By: Navneet Munot, CFA, CIO, SBI Mutual Fund and Director IAIP
Sensex was down 1.6% during the month. Poor earnings season and adverse results for NDA in Bihar state elections dragged investor sentiment.
Looking at the economic data and comments from various Fed officials, the US Federal reserve seems to be on course to hike the policy rate by 25 bps in December. We are also likely to see a long period of policy divergence among global central banks actions. While the Fed is commencing normalization of policy, central banks in Europe, Japan and China remain in an expansionary policy mode. US Dollar has been appreciating against other currencies, US yields have been inching up and commodities had one of the worst month. We expect the volatility in global markets to subside once the event (Fed rate hike) is behind us.
Terrorist attack in France, rift between Russia and Turkey and skirmishes in south-china Sea highlights the underlying geo-political tensions. Historically, events like these would have pushed up the price of Gold and crude oil but factors driving these prices now are different. Oil producing countries are refraining to cut production fearing onslaught from alternatives amidst demand slowdown and potential new supply from markets like Iran. However, we believe most of the commodities are near capitulation at their long-term cost curves. Some of the soft commodities have bounced back on fears of El Nino and lower crops next season. India being on the consumption end has remained a key beneficiary of the soft commodity cycle as it helped manage the economic trinity of inflation, interest rates and twin deficits.
The government continues with the executive action addressing systemic issues in key sectors like mining, railways, defense, banking, roads and power. RBI has been accommodative in its stance with a 125 bps rate cut through the year. Several sectors too are opened up for higher foreign investment limits. Winter session of parliament has started with renewed hopes on the passage of the GST bill. A comprehensive GST draft document stands to facilitate consensus on the policy.
The government has smartly pushed the envelope through states to address tricky issues on land acquisition and labor laws. With several states competing for the pole position as investment destination, the ease-todo-business template is fast permeating to the ground level. New cities like Amaravati (AP) and Naina (Maharashtra) have been announced. The large FDI commitments during the current fiscal endorse the same.
While the corporate commentaries remain depressed, growth revival seems to be round the corner, in our view. Several high frequency indicators like indirect tax collections, power generation, coal production, petrol consumptions, passenger car sales, new job initiations, and aviation passenger traffic are showing up. A close look at the quarterly results suggests ~70% of last full year capex has already been expended in the current year so far, thanks to tax incentives for investments in capex/R&D. Concurrently, the rural economy is in mild stress. When looked at in the wake of the fact that we have faced among the worst two successive years of draught, lower MSP hikes and cut down in government rural spending, the rural economy has actually showed resilience. We expect the base effect to come in place in the next fiscal while government spending on infrastructure and irrigation also has the positive effect. Impact of pension and pay revisions for military personnel and government employees will also help in reviving the private consumption.
In spite of uniqueness in its emerging market peerset, India gets tagged to emerging market allocations, mirroring the negative sentiments in the outflows. This year, these outflows were counter-balanced by sustained domestic institutional flows. The domestic flows have been driven by increased thrust on financialization of savings and recency effect of relative outperformance of equity as an asset class.
We continue to believe that India is entering an investment super cycle on the back of bottoming out macro, lower factor costs and benefits of global liquidity seeking growth in a growth-starved world. Midcaps tend to benefit more during such positive cycle, as it navigates positive reflexivity on the back of improving policy environment, leaner operating structures, softer input cost regime and lower cost of capital. After an initial gold rush in this segment, market has been selective. We expect this segment to present new opportunities driven by disruptions across markets, technology, governance and consumer behavioral preferences.
In the short term, markets will be cautious ahead of US Fed action and the ongoing parliament session. We are nearing end of earnings downgrade cycle and the current volatility is offering an entry opportunity for investors with long horizon.
During the month, bond yields moved up by about 15 bps with the curve shifting largely in a parallel manner. Changing expectations of policy normalization by the US Fed and FPI outflows contributed to the currency weakening by about 2.10% during the month. While local bond yields have directionally tracked the up move seen in US treasuries over the past 2 months, local factors have also contributed to the same. The larger net supply of government primary auctions over the last 2 months has resulted in yields inching up even as trading positions remained light on account of both seasonality as well as event risks. Liquidity conditions tightened at the margin on account of festive season currency withdrawals and slowdown in government expenditure.
RBI’s policy stance remains accommodative. However, having delivered a cumulative 125bp of rate cuts already, we expect the RBI to stay on hold for remainder of the financial year and focus on developments in (1) commodity prices, (2) external environment, (3) effect of Pay Commission implementation, (4) fiscal consolidation path and (5) transmission of policy rates before embarking on any further rate cuts. While we remain confident of a structural downshift in inflation, the bar for additional policy accommodation in the near term has definitely shifted higher.
The focus of RBI is now likely to shift towards ensuring better transmission of rates especially in the loans market. We expect the RBI to keep interbank liquidity in reasonable balance over December through term auctions given that tax outflows could further strain banking liquidity.
Bond market is also likely to feel the heat from US Fed action. Despite the accommodative stance communicated in the monetary policy review and prospect of favorable demand-supply dynamics over the next few months, bond yields have slowly been inching up. 10-year bond yield is trading at 100 bps spread over the repo rate, highest in recent months. While our medium term view remains positive, we have marginally trimmed duration as a tactical move.