Equity Commentary
During the quarter all markets including India continued its northward journey because of a strong global rally arising from indications of economic improvement and abundant liquidity following all assts class globally. The influx of liquidity and more importantly continuity of this has surprised everybody world over. India has emerged as one of the best performing markets globally, recouping the underperformance of the previous one-year.
During the last quarter, all global major indices has run up significantly. The BSE Sensex has delivered return of 18.2%, whereas the global major indices such as Dow Jones and Nasdaq also has shown upward of 15% return in the last quarter. This was mainly due to continuous improvement in economic data points globally, leading to better market sentiments and increased risk appetite. This has been helped by the belief that perhaps the global economy has bottomed out. While the economic recovery in Asia has been decisive, it has been tentative in Europe and the US. It is anticipated that the US and Europe will show some pickup in economic activity in the next year. However, it is also true that medium-term economic prospects in these areas may well be constrained by such secular factors as mounting job losses, wealth destruction and associated consumer de-leveraging, as well as a necessary withdrawal of massive fiscal and monetary stimulus.
Globally, the GDP growth, which had dipped significantly since emergence of the crisis in September 2008, has been recovering in most countries over the past two quarters. In the US, decline in real GDP (Q-o-Q, annualised) was lower at 1.0% in Q2CY09 against 6.4% in Q1CY09, Japan’s GDP, which had fallen 12.4% in Q1CY09, turned around by growing 3.6% in Q2CY09. Among the emerging economies, China led with a growth of 7.9% Y-o-Y in Q2CY09 on top of 6.1% growth in Q1CY09. While emerging economies showed faster return to the growth path as expected, even the recovery in advanced economies such as Euro zone, Japan, Singapore, the US and UK in the latest quarter has been significantly better than expected.
While GDP figures globally have seen an improvement, the industrial production too is simultaneously picking up in several economies, led by China and India. However, the prime concern that continues to persist globally is sustainability of this fast-paced recovery. Other pressures that continue to mount on growth are the high unemployment rates in several economies and rising commodity prices that have been fuelling inflation expectations. Concerted and coordinated efforts by central banks and fiscal measures taken by governments seem to be at the core of the economic recovery in most countries
In case of India, Q1FY10 GDP growth had been strong at 6.1% Y-o-Y after having grown at ~5.8% in the past two quarters. While growth in H2FY09 was held back by dismal industry and agriculture performance, Q1FY10 growth largely reflected broad-based industrial turnaround. However, concern remains around export oriented sectors (textiles, leather, gems and jewelery, amongst others) which are yet to exhibit growth momentum. Improvement in credit disbursement in consumer segment since Q4FY09 and stimulus packages announced by the government and RBI are significantly responsible for the growth in IIP.
However, the weak link for this year remains Agriculture. Monsoon, during 2009, remained deficient at ~23% of normal, with the North-West region facing most of the brunt. The current season has seen the worst deficiency since 1972, when it stood at ~24% of normal. Recent experience in India suggests that as rain deficiency moves beyond the threshold range of 10-15%, the incremental damage to agriculture is much more than proportionate. Delayed and deficient monsoon during the year has adversely impacted agriculture and allied activities, as large part of the kharif (summer crop) cultivation is directly dependent on monsoon. However, the impact of below normal monsoon to some extent would be eased by the government focus on rural spending through programmes like NREG etc and the cushion of a strong rural income over the past three-four years.
Accordingly, agricultural growth is likely to decline by ~2-3% in FY10E and would impact GDP growth. Given this, for FY10 the GDP estimate has been revised to ~5.5% from 6-6.5% earlier. Bulk of the impact will be from the direct effect of monsoon on agriculture. This will also pose a threat to inflation. Inflation is emerging as a major challenge globally, especially the food inflation. The supply side constraints in addition to domestic developments, pace of global recovery and liquidity will continue to influence commodity prices and the general price level.
Outlook
We anticipate that markets will be conditioned largely by liquidity and global dynamics over the next few months. However, we do not see a strong earnings cycle post 2009 due to muted global GDP growth, surplus in several global commodities, subdued capex cycle and limited improvement in profitability. However, on the domestic front, macro economic data is encouraging and definitely showing an improvement. The government has been focusing on sustainable economic growth and has been taking measures to increase thrust on infrastructure spending. In India, the focus on rural infrastructure, irrigation, roads, rural housing has risen sharply. Focus on rural development would have a large multiplier effect on job creation and provide an impetus to consumption. However, fiscal deficit may remain high in the near-term as the priority seems more to remove structural impediments to growth.
The recent quarterly results for most companies were better than expectations. Advance tax collections for the second quarter of the current financial year (2009-10) have also shown robust growth. The September quarterly results are going to be keenly watched as some sectors have shown a relatively better set of numbers like FMCG, auto, banks, IT and cement but we are yet to see an improvement across other sectors.
In the near-term, we expect Indian equity markets to continue to take cues from global markets, liquidity flows, global economic data and the upcoming domestic quarterly corporate results. The BSE Sensex now trades at a forward P/E of ~ 18 X, which is on the higher side than the historical valuation. Although it is natural to be more cautious following such a strong rally, we are still positive on Indian economy and market over the medium to long term, given India’s ability for sustainable long-term growth due to its inherent strengths.
Fixed Income Commentary
The recovery in Indian economy is very well reflected by indicators, which after touching bottom during the period of December 08- February 09, are now showing signs of improvement. This includes industry and core sector performance & revival of capital flows etc. The IIP for the month of July 09 and August, 09 stood at 7.2% and 10.4% respectively. Particularly significant has been the growth in the manufacturing sector, which has grown by an average rate of 8.5% in June - August 2009.
Inflation turned positive once statistical mirage faded away. For the week ending October 3, 2009, WPI inflation stood at 0.9% YOY. On the other hand, CPI continued to rise reflecting increase in food articles price of around 14 % YOY. So far, hike in Minimum support prices and anticipated shortfall in food grain production have driven the prices of food articles. It is expected that WPI will also pick up once economy revives and it will be in the region of 5%-6% by end of March 2009.
Globally three major industrial countries, like, Germany, France & Japan have shown positive growth sequentially for quarter ending June 2009. This should be seen in the light of moderate fiscal intervention in these countries after the global financial crisis. The pace of decline in the US and UK economies also decelerated in the QE June, 09. The Federal Reserve recently said it would reduce its emergency programs that auction loans to commercial banks and Treasury securities to bond dealers, citing “continued improvements” in financial markets. Its assistance for money market mutual funds will expire on Oct, 30, 09.
Banking liquidity was ample in the absence of credit growth as reflected in bank's investment in Liquid Mutual Funds and daily subscription of Reverse Repo. The amount of investment by banks in Liquid Mutual Funds has grown by over 300% from March 2009. In addition, banks have been parking more than INR 1 trillion consistently with the Reserve Bank since May 2009. It is expected that credit growth will resume once economy stabilizes and confidence returns due to pick up in investment demand.
The bond market was extremely volatile due to continuous supply of Government securities despite consistent RBI purchases. Spreads on Corporate bond tightened on account of ample liquidity and demand from end investors. Money Market securities did exceedingly well due to demand from Mutual Funds and thus spreads got contracted.
Going forward, it is expected that RBI will gradually remove the various liquidity facilities provided to combat global financial crisis as Indian economy shows signs of recovery. Commercial interest rates will be stable in the light of ample banking liquidity. Yields of Government securities are expected to remain firm due to inflationary outlook and gradual removal of monetary & fiscal accommodation.