Equity Market Review

IIndian markets traded with a negative bias in August due to rising border tensions with China, weak quarterly earnings which resulted in downward earnings revision and notable FII outflows. Nifty and Sensex ended the month lower with (-1.6%) and (-2.4%) losses.
Global markets were volatile amid concerns over the nuclear threat issued by North Korea. Worldwide, Hang Seng was top performer with (+2.4%), followed by FTSE which was up (+0.3%). Dow Jones ended the month with (+0.3%) gains and Euro Stoxx ended with (-0.8%) losses. Nikkei was worst performer with (-1.4%).
MSCI Emerging markets outperformed, Indian domestic markets with (+2%) gains. MSCI ACWI Index ended with (+0.2%) gains. BSE Mid cap and Small cap index both outperformed its larger peers. BSE Mid cap ended with (+1%) gains and BSE Small cap closed with (-0.6%) losses.

Sector Performance

Majority of sectors traded with a negative bias. Oil & gas was top performer with (+7%) gains. Metals (+6.9%), Consumer Staples (+0.8%) and Real Estate (+2.2%) outperformed Nifty. Power (-2.7%), Auto (-3.2%), Banking (-3.3%), Capital Goods (-3.6%) and Information Technology (-3.6%) underperformed Nifty. Healthcare with (-7.4%) was worst performing sector in August.

Institutional Activity

After three months of net inflows, FIIs reversed their position to net sellers with outflows of $2.5 Bn over the month. Nonetheless, year to date, FIIs remain positive with $6.4 Bn inflows. Domestic investors with robust net inflows of $2.5Bn in August helped offset the FII outflows taking the YTD tally to $6.5Bn. Mutual Funds continued to remain buyers to the tune of $2.7 Bn. Insurance companies remained sellers to the tune of $239 Mn.

Macro Economic Developments

Transition to Goods & Sales Tax (GST) weighed on IIP in month of June as it contracted by 0.1% vs 1.7% growth in May. Manufacturing output contracted by 0.4% vs 1.2% growth in previous month as Capital goods continued to contract to -6.8%. Muted growth witnessed in Mining at 0.4% vs 0.9% in May and Electricity generation was also muted at 2.1% vs 8.7%. Muted consumption demand resulted in Q1 GDP growth of 5.7%. July CPI rose to 2.4% vs 1.5% in previous month led by tomato price shock. Core CPI inflation (ex food and fuel) at 4% was almost unchanged compared to previous month. In the month of July, WPI also inched up to 1.99% vs 0.9% in tandem with CPI led by food inflation. Trade deficit in July dipped further to $11.45 Bn vs $12.9 Bn in June led by slight dip in imports. Imports were up by 15.4% led by gold and crude. Exports dropped as pharma, jewellery and apparel were laggards. The Indian Metrological Department stated that rainfall is currently at 96% of Long Period Average in-line with earlier forecast of normal monsoon. Although the rains were at lower end of the range, heavy rainfall in last week of August is likely to improve the metrics. Monsoon session of Parliament which concluded on August 11 witnessed passage of 14 bills by Lok Sabha and 9 bills by Rajya Sabha. Crucial bills passed by both houses included Banking Regulation Amendment Bill and Integration of Kashmir under GST. RBI cut repo rate by 25 bps in August policy meet was in line with expectations. RBI hinted at market linked lending rates probably along the lines of LIBOR, which if implemented could put pressure on margins of bank.

Outlook

Result season for Q1FY18 was muted due to weak underlying condition in sectors such as Banking, Information Technology and Healthcare. Disruption in domestic sales of Consumer staples, Automobiles and other distributor driven business before implementation of GST also hurt quarterly numbers. Q1FY18 net profits for Nifty-50 companies declined by 8.4% YoY. Corporate commentary has been strong about pick-up as trade re-stocks going into festive season. If monsoon continues to maintain its momentum across India, it makes a case for recovery in rural consumption. Although disruptive changes have impacted growth in last few quarters, we believe structural reforms have laid a solid foundation for long term improvement in economic growth and corporate profitability. Indian’s equity holding at 3.8% is small compared to other assets classes but its proportion is rising. Flows into domestic mutual funds remain strong and have been a critical support to the market when FII flows have weakened. On the valuation front, things do look frothy unless supported by earnings revival in H2FY18. Geopolitical tension can spark volatility in near term, but such instances should be used to increase allocation to Indian equites from medium to long term prospective as we continue to remain invested in companies which will participate profitably.

Debt Market Review

Indian government bonds ended lower over the month, amid rising inflationary risks. Earlier in the month, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) lowered the repo rate by 25 bps to 6.0%. It reiterated neutral stance and remained cautious on inflation outlook. Weaker than expected GDP data and weak quarterly earnings weighed on investor sentiment.
Fixed income assets gained over the month in light of risk aversion. Globally, equity markets were weighed down by geopolitical tensions pertaining to nuclear tests done by North Korea. In the US, Investors focused on the debt ceiling debate after President Donald Trump suggested that he may shut down the Government if Congress did not approve funding for his wall on the Mexican border. The debt ceiling must be extended by September 29. Crude oil prices eased 2% over the month.

