Hexagon Wealth

June, 2013
Market Watch

The Sensex rose by 1.3% during May and finished the month at 19,760, swinging about 700 points through the month. The S&P BSE IT index was the biggest gainer and rose by more than 6%. Possible drivers are the rupee depreciation, making exports more competitive; positive data coming in from the US; and last minute information regarding Narayana Murthy re-joining Infy as Chairman which boosted Infy on the last trading day by 2.79%.

Markets are close to five-year highs but current valuations are more attractive than they were at the previous peaks in 2008 and 2010 due to improved book values of shares and enhanced Earnings per Share. Unlike the past when the peak was associated with PEs of about 23x we are currently at 16.75x trailing and about 15x forward PE which is reasonable if it weren’t for the uncertain domestic environment.

In spite of the run-up, this month’s volatility suggests that we are on shaky legs. The market is unable to sustain higher levels in the absence of positive economic data and earnings upgrades.



Indian bonds rallied (prices increased) in May with the yield of the existing benchmark 10-year government bond falling 29 basis points. Expectations of lower interest rates contributed to the fall in yields as wholesale price inflation (WPI) fell to 4.89% in April – the lowest level since November 2009. As the WPI is now within the RBI’s comfort zone, the central bank may have more room to ease rates, if the fall in retail and wholesale inflation is sustained.  However, the Governor’s warning about the upside risks to inflation and the urgent need to curtail the CAD dampened sentiment and depressed bond prices in the last week of the month.

In May, our recommended short, medium and long-term debt funds have generated double-digit returns (on an annualized basis). A laddered debt portfolio with a modest allocation to duration funds will limit downside risks and enable you to benefit from spread compression and interest rate cuts if any.


Only a modest uptick in growth

Percent Growth

In FY13, India’s economy expanded by only 5% - the slowest pace in a decade. However, GDP rose by 4.8% in the fourth quarter – a marginal increase from the previous quarter. This suggests that the slowdown in Asia’s third largest economy may have bottomed out.

Sluggish demand adversely affected consumption and services in the fourth quarter. However, the contribution of investment to GDP rose (measured by gross fixed capital formation) even while the government’s recent austerity drive limited the increase in spending. The actual fiscal deficit in FY13 was 4.9% - lower than the revised estimate of 5.2%. This may reduce the risk of a sovereign downgrade.

There are some green shoots ahead as the recent fall in interest rates may gradually stimulate consumption. A normal monsoon may result in higher growth in agriculture. According to the OECD, India’s economic growth may gradually recover in 2013 if the bottlenecks for investment are reduced. The benefits of the FDI-reforms may also start to trickle through the economy. Finally, the improving global economy and the Rupee depreciation may result in higher exports.

Earnings Outlook

For Sensex companies, revenue and operating profits rose in the fourth quarter, but a larger sample of 2651 companies for the whole year looks dismal, as shown in the table.

But earnings may be upgraded over the next few quarters.

Sector Breakdown

­ -   Pharmaceutical companies benefited from overseas markets and the depreciation of the Rupee. On a moving average basis, sales growth remained in double-digits However, the sector faces headwinds because of the new Drug Price Control Policy.
­ -    Most FMCG companies reported strong earnings led by Hindustan Unilever. Margins may expand as input costs fall but the volume growth in premium products may decelerate. However, the rural penetration rates for several products are quite low showing potential to increase.
­ -   The earnings of capital goods and infrastructure companies disappointed the market, especially as new order inflows remained sluggish. L&T was an exception with good order flows, but shares fell drastically as the company’s net profit fell by 7%. We think the valuation of L&T seems attractive at current prices.
­ -  The divergence between private banks and PSU banks continued in the fourth quarter. Several private banks reported healthy earnings. However, asset quality concerns continued to depress public-sector banks. All Banks fell due to the new provisioning norms from RBI.

Over the next few quarters, lower interest rates may reduce borrowing costs and push up profits after tax, especially for small & midcap companies. The recent decline in commodity prices may also lead to margin expansion. Earnings growth may eventually return to the long-run average of 15%.

Refer a

What is different about QE this year?

Last month, the minutes from the Federal Reserve’s meeting spooked global markets as some of the Fed’s policy makers suggested that the quantitative easing (QE) program could be tapered off. However, the chairman of the Federal Reserve, Ben Bernanke vetoed premature monetary tightening. Given that markets discount future events, the apprehension of a reversal in the Fed’s policy is already affecting markets.

