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Fund Managers Commentary
May 31st, 2008
Equity Market
Markets during the month of May were driven by inflation worries and high oil prices. The Sensex ended 5% down at 16,415 while Nifty ended 5.70% down at 4870. In the volatility experienced during the month, large-cap stocks did better than small and mid-cap stocks. The sectoral indices which outperformed the Sensex were IT, Metal, Health Care and FMCG while Capital Goods and Consumer Durables were in line with the Sensex. Auto, Bank, Oil & Gas, Power, PSU and Realty lagged the Sensex. For the month, FIIs were net sellers of USD 1.24 billion, while Domestic institutions were net sellers of USD 96 million (as per data available up to 29th May 08).
India's GDP grew 8.8% in the fourth quarter ended March 2008. For the Financial Year ended March 2008, the GDP thus grew by 9% (recording a third consecutive year of 9% plus growth) backed by better than expected growth of 4.5% in the agriculture sector, while the service sector grew by 10.8% and industrial growth was 8.5%. Gross Capital Formation rose 13.3% to 35.2% of GDP reflecting investment led growth. In trade data released for the month of April, exports showed a growth of 31.5% while imports grew by 36.6%, taking the monthly trade deficit to USD 9.9 billion. The key reason for growth in imports has been the acceleration in non oil imports, while oil imports have grown by 46%.
Based on Q4FY'08 financial performance of corporate India, there are some initial signs of slight moderation of top-line as well bottom-line growth going forward mainly due to global economic slow-down as well as rising input cost pressures without commensurate pricing advantage. India has had five years of significant corporate profit growth with capacity utilization currently at highs. In line with the fundamentals, markets had priced certain stocks at valuations befitting the growth posted by them, these stocks could disappoint if they do not justify the premium placed on them. Meanwhile, investors would do well to look at investing in stocks where the markets may not be valuing the growth potential rightly - with an aim to both, manage volatility and get decent returns.
Inflation is being driven by rising food and oil prices. Food prices could ameliorate if we have a good monsoon. Oil prices on the other hand have created a dilemma of choosing between growth and inflation for the monetary authorities across the emerging world. In the meanwhile, emerging countries (that constitute 90 percent of the incremental demand of oil) like China, India, Malaysia etc. have been heavily subsidizing oil consumption thus failing to give their markets the price signal to economize on consumption. If there is a hundred percent pass through of prices, it is likely that incremental demand will fall off, impacting the price of oil negatively.
In regulatory news SEBI allowed cross margining in the futures and cash markets for institutional investors. RBI eased lending norms for infrastructure projects. RBI liberalized External Commercial Borrowings norms too for Indian corporates, most of who are in the middle of their capital expenditure cycle to meet their respective market demand conditions.
Financial markets now seem to be optimistic that the financial crisis in the US markets is over, which is reflected in the recent rise of equity markets world over. However, one needs to keep a close watch on economic data (like house prices, consumer spending etc) to check on the health of the US economy.
Going ahead, the market will keep an eye on the progress of the south west monsoons that have announced their arrival in the state of Kerala. Initial forecasts are that the monsoon would be close to the long term average and that bodes well for the nation. While in the short term, there may be volatility in equity markets, we are bullish on the prospects for the Indian market in the long term due to the strong structural drivers of the Indian economy like positive demographics, consumption, skill base, potential for financial intermediation etc. We think such volatility affords long term investors a chance to capitalize on a secular growth story.
Debt Market
The yields went up across the curve by around 20-25 basis points as inflation continued to rise, touching a four year high of 8.10% for the week ended 17th May 2008. The final figures for inflation were revised up by 100-150 basis points over the provisional figures aggravating inflationary concerns. The 10yr benchmark ended at 8.10% up from 7.88% from the beginning of the month. The rupee continued its downward slide touching a high of Rs.43.20 / $ before the RBI intervened to halt the depreciation. It also relaxed the ECB norms for rupee expenditure and enhanced the limit of FII Investment limit in Government Securities from $3B to $5B and in corporate debt market from $1.5B to $3B. Oil continued its surge upwards touching an all time high of $133/barrel before ending the month at $127/barrel. Liquidity, though remaining adequate for most of the month, turned negative from May 24 onwards as the third CRR hike came into affect and forex flows turned net negative. Liquidity is expected to remain tight as advance tax outflows from the system drain out liquidity from the middle of June. The OIS segment of the market reacted most negatively to the turn of events as the 5yr OIS moved up by 70 basis points to end the month at 7.97%, compressing the spread between the 5 yr Gsec to 7 basis points.
Internationally, inflation has become a big concern, with several countries experiencing multi year high inflation levels. US yields inched up above 4.00% to end the month at 4.05%. The Fed Fund futures are discounting a possibility of a rate hike by early 2009, amidst rising inflation. The European Central Bank has also expressed concern on inflation indicating the next move on interest rates may well be a hike, depending upon evolving conditions.
The combination of factors like rising inflation, depreciating rupee and rising subsidies on oil, fertilizers etc is most likely to put upward pressure on yields going forward.