Equity Commentary – Dec 2010
The 2000-2010 decade was a golden decade for India. During this decade, India’s nominal GDP nearly trebled from $ 0.5 trn to $ 1.3 trn. Per capita income grew by 2.5 times from $427 to $ 1058. Robust economic growth created significant opportunities for the corporate sector. The decade was marked by emergence of several global-sized Indian companies and mid-sized challengers across sectors in India. Indian stock market reflected the underlying economic growth momentum and delivered 18% CAGR, making it one of the best performing emerging markets of this decade. Market capitalization of the listed Indian companies expanded fourteen times over the decade. In terms of market capitalization, India is now ranked 8th globally compared to its 17th position a decade ago.
The Year 2010 for Indian market ended on a high note. In 2010, Indian equity market outperformed its global peers by a wide margin. Sensex gained 17.4% as against 11% gain of Dow Jones (US) and a fall of 14.3% of Shanghai Composite Index (China). The growing divergence between India and the rest of the world in terms of consumption demand was reflected in the Sensex returns. In 2010, two things broadly have happened – (1) Continuous and sustainable recovery from troughs in fundamentals across the globe and (2) Abundant liquidity chasing few asset classes and market. India has been clearly a big beneficiary of both.Globally, the last quarter saw recovery in equity markets supported favorable economic data points and increase in risk appetite of investors. Quantitative easing measures and tax cut announcements by the US government further revived the confidence in the growth of US economy in 2011. In Europe, though countries such as Greece & Ireland continued to face fiscal deterioration, investors showed faith in the corrective actions taken/proposed by ECB. The optimism that the worst could be behind us was reflected in the stock index gains. Dow Jones (US) was up by 7%, FTSE (Europe) by 6.3% and Shanghai Composite Index (China) by 6% in this quarter.
In India, the last quarter of 2010 was particularly volatile. After reaching the high of 21000 during the quarter, Sensex corrected on fears of slowdown in policy reforms, persistent high inflation and rising interest rate and concerns over valuations of securities. Though the quarter ended with a net positive 2% gains for Sensex, the Mid-cap and small-cap indices fell by 3% & 6% respectively. This divergence in the returns indicates preference for frontline stocks by the investors towards the end of the quarter. Besides economic factors, news and developments regarding improper procedures of lending and potential loan ‘scams’ in the banking industry, and significant political disturbance at the national level due to cases of alleged corruption also affected the markets.
FII inflows continued to be strong during the quarter, with about $10 bn inflows. FIIs has shown tremendous faith in Indian economy and have invested 29.4bn$ in the Indian equity markets in 2010 – highest ever investments in a single year. However, mutual Funds were net sellers to the tune of US $6.2 bn. Domestic Institutional Investors did not manage to attract strong inflows because of regulatory changes happening in the industry. Once the industry realigns itself to the changed regulatory environment, inflows are again expected to pick up.
The Indian markets were to some extent guided by the general indications of healthy economic environment in the country. GDP growth for the previous quarter came in at 8.9%, thus underlining the strong fundamentals of the Indian economy in a fragile global environment. IIP numbers showed volatile monthly movements, but also indicated a pickup in the month of October. Consumer demand remained healthy, with strong growth in automotive sales. Growth from trade and manufacturing too remained healthy, indicated by strong growth in sale of commercial vehicles. The quarter saw credit growth picking up to almost 23%, after a slow start at the beginning of the financial year. The quarter also saw declaration of Q2 FY 11 results of companies, with most of them reporting healthy sales and profit growth. However, margins were impacted due to higher raw material costs, as commodity prices increased significantly over last year.
Economy:
The year 2010 witnessed rising interest rate cycle as RBI hiked policy rates partly in order to contain inflationary pressures and partly as a process of policy rate normalization. Significant inflationary pressures and tight domestic liquidity situation have put the central bank in a quandary. Policy choices made to bring inflation have started affecting growth. We are witnessing moderation in Inflation as well as Industrial Production. However, a healthy domestic consumption demand is largely likely to continue. This will be critical in sustaining growth in many sectors. Corporate capital expenditure will likely be under some strain till liquidity in the economy improves. However, government spending on infrastructure is likely to accelerate, which will support growth.