Even if the Fed decides to turn off the QE tap, there will still be an adequate supply of global liquidity. The Bank of Japan intends to continue pumping money into the economy till inflation reaches 2%. In contrast to India, Japan has been fighting deflation since the 1990s. This trend continued in April as core consumer prices fell by 0.4% on an annual basis.

At its last policy meeting, the ECB also hinted that it would pursue expansionary monetary policy – even to the extent of negative deposit rates. Central banks in South Korea and Australia have also cut interest rates - partly to stimulate their economies. However, these countries do not want to fall behind their Japanese rivals in export competitiveness as the Yen has fallen significantly against the dollar this year. This may make Japanese exports more attractive.

Main Policy RatesIndia
                                          Policy Rates

As a result of various quantitative easing programs, interest rates in several countries are close to record lows.

What does this mean for India? Historically, India has attracted more FII flows in the previous QE rounds.  However, these inflows failed to push up Indian equities as inflation generally rose towards the end of the QE programs.

This was because commodity prices rose during the last QE rounds. However, this phenomenon has not occurred this year. In fact, commodity prices have fallen over the last year.

Falling commodity prices are positive for India as inflation pressures may fall. Therefore, Indian equities may benefit from this round of QE. Globally, a “Great Rotation” from bonds to equities may occur, as investors pursue higher returns.

India’s economic growth slowed last year but the country is still growing faster than several developed countries and BRICS countries (with the sole exception of China).

Foreign investors favour India but the Rupee remains under a cloud

In the first five months of 2013, India has attracted more than Rs 80,000 crores in FII inflows –the best January-May since 2000. Strong FII flows generally push up the Rupee. However, the Rupee fell by 5% during the month.  On May 31st, the Rupee fell to 56.5/$ - almost a one-year low.

This anomaly is partly because of the strong dollar. The dollar has appreciated against the Yen and the Euro as the central banks of these countries are considering aggressive monetary easing measures while some Federal Reserve officials want to gradually reduce QE. Buoyant economic data has also supported the dollar – U.S. consumer confidence is now back at pre-crisis levels while the Eurozone is struggling in the longest recession since the bloc was formed. European investors may prefer to invest in dollars as the U.S. economy is relatively more attractive.

However, domestic factors have also depressed the Rupee as CAD-related concerns persisted.

Low economic growth concerns have managed to cap the rupee upside in the recent past despite strong dollar inflows in equities. Worries on current account deficit and questions on Government's ability to push reforms are weighing on the sentiment. Then, there is high dollar demand from gold and oil importers.

A falling Rupee may make petrol and diesel more expensive as India is a net importer of oil. However, exporters are likely to benefit as they will earn more for every dollar worth of goods and services sold.

International funds may also gain from the depreciation in the currency as these funds will generate higher returns in Rupee terms. Funds such as JPMorgan ASEAN Equity Fund and ICICI Prudential U.S. Bluechip Fund are the best performers in their categories and have consistently generated high risk-adjusted returns.

Lets’s Learn: Inflation Indexed Bonds

Inflation-indexed bonds (IIBs) aim to generate returns higher than inflation. The coupon payments of these bonds are usually tied to the inflation rate to protect investors from negative real returns. If inflation increases, the principal due at maturity and the coupon payments also increase. Unlike regular bonds, inflation-indexed bonds deliver “real” or inflation-adjusted returns. These bonds are popular in developed countries such as the U.S. (where they are known as Treasury Inflation-Protected Securities or TIPS). However, these instruments are a novel concept in India and the first inflation-indexed bonds will be issued on June 4th.

IIBs may reduce India’s gold imports. Over the last few years, the demand for gold rose as inflation rates spiked. Consequently, there are more savings held in unproductive physical assets such as gold and real estate rather than in financial assets like bonds and equities. Investments in financial assets can be used to fund investments and increase economic growth. However, investments in gold and land do not benefit the economy. Inflation-indexed bonds may help channelize more savings into financial assets and may reduce the value of gold as an inflation hedge. This will reduce India’s import bill and ease the pressure on the current account deficit (CAD) which rose to a record high of 6.7% of GDP in the third quarter of FY13.

However, there are some caveats. The inflation-linked bonds will be linked to the wholesale price index (WPI) rather than the consumer price index (CPI). The purchasing power of Indian consumers and investors is better reflected in the CPI and not the WPI. Therefore, WPI-linked bonds may not adequately protect investors against inflation. Falling inflation will reduce the attractiveness of these bonds. Presently these bonds will be more attractive to Foreign Institutions and Indians will have to wait for the next issue which may be linked to the CPI.

Global Indices: Wall Street Journal
Domestic Indices: BSE/ Accord Fintech



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