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Market Outlook
 
Equity
 

The markets fell in the first week only to end the month much higher, with the BSE Sensex closing up 8.1% at 15670 and Nifty closing up 8% at 4636. Reflecting the increasing risk appetite of investors, Mid Caps out performed Large Caps, which in turn outperformed the less liquid Small Cap stocks. In terms of sectors the July rally was selective, with sectoral Indices like Auto, FMCG, IT, Metal and Realty outperforming the Sensex by huge margins, while Banks, Capital Goods, Health Care, Oil & Gas, Power and PSU Indices underperformed significantly. However, in this rally which began in March’09 and later picked speed from May ’09 in India, a number of sectors have participated which was not the case in the 2006-07 up move. For the month, in cash equities, FII’s were net buyers of USD 2.3 Billion (USD 823 million in June 09), while Mutual Funds were net buyers of USD 233 million- data till 30th July 09 (USD 163 million June 09). Global equities, especially emerging market equities have been seeing good in flows over the last month of which India has received a fair share.

The month of July 09 was full of activity with the presentation of the Railway Budget, Finance Budget and RBI’s quarterly monetary policy review. The Railway budget for FY10 laid out plans for major investments in rail infrastructure along with a number of new initiatives. The Union Budget presented for FY10 by the new government focused on infrastructure development, agriculture and putting money back in the hands of consumers. The budget gave a push to infrastructure investments in sectors like power, highways, gas transportation and urban infrastructure. Agriculture development through greater availability of credit and irrigation facilities was emphasized, while reforms are targeted at the fertilizer subsidy system to make it nutrient based and directed at the farmer. As expected inclusive growth was one of the main themes of the budget with the amount for National Rural Employment Guarantee Scheme (NREGS) being increased 144%, National Food Security Act being introduced to ensure availability of food for below poverty line families, Rural road and housing being given a fillip through Bharat Nirman, and other efforts targeted at weaker sections of the economy. In its financial proposals the budget is looking to achieve a higher fiscal deficit of 6.8%(compared to 2.5% FY08), at the time of a world economic slow down, with the purpose of pushing infrastructure investments, and putting money in the hands of consumers through removal of surcharges and raising of exemption limits. The revenue and capital receipts assumptions of the budget seem conservative and therefore there could be a surprise on the upside.

RBI in its quarterly monetary policy review kept the key rates (Repo rate-4.75%, Reverse Repo rate-3.25%, CRR-5%, SLR-24%) unchanged, while raising its forecast for inflation to 5% from 4% by the end of March 2010 (in face of possible higher food inflation). Taking a cautious stance the RBI has kept the GDP growth target at 6% for the current year. In terms of other economic trends, industrial production rose by 2.7% YoY in May from 1.4% in the previous month on the back of strong manufacturing activity. India’s trade deficit reduced to $6.2Bln from $9.1Bln in the same period last year with exports falling for the eighth month in a row by 28% and imports falling 29% in June.

Global flow of funds into riskier asset classes has been the main driver of a massive equity market rally across the world since beginning of March 09.The predominant part of the rally was the recovery in prices of most beaten down stocks (which have substantially re-rated since). We think at this point, the equity markets world- wide are pricing in a recovery in the US economy, hence revival of global economic growth. Therefore, from here on any further rally is likely to be based on earnings surprises/ upgrades from companies. On the other hand Global High Yield Bonds as basket are priced to generate double digit returns based on an assumption of a 14% default rate- which is equivalent to pricing in a continuing recession. Hence, we think the equity markets world wide need to consolidate for some time before the next up move.

The quarterly result season from corporates is getting over and so far the trend has been reasonably good with a number of companies showing positive surprise in terms of bottom line growth. However, most of the gains have come from cost reduction initiatives as also extraordinary income. Top line growth seems to be muted with volume growth subdued for most companies and the pricing environment remaining weak. However the month on month improvement in the volume sales of automobiles, cement, steel etc has been quite encouraging. On the monsoon front, there was some better news with the Indian Meteorological Department stating that with a revival of monsoons in the last two weeks of July09, total rainfall since the beginning of June was only 19% below normal (compared to 27% below normal mid July).

In August 09 the market will look with interest at the progress of the monsoons, and road map/policy announcements by various central government ministries, as per the Prime Minister’s deadline of first hundred days of the new government. The market will also focus on news from the Chinese and US economies to get a grip on prospects of revival of global economic growth, while the fragile state of the European banking system will continue to be looked on with concern.
 
Debt
 

Two major events this month were the federal budget on July 6th and RBI’s monetary policy review on July 28th. The budget projected a fiscal deficit of 6.8% of GDP, which was much larger than the market’s expectation. Bond prices tumbled on concerns of the large borrowing program of INR 4 trillion (INR 4, 00,000 crs). However, overall, markets showed strong resilience with the benchmark 10-year yield remaining well below 7%. In the monetary policy review, the RBI projected a continual economic recovery, inflation of 5% by March’09 and the possibility of removing excess liquidity injected during the financial markets crisis. However, the RBI reassured the markets that the current liquidity would be maintained till there were definite signs of economic recovery. Bond yields remained largely flat over the months amidst high volatility.

Liquidity continued to remain abundant with the RBI’s reverse repo auctions consistently getting an average subscription of INR 1.29 trillion. However, overnight rates showed firmness towards the month end with strong demand from borrowers. Money market rates at the shorter end of three months hardened by 25 bps. 1-year bank CD rates eased marginally with continued demand from mutual funds and banks. Corporate bond market was mostly lackluster with poor volumes and spreads widening marginally. With a spate of IPOs lined up over the next month, demand from IPO financiers should keep overnight rates firm in the near term.

Inflation remained in the negative territory, largely remaining unchanged over the month at -1.5%. Even though inflation is currently projected at 5% by RBI by March’10, the pace of global recovery and progress of the monsoon will provide a clear direction in the next months.

With a front loaded borrowing program and expectations of a roll-back of excess liquidity by the RBI as the economy stabilizes and inflation inches up, sustained buoyancy in commodity prices (specifically crude oil) markets are likely to be volatile over the next month.
 
 
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