We are pleased to bring you the next edition of Equity and Debt Market updates for the month of February’14. This will enable you to gain insights about the macroeconomic changes and indices and HDFCL investment strategy and fund positioning.
Markets- Indian equity markets reversed their previous month losses during the month of February. Market rally was broad based with mid and small cap stocks outperforming the large cap stocks. FIIs were net buyers to the tune of Rs26bn while mutual funds were net sellers to the tune of Rs.13bn. Sectors that outperformed during the month were capital goods, auto, pharma, banks and IT. Sectors that underperformed were metals, auto, real estate, FMCG, oil & gas and power.
India’s trade deficit was USD9.9bn in January, almost flat versus USD10.1bn in December 2013. The gains were driven by muted gold imports and continuing slowdown of both Oil and non-oil imports.
India’s industrial production (IP) surprised positively at -0.6% y-o-y in December 2013, improving from -2.1% y-o-y in November. The surprise was due to a lower decline in Consumers goods to 5.3% y-o-y in December versus a decline of 8.8% in November.
CPI inflation dropped to 8.79% y-o-y in January from 9.87% in December. Food inflation dropped sharply to 9.87% y-o-y in January from 11.97% from December as vegetable and fruit prices corrected.
WPI inflation declined to 5.05% in January from 6.16% in December, lead by sharp drop in food article inflation from 10.78% to 6.84%.
India’s fiscal deficit during the first ten months of FY14 (Apr-Jan.), was Rs 5.32 trillion, which is 101.6% of the full-year target revised estimates.
GDP for 3Q FY14 released by the government shows country grew by only 4.7% in the quarter lower than estimates of a growth of 4.9%.
Fund Positioning -
Overweight Sectors-Banks, Cement, Pharma, Telecom, Capital Goods
Underweight Sectors-Auto, FMCG, IT, NBFCs, Power, Realty
We have reduced weights on autos, banks, metals, FMCG, and added IT and Pharma sector during the month.
During the month of February, the growth series of fund outperformed the benchmark by 20pbs while Bluechip fund outperformed the benchmark by 50bps. The opportunities fund outperformed the benchmark by 5bps. Given the sharp underperformance till July 2013 and deterioration in the macro outlook, we had decided to de-risk the portfolio in July’13 by aligning the portfolio closer to the benchmark and increasing weight on the defensive sectors. However, in last 5 months the market has been on a upturn and we are seeing interest coming back in the cyclical and midcap names on hopes of economic recovery. In last 2 quarters, the results of large companies have been better than market expectations. Also initial signs of cyclical recovery are visible on ground.
Therefore we modified our strategy and while we continue to increase weights on defensives, we do not plan to go significantly underweight on cyclical sectors. We will remain valuation focused and maintain exposure to select cyclical stocks, where we believe the valuations are attractive and risk-reward is favorable from medium term perspective. The strategy has been paying off and the underperformance has been arrested and the Opportunities Fund and Growth series of funds have actually started outperforming the benchmark in the last 6 months.
Inflation has been coming off and situation on external trade and currency front has been better. In fact the INR has been amongst the best performing currency in the emerging markets. Also the steps by government in clearing stuck projects are bearing fruit and we are seeing some early signs of pickup in the execution of these projects.
We believe that inflation should start coming off gradually to lower levels in coming months, which should bode well for the 2014 calendar year. Also since general election is expected in April/May, we expect election outcome to decide the future course of the market in the medium term. Also global monetary policy in terms of rolling back stimulus will be key for the global liquidity and could be the key event to watch out for the direction of FII flows in the markets. We expect the market volatility to increase as we approach the elections.
The market valuations are attractive at about 13.5x FY15 estimated earnings for SENSEX, which are building in about 18% earnings growth in FY15.
