry groups recorded contraction as capital goods production growth dipped 8.7% while both consumer durables (-5.1%) and non-durables (+0.3%) showed tepid performance. Consumer electronics was the only segment which witnessed strong growth of 10.6%. GDP growth for 4Q stood at 5.8% which was lower than street estimates, taking annual number for FY19 to 6.8% (vs 7.2% in FY18).
CPI for the month of April stabilized to 2.9% as weakness in core inflation was squared off by rising food prices. Core inflation was at 18 month low as economic activity remained subdued and food inflation rose by 6.6%. WPI inflation slipped to 3.1% on back of cheaper fuel prices and manufactured items. Trade deficit for the month of April widened to 5 month high of $15.3Bn on back of a sharp decline in export growth and rising oil import bill. Weaker exports resulted in non-oil trade deficit rising to 5 month high on back of weak global trade, while domestic slowdown also impacted imports.
India markets cheered the strong mandate to the incumbent BJP led NDA government. The market has high hopes of reforms from newly elected NDA government along with fiscal stimulus from RBI. Crude has a strong linkage to India’s macroeconomic position, hence, the softness in month of May (-16.4%) bodes well for the economy. Soft crude prices would keep CAD/BOP/currency and inflation under check. While earnings are set to recover in FY20 continuation of domestic economic slowdown could derail things. A full blown economic war between China and USA could worsen global economic conditions and sentiments.
Despite index valuations at a high, we believe that there are relevant opportunities available across various segments of the market. Investors with long-term horizon should continue to remain invested. Historically, within the equity universe, mid-cap and small cap have generated wealth over longer period, albeit with higher volatility. We expect earnings recovery in FY20 so stock picking will be more important in this challenging environment; hence we continue to remain invested with strong and able managements.
Debt Market Review
Indian sovereign bond ended 38 bps lower to 7.03% in May as decline in oil prices and expectations of a rate cut softened yields on government bonds. The yield has fallen the most since November 2016 helped by foreign inflows after Narendra Modi’s election win.
The central bank’s plan to infuse up to Rs 15,000 crore of liquidity into the system on June 13 through open market operations helped lift bond prices, driving yields lower.
US government debt yields slid to new multi-month lows after President Donald Trump’s new tariff threats on all Mexican imports took investors by surprise and aggravated an alreadystressed US trade outlook. The US 10-year Treasury yield hit a 20-month low at 2.17%, while the 2-year treasury yields fell to their lowest since February 2018 at 2.007%.
The 10-year benchmark G-Sec yield closed at 7.03%, down by 38 bps from its previous close of 7.41% while that on the short-term 1-year bond ended 30 bps lower at 6.30%.
In the corporate bond segment, yields fell across the yield curve over the month. The 10-year AAA bond yield ended 40 bps lower at 8.00%, while the short-term 1-year AAA bond yield ended 70 bps down at 7.30%.
The spread between 1-year and 10-year AAA bond widened. Within the short term segment, yield on 3-month commercial paper (CP) was down 100 bps to 6.70% while 1-year CP yield was down 90 bps at 7.60%.
India’s economic growth fell to 5.8% in the January-March period of 2018-19, the lowest in 20 quarters, due to a sharp slowdown in investment and manufacturing growth as well as a contraction in agricultural production. This pulled down the GDP expansion to 6.8% in FY19.
Nikkei India Services Purchasing Managers’ Index (PMI) dropped to 51 in April from 52 in March. The Nikkei India Manufacturing PMI declined to 51.7 vs 52.7 in March. Retail inflation touched a six-month high in April to 2.92% vs 2.86% in March on high food prices. WPI-based inflation was pegged at 3.07% in April vs 3.18% in March on cheaper fuel and manufactured items.
Growth of eight core sectors slowed to 2.6% in April. Exports stood at $26.07 billion in April, managing an overall positive growth rate due to high realisations from petroleum receipts. Import growth reached a five-month high, registering 4.4% growth.
Pre policy, the 10-year benchmark was trading at around 7.00% with most market participants expecting a 25 bps rate cut. However, the market was divided on the stance change; in fact the majority of the market was expecting a 'neutral' stance. So the 25 bps rate cut along with an accommodative stance came as a positive surprise. Further, that the decision was a unanimous 6-0 vote also triggered rally in the bond markets with 10 Gilts trading around 6.90%. 5-year gilts also traded better from 6.85% to 6.75%. Yields on Corporate bonds in the 5 year and 10 year were also lower by 5-10 bps.
With an accommodative stance, there can either be a rate cut or a status quo in the next policy. With this rate cut of 25 bps, the MPC since December 2018 has cut repo rate by 75 bps from 6.50% to 5.75% and changed the stance from 'calibrated tightening' to neutral to 'accommodative'.
We think that the next policy will be guided by more clarity on inflation trajectory especially with the factors like food prices movements, June and July rainfall across the country, crude price movement, some certainty on trade issues between US and China and core inflation prints. The RBI would focus on transmission or the cumulative 75 bps rate cuts and also debate on the space which the MPC has to lower rates in order to maintain 4% headline CPI. 5.75% on the repo rate is the lowest repo rate since the formation of the MPC.
The 1-3 year AAA corporate bond curve (PSU) ahead of the policy has already priced in a 25 bps rate cut and had rallied to 7%-7.30%. With repo rate at 5.75%, the 1-3 year AAA corporate bond segment still offers good carry over the repo rate.
At the longer end of the curve, despite a positive fundamental outlook for interest rates, near term technical factors such as demand supply mismatch may keep longer end yields volatile and elevated. The corporate bond curve is very steep with the difference in yields between 10 year and 5 year paper of the same issuer is at 60 bps. Hence, from a medium term perspective, we believe the longer end of the AAA corporate bond curve is an attractive investment opportunity, with spreads over G-Secs in the 80-120 bps range versus the historical average of 50-60 bps.
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