Market Update Nov 2014

ECONOMIC UPDATE   Index of Industrial Production (IIP) remained subdued at five-month low of 0.4% in August'14, down from 0.5% in July'14, mainly due to contraction in manufacturing output and lower production of consumer goods.   CPI inflation in September'14 fell to the lowest level in nearly three years to 6.5%, from 7.7% in August'14. Most importantly, core CPI inflation has declined by 105bps m/m to 5.7% in September'14. WPI inflation fell to a five-year low of 2.4% in September'14 against 3.7% in August'14 due to decline in primary articles and fuel inflation.   Exports in September'14 grew 2.7% yoy to $28.9bn, while imports grew 26% to $43.2 bn. As a result, trade deficit widened to $14.2bn, the highest in 15 months, from $10.8bn in August'14.   Indian rupee appreciated by 0.6% to INR 61.37 per dollar in October'14 versus INR 61.76 at end September'14. Direction of dollar index, FII flows and trade deficit would be the key determinant for rupee levels in coming months.

EQUITY MARKET UPDATE   Indian markets continued to scale newer highs in October with FIIs (foreign institutional investors) inflows continuing. Mid cap and small cap stocks underperformed the broader market with the CNX midcap index gaining 3.7% in the month. BSE100 index gained 4.6% in October.   FIIs continued their buying streak and were net buyers to the tune of INR.8.8bn; also mutual funds were net buyers to the tune of INR.55.0bn.   Sectors that outperformed were capital goods, banking, power and auto. Sectors that underperformed were realty, FMCG, pharmaceuticals, IT, metals and oil & gas.

Outlook-   Government has seized the opportunity provided by the easing global crude oil prices by announcing long awaited diesel deregulation. This would open the field for private players and eliminates subsidies.   Government has also resolved the long-pending issue of domestic gas price by hiking the same from US$4.2/mmbtu to US$5.6/mmbtu.   Inflation is expectedly moving lower and the RBI remains committed to keeping the economy on a disinflationary course.   We believe, if the economy stays on course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster it will provide headroom for an easing of the policy stance.   With this backdrop we maintain a positive bias on the market going forward. The market valuations are reasonable at about 17.6x FY15 estimated earnings for SENSEX.

DEBT MARKET UPDATE   Bond markets moved significantly during the month. 10Y G-sec moved down by 23 bps. Long bonds moved more and spread compressed.   However, RBI unexpectedly announced OMO sales of INR. 10,000 crore during the month to suck out additional liquidity. This move caused 10 bps sell off but market overcame the shock as inflation data was better than expected.   The FII interest in bonds continued to remain strong. FIIs have invested INR 145,600 crore in current year (till Oct). FIIs’ purchases in the Corp bond segment continued to remain strong as limits in G-sec are almost full. FIIs buying in corporate bonds have caused spread compression in 3/5year segment.   Both CPI and WPI surprised on the lower side with core CPI falling more sharply. Importantly, the fall in inflation data was more than what can be attributed to base effect in both series.   Market reacted positively as sustainable fall in core inflation is in line with RBIs inflation target. Crude Oil price fell significantly and is now hovering around USD 85 per barrel.   The 10-year benchmark G-sec bond eased to 8.28% at the end of the month from 8.51% at the end of the previous month.

Outlook-   Inflation would continue to dominate the factors that determine the monetary policy. Core inflation has been steadily trending lower. The fall in commodity prices, especially crude oil prices, iron ore, coal are likely to keep core inflation subdued.   In the near term, there seems to be little evidence of any pick-up in growth led demand as readings of industrial growth are tepid. Hence, fear of demand led price pressures are unlikely to surface as quickly as it were feared earlier.   We expect RBI to continue to maintain a sharp vigil for evidence of any demand led pressures for a few more months, as the RBI is targeting a 6% CPI inflation level for January 2016. However, probability of a rate cut by the end of the financial year is higher than was earlier.   Meanwhile, the Government is committed on maintaining the fiscal deficit for the year at the budgeted level of 4.1% of GDP. The recent announcement of 10% cut in non plan expenditure shows that Government is already making room for revenue short fall which is almost certain. We currently do not expect any additions to the scheduled borrowing during the remainder of the year.   The continued slide in crude oil price has improved the economy’s macro parameters with both CAD & fiscal deficit being impacted positively. If sustained, recent fall in crude oil prices will improve the economy’s outlook and investors’ confidence in the economy.   We expect bonds to continue to trade in a narrow range with a bias towards lower yields. At the short end of the curve, the RBI’s pro-active measures have helped contain the volatility in overnight rates and anchor the short end yields. However, we believe that yields might fall sharply if inflation data surprises more on lower side and market starts discounting a rate cut earlier than previous expectations. However, more aggressive OMO sales by RBI might slow the pace of fall in yields.

Source : Bloomberg