The key domestic indicators are still showing reassuring trends that India would continue to shine. Consumer discretionary spending is growing, bank credit is picking up and commercial vehicle sales continue to remain strong. Favorable demographic profile along with increase in disposable income is helping India to sustain consumption growth. For 2011, Indian economy looks firmly entrenched on the growth path. India’s macroeconomic environment should hit steady state. Essentially India’s growth is likely to remain strong but would moderate, inflation will continue to fall, and interest rate is likely to remain firm.
Equity Outlook:
In 2010, domestic as well as global macro conditions were favourable for equity markets. However in 2011, we see commodity-led inflation pressures, tightness in domestic liquidity and continued noise on corruption scandals as major headwinds. While structural growth drivers will remain in play and augur well for medium-term earnings growth, the year 2011 could be more challenging and volatile.
However, amidst all the concern, Indian economy is still likely to do better than most of its counterparts. India’s earnings growth for Q3FY11 is also expected to be good, in spite of margin pressures. However, policy measures of raising interest rates may impact the growth prospects of the economy. And last but not the least, global headwinds, which can cause serious damage to global recovery and hence impact FII inflows to emerging markets like India. The market direction will be determined by the RBI response to immediate headwinds such as Liquidity and Inflation and the upcoming domestic quarterly corporate results.
Global economy remains fragile, particularly Eurozone and US. While there have been massive interventions in the EU and the US to kick start recovery and prevent economies from slowing further, the results have been mixed, at best. High unemployment continues to be a challenge, preventing a sustainable consumption led economy growth. Any improvement in the economic environment will get gradually factored in the markets.
Overall the outlook for equity markets looks to be directionally positive. However, this will be tempered by several challenges being faced by governments and corporate sector alike. In an environment of rising cost pressures and hardening rates, we see stocks with strong growth visibility being well placed to outperform. Companies with significant competitive advantages and agility are likely to outperform the market. Year 2011 will be a year of astute stock picking. However, the medium-to-long-term outlook remains strong driven by India's robust macro fundamentals, its inherent strengths and the prospects of beginning of the next earnings growth cycle.
Fixed Income Outlook:
Inflationary concerns and tight banking liquidity have been the twin dominant themes for the Fixed Income markets in the last quarter. Firm food prices due to unseasonal rains saw food inflation increasing to double digit levels in December 2010. This was after food prices moderated to single digits in 8.6% due to correction in prices of food crops on the back of good Kharif output & high base effect. Along with this, firming of other commodity prices such as metals and crude oil has increased the inflationary risks for the economy. Now, there are chances of upward revision of WPI inflation from expected 6% by March 2011.
The banking system has been facing persistent liquidity tightness. The liquidity shortage in the system has been averaging around INR 900 bn during the quarter October- December 2010. Slow spending by the government, higher demand for cash by the households and slow pace of deposit mobilization led to deficiency of funds for the banking system. Thus, extremely tight liquidity has resulted in sharp rise in short term rates. The overnight call rate was hovering around the upper end of policy rate corridor for most part of the quarter. The 3 months CD rate rose by over 200 bps during the quarter to reach 9%. In response to the tight liquidity, banks raised deposit rates twice during the quarter. It has also prompted RBI to initiate steps in the form of government securities buy back and SLR reduction to infuse liquidity. During the mid-quarter Monetary Policy Review, RBI permanently reduced the Statutory Liquidity Ratio by 1% to 24% for all Scheduled Commercial Banks & Co-operative Banks.
The outlook on government finances has improved significantly. For the period up to November this fiscal year, gross tax revenue grew by 26.83% vs. budgeted growth of 17.9% backed by strong GDP growth. We expect the economy to clock a growth of more than 8.5% for this fiscal. The buoyancy in tax revenue will help the government meet its fiscal deficit target although the rising commodity prices will pose a challenge in meeting the oil subsidy burden. With the disinvestment schedule so far on its target, the government should be able to contain the fiscal deficit within the budgeted 5.5%.
Yield on the government securities was range bounded during the last quarter. While inflation and tight liquidity were the dominant themes, improved outlook on government finances helped in containing the upward bias in yield. Spread on corporate bonds widened across the curve due to tight liquidity and lack of buying support.
Going forward, we expect bond yields to be in the narrow range with firm bias. Commercial interest rates are expected to remain firm till such time banking liquidity comes back to normal.