Outlook

The 10 year g-sec benchmark continued to trade in a range of 6.40-6.55% through the month of August, with a slight upward bias – closing the month at 6.52%. Higher than expected CPI at 2.36% vs 1.54% previous month, and market expectations of 2.05% led to markets not being sure whether there would be any further rate cuts left in this easing cycle. While bulk of the increase came from vegetables (especially tomatoes), core inflation also rose marginally on a yoy basis. The HRA impact is yet to be seen in the CPI data, which is expected to start showing up from next month onwards. The CPI for August (to be released on Sep 12) is again expected to be on the higher side, with onion prices now being the culprit, apart from impact of the centre’s HRA implementation and the GST impact on some of the services component. A reading of above 3% could lead to further erosion of market confidence on further easing by the RBI.
The Rupee had a strong run in the first week of August, breaching 64 and moving all the way down to 63.58 leading to increased worries around rupee overvaluation and consequent negative impact on exports. However, reversal of FPI flows in equity market, moderation on the debt side due to lack of free limits and increased risk-off appetite globally, led the currency back to above 64 levels. For the month, FPIs invested Rs. 12,700cr in debt, while sold almost an equivalent amount from the equity market.
Growth indicators continue to be anemic, with almost all fast indicators (IIP, PMI, credit growth trends) indicating downside risks to GDP estimates for the quarter and the year as a whole. At the August 2 MPC meeting, RBI delivered a 25bps rate cut (repo rate came down to 6.0%), while maintaining a neutral stance. Given that the headline CPI inflation is expected to rise from the recent lows, the central bank decided to remain cautious and data dependent. Headline CPI inflation was projected to rise a little above 4% by March 2018. The statement reflected cautiousness about the future inflation outlook, especially given the uncertainty about the impact of HRA allowances, GST related deferred price adjustments and the mean reversion recorded in vegetables and some other food items from July. The medium-term risks to inflation arise from potential fiscal spillovers as a consequence of implementation of farm loan waivers, and a possible increase in HRA allowances by states in the period ahead, which, as per RBI’s estimate, could push headline inflation by an additional 100bps above the baseline estimate over 18-24 months. RBI’s bias continues to be relatively hawkish (vs market expectations), when it comes to forming a view about the medium-term inflation outlook.
While the global situation (given geo-political risks around North Korea and the ineffectiveness of Trump administration in passing key legislation) is fluid and needs constant monitoring for their eventual impact on our markets, we believe that RBI – assuming that their current framework does not undergo a surprise change - is more likely to maintain status quo on rates especially if inflation trends higher towards the 3-4% over the next few months. Having indicated their comfort with real rates of 1.5-2% during the post policy call, current policy rates are then consistent with a medium term inflation projection of 4-4.5%, and don’t necessarily call for further easing, notwithstanding any growth disappointment.
Abundant liquidity and lack of deployment avenues for banks are likely to offer a positive backdrop to bond yields, which combined with robust inflows into mutual funds, should continue to support spread compression across various segments.
With a stable to positive monetary policy bias over the coming quarters along with abundant liquidity, yields at the short end are still at attractive levels, hence ultra short (L&T Ultra Short Term Fund) and short / medium term funds (L&T Short Term Opportunities, L&T Banking and PSU Debt Fund, L&T Triple Ace Bond Fund), which invest in this segment - can provide good carry over liquid funds. Yield oriented funds in the ultrashort segment (L&T Floating Rate Fund), and short term segment (L&T Short Term Income Fund) are also well placed to provide good risk adjusted carry for investors over the coming year.

Market performance

The 10-year benchmark G-sec yield closed at 6.53%, up by 6 bps from its previous close of 6.47% while that on the short-term 1-year bond ended 15 bps lower at 6.14%. In the corporate bond segment, yields fell across the yield curve over the month. The 10-year AAA bond yield ended unchanged at 7.46%, while the short-term 1-year AAA bond yield ended 14 bps lower at 6.76 %. The spread between 1-year and 10-year AAA bond narrowed. Within the short term segment, the yield on 3-month certificate of deposit (CD) fell 11 bps to 6.15%, while that on the 1-year CD was down 5 bps at 6.48%. Meanwhile, yield on 3-month commercial paper (CP) was down 3 bps to 6.57% while 1-year CP yield was unchanged at 6.94%.

Macroeconomic developments

Inflation: Annual WPI inflation rose to 1.9% in July, up from 0.9% in June, due to gains in food and commodity prices. Meanwhile, CPI inflation rose by 2.4% in July, up from 1.5% in June, due to gains in food prices.
Industrial production: Industrial production fell into negative territory for the first time in four years, at -0.1% vs 2.8% in June. Manufacturing fell to -0.4% vs last month’s 2.6% gain.
Electricity moderated to 2.1% vs 8.3% and mining rose 0.4% vs 0.2% in May. Capital goods fell by 6.8%% as against the 1.4% fall in May while consumer durables declined 4.9% against 9.5% fall in the previous month.
Rupee: The Indian currency appreciated 0.4% over the month, and closed at Rs 63.90 per US Dollar.
Source: Bloomberg

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