Market at New High… What Next?

Reference : “Market Preparing Itself To Scale New High” - December 10, 2012

From December 2012 till date market has made multiple attempts to make new high in the midst of very negative news flows. As we speak we have crossed 21000 on Sensex after a lot of toil, frustration and disbelief.

There were two big black swan events in the market which spooked sentiment on the street. First was the sharp depreciation in rupee and second the reversal of interest rate cycle. In Budget Blog we clearly mentioned about risk on both fronts. After both these events we started believing that the worst is in the price and market will move upward. We are extremely happy with our investors behavior who believed in us and stayed the course against common wisdom.

Now the big question in all our minds is what next? We would like to share our perspective on the market…

1.       Valuations – in our opinion market is extremely cheap. Earnings have not grown in the last 5 years due to currency fluctuation, commodity price fluctuation and government policy interventions. Most of the companies have been resilient in this market and mindfully allocating capital. In every fall weak companies tend to lose competitive advantage and business shifts to stronger players. This will help some of the stronger companies to take advantage of up cycle where earnings tend to grow faster than economic growth because of better utilization of capacity.  Foreign investors have clearly recognised this opportunity and invested heavily in the market at the cost of domestic investors who have largely stayed out.

2.       Sentiment – on this front we have hit rock bottom. Majority of domestic investors are in denial about the recent rise and are highly underinvested in equities. In the last 5 years of savings in India a major bulk has gone to real assets like gold and real estate with the allocation to equities having been reduced dramatically. In any asset class when it is hated the most, it ends up giving a big move. In our opinion equities at new high will make people at large look at it and create more consensus towards it.  

3.       Technical – smart investors have made big investments in the market. With all the bad news we have witnessed huge selling across the board which is getting absorbed by such investors. Once selling becomes light, market will find it easy to move upwards. Market has consolidated beautifully over the last 6 years. On every incremental good news market will start making higher top and higher bottom. Also conviction amongst people will increase and participation will increase.

4.       Long term story – in the bull market of 2003-2007, we all believed that equity is the best asset class to beat inflation and in the long term equities tend to outperform all  asset classes. This theory still remains valid but the general belief in it has vanished. From 1978 to 2013 markets have multiplied 210 times inspite of multiple elections, wars, natural calamities, bad governance, etc. The next 30 years will definitely be better than the last 30 because of the rising aspirations of every Indian. There is no better way to play this story other than equities.

We would request all of you to look at your allocation and correct your underweight position on equities.

Finally I would like share this video with you… Did you know - 

http://www.youtube.com/watch?v=YmwwrGV_aiE

Debt Crisis

In continuations to our earlier blog – “Converting Structural problem into cyclical problem” (March – 2013)

As we speak MF Industry is under tremendous pressure with its position in debt market. We have built our largest book of more than 1 Lac crores in long bonds. Our exposure to corporate debt is highest in recent past. Markets have become illiquid with yield spikes. Yield curve has shifted upward by more than 100 BPS on long duration and more than 200 BPS on short duration. Yield curve is once again inverting. Ominous signs for economy. We are staring at sharp decline in economic activity.

It was a black swan event triggered by RBI move to make money expensive in this country. We have been running real interest rate negative for last 3 years. This has built huge speculative activity. People are leveraging and buying house, Gold and spending as value of money is sharply declining. At the same time people at large are speculating in currency, commodities and Bonds. After a long time Reserve Bank has come forward and made real interest rate positive.

Effect of Positive real interest rate

•  Cost of money will go up
•  Will provide incentive to saver and hence capital formation in this country
•  Speculative activities will come down
• It will also channelize money in more productive investments. It may have big impact on residential real estate. Demand may come off sharply.

Our Recommendations

• Investors will have to digest extreme volatility in the market
• Stay away from funds investing in private corporates specially in shorter durations (Accrual Product). Sharp decline in economic activity will increase demand for money by corporates to manage working capital cycle.