Debt Market Update
Previous Month – The bond market movements in February were relatively muted and secondary market volumes were on the lower side. The first half of the month saw some major positive developments on the economic side. Firstly both the inflation gauges saw a sharp fall in the headline readings, due to a sharper than expected fall in food prices. The headline inflation readings have come back close to the levels prevailing prior to the spike in food prices. Secondly, the fiscal deficit numbers also pleasantly surprised the markets. The deficit for the current year was scaled lower to 4.6% of GDP from the Budget estimates of 4.8% of GDP. Moreover, the Interim budget for the next year, too, projected a lower than anticipated deficit at 4.1% of GDP. But the markets largely shrugged off the positive developments and traded in a narrow range. The months of January and February also saw huge (approx USD 6 bn) FII investments in the debt markets. However, the investments were concentrated at the short end of the curve only, and FII investment limits in T-Bills and CPs were fully utilized. The 10-year benchmark Government security ended the month at 8.86%, slightly higher than the 8.78% levels at the end of last month
(as on 28-Feb-2014)
Over the last one month, the returns of the bond funds have been affected due to the credit spread widening (driven by the liquidity tightness) at the short end of the yield curve. Hence the Income fund that had maintained a larger allocation to the shorter end of the curve has seen a slight under-performance during the month. We expect that the short end of the curve will recover once the current fear of liquidity tightness plays out towards the end of March.
Market Outlook – The key to the direction of the bond markets are the developments on the inflation front and the developments on the Government’s finances. Inflation control has become the primary agenda of the RBI’s Monetary policy. RBI is unlikely to be swayed by the current trend of easing headline numbers led by fall in food prices. Food prices have proved to be quite volatile in the past and RBI is probably watching the developments on the core inflation portion more closely. Core inflation has been very stable at elevated levels in the past few months, and there are no early signs of any significant reversals on this front. Hence, there are no expectations of any rate cuts from RBI in the near future.
In the absence of any rate cut expectations, the bond markets are likely to be guided by the developments on the Government’s finances and consequently, its borrowing requirements. Even though the Government did project a lower than expected fiscal deficit for the next year, these numbers are likely to undergo a revision, most probably on the higher side, once the new Government presents its budget for the year. Hence, the markets were not really impressed with the lower deficit projection in the Interim budget. This uncertainty is likely to keep the markets cautious in the coming months. As the next year’s borrowing gets underway from April, we may see renewed pressure on bond yields from the incessant supply.
The short end of the yield curve is likely to see some relief as the liquidity tightness eases from April. The key reason, apart from seasonal factors, for the tightness has been the increase in the Government’s cash balances, as spending has been compressed to meet the fiscal deficit targets. Once the Government starts spending its cash hoard, system liquidity will improve.
Strategy- The current levels of bond yields are pricing in some concern regarding the probable level of fiscal defcit for the next year. This concern is likely to be a large overhang on the markets in the coming months. Hence, the portfolio positions at the longer end of the curve are being trimmed, in anticipation of better levels for building the positions afresh. However, with the absolute yield levels being quite elevated, the scope for a further large rise in yields is limited. Any rise in yields would be a good opportunity to increase investments at the longer end of the curve.
However, the short end of the curve provides an opportunity to add positions at elevated yield levels with the expectation that these yields could ease once the outlook on the liquidity front sees some improvement.
However, one key factor that has not been priced in by the markets is the behavior of the FII investors. Over the last two months, the short end of the curve has seen a large inflow of investments from FII accounts. These flows have picked up, ostensibly, to benefit from the attractive yields available. The stability of the currency has been a key factor in boosting their confidence in investing in India. If FII investments pick up at the longer end of the curve, we can see a fall in yields from the current levels, notwithstanding any concerns on the probable fiscal deficit levels.
Mr. Gajri joined HDFC Standard Life in April 2009 with a rich experience of 14 years in investments and banking industry. He started his career in 1995 with Citibank and was associated with it for over 6 years delivering various roles. He joined Tata AIG Life Insurance Company in October 2001 to start the investment function and stayed there until April 2009, the last role being that of the Chief Investment Officer.View Complete Profile
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