We would advise clients to create buckets for different time frame investments and invest in very high quality assets.

Time Frame	Product
Less than one year	Arbitrage Funds / Liquid & Liquid Plus
One Year to 2.5 Years	Bank Debt Funds. Industry at large is expected to launch Bank CD FMP this will create huge demand for Bank CD’s. We would advise clients to build position in advance. Money is expected to move out of short term and duration products. Which will reduce demand for corporate paper at the same time working capital will ensure supply of corporate papers.
More than 2.5 Years	Long term Gilt Funds. This is most liquid part of the market. Idle for FII’s to move in and move out. Crisis in debt market will ensure that more and more people will move towards Bank FD’s. Due to scare of NPA’s banks will find more comfortable to invest in G-Sec. Yield curve is inverted and may remain for some time.

Warning

1.      Avoid Short term funds

2.      Be cautious of underlying securities in debt funds

3.      Avoid Accrual products

4.      Match your investment horizon with very safe and liquid asset class

5.      Smart investors always tend to prefer higher quality asset

We would urge investors to show lot of calm and open mind to new ideas.

Budget 2013

Converting Structural problem into cyclical Problem

In the last 3 years we have seen a tight monetary policy and loose fiscal policy. In the last 3-4 months of fiscal 2012-13 we have seen that the government has tightened its belt on fiscal side by curtailing expenditure and reducing subsidies. In Budget 2013 the government is trying to move in the same direction. This will result in a very tight fiscal policy if they are able to achieve 4.80% fiscal deficit. We would like to put our thoughts on various key concerns for the economy –

1.      Inflation –

As per RBI & IMF estimate, WPI for March 2014 is targeted at 7.0% to 7.20%. We would like to go with that estimate as we think reducing subsidy in oil will increase inflation. Also high current account deficit will put pressure on rupee and eventually keep inflation slightly elevated in the 7.0% range.

2.      Interest Rates –

In our opinion we don’t expect a sharp fall in borrowing cost for fiscal 2013 -14 as RBI will be more worried about current account deficit and currency. We expect a cut of around 50 BPS to 75 BPS for the fiscal. Also RBI will find it difficult to transmit cut in interest rate into the real economy.

3.      GDP Growth –

As per CSO estimate and budget estimate GDP is expected to be at 6.10% to 6.70%. Our house view is that in a period of fiscal consolidation it is challenging to spur growth. In our opinion we may undershoot growth numbers for the fiscal.

4.      CAD –

Current Account Deficit (CAD) is at a historical high and may remain at an elevated level due to a very high import bill. Gold imports may come down due to lackluster price movement and fall in investment demand of gold. High CAD will keep currency vulnerable and volatile.

5.      Fiscal Deficit –

The government is focusing on controlling fiscal deficit at 4.80% of GDP level. There are certain moving parts in this budget. For example spectrum auction and disinvestment together are expected to garner almost 90000 Crores. This may be difficult to achieve. Also revenue growth of around 18% may be difficult if growth decelerates. But there is certain flexibility in planned expenditure which can be curtailed to achieve a 4.80% fiscal deficit.

Asset Market View

1.      Equity Market –

In a period of reasonably high inflation and low growth – high quality stocks that can protect margin will outperform. We would advise clients to stick to high quality stocks in this period. In the next 2-3 quarters we expect cyclical slowdown and deep cyclical stocks may disappoint investors. This will make strong bottom for these stocks. We would advise our clients to finally look at these stocks in the next 2-3 quarters and start loading them up in their portfolios.

2.      Debt Market –

Currently we have an inverted yield curve. Short term rates are in the range of 9% plus and long term rates are at 8%. In our opinion yield curve will start flattening out after April. We would advise our clients to split their debt book between short term and long term bond funds.

(Imp – In the entire hypothesis commodity prices including OIL can act as beta. Any fall in OIL & commodity prices can change the whole equation)