Hexagon Wealth

October, 2013
Market Watch

After three months of losses, the Sensex rose by 4% in September as global markets cheered the Federal Reserve’s decision to postpone tapering its quantitative easing programme. After the Fed’s announcement, the Sensex rose to a 34-month high of 20,647 on 19th September. But the index fell during the last week of the month as the RBI’s rate hike and concerns over the US debt ceiling and government shutdown depressed sentiment.



The S&P BSE Power Index was the biggest gainer and rose nearly 10% as power generation companies attracted investors’ interest after the Cabinet Committee on Economic Affairs announced that it would auction coal blocks to enable the government to allot coal mining licences through competitive bidding to private companies. The Power index outperformed sector funds such as Reliance Diversified Power Sector Fund which only generated a return of 4% in September.

The S&P BSE IT Index was the only loser in September as the index fell by 2.3%. However, the index rose by 25% between July and September - the biggest quarterly gain in the last four years as the rupee depreciation and positive U.S. economic indicators boosted IT stocks.

During the quarter, TCS – Hexagon’s favourite IT stock - rose by 27% and outperformed the IT index. Last December, we advised our Top Value clients to purchase TCS. Since then, the stock has jumped by about 66% and was trading at Rs 1,928 by the end of September.

In contrast, bonds were unlucky during the quarter as prices fell and the yield of the benchmark 10-year bond rose by 133 basis points – the biggest rise since the quarter ended March 2009. Indian fixed income securities have been adversely affected by the decline in the rupee and by redemptions by foreign investors. The RBI’s unexpected interest rate hike also added to the pressure on the debt market.

The volatility in the bond and equity markets is likely to continue until investors have more clarity about the Fed’s plans to wind down its stimulus. The negotiations over the U.S. debt ceiling may add to the uncertainty in the markets and the rally in the domestic equity market may not be sustainable in the absence of earnings growth and positive economic data.


Has the tide turned for fixed income investors?

In September, the RBI’s unexpected rate hike depressed sentiment in the bond market as the yield of the benchmark 10-year bond rose by 39 basis points after the central bank’s announcement. Yields may remain volatile in the short run but on the whole, most bond funds (with the exception of gilt funds) have managed to recoup the losses they suffered earlier in the year. The yields of most fixed income instruments rose and prices fell in July and August when the RBI implemented liquidity tightening measures in an attempt to stabilize the currency. However, as shown in the graph, even long-duration income funds such as Templeton Income Builder (one of our recommended funds, but only for investors with higher risk appetites, and even these investors have only small allocations to this fund) have managed to generate positive returns this year.


In the second week of August, the yield on India's 10-year benchmark government bond rose to as much as 9.23% after the government imposed capital controls to reduce the volatility in the rupee. But the yield eased to 8.77% by the end of September. In spite of the fall, investors with 3-5 year horizons can still use the opportunity to add long-duration funds to their portfolios as interest rates must fall eventually. In a statement last week, Dr Rajan said that India’s current account deficit (CAD) is no longer a serious threat. The CAD rose to a record high in the last fiscal year and was one of the factors which prevented the RBI from cutting rates aggressively. The CAD may gradually improve as the fall in the rupee makes India’s exports more attractive. The government’s restrictions on gold imports may also ease the stress on India’s current account although according to some estimates, gold imports may rise by about 75 tonnes in the third quarter of the current fiscal due to festival consumption. Any fiscal consolidation measures may gradually allow the RBI to shift its focus to growth and pursue monetary easing after inflation stabilizes.

The RBI imposes short-term pain for long-term gain

FDI Reforms

In his first monetary policy meeting as RBI governor, Dr Raghuram Rajan surprised markets by hiking the repo rate by 25 basis points to 7.5% - the first increase in nearly two years.

The Governor expressed concerns about rising inflation. In August, headline wholesale price inflation (WPI) rose to a six-month high of 6.1%. The sharp depreciation in the rupee has pushed up inflation as India is a net importer of many commodities such as fuel.

The RBI expects that WPI inflation may be higher than initial projections this year. The central bank’s decision may adversely affect short-term growth but stable inflation is a pre-requisite for sustainable long-run growth. However, the hike in the repo rate led to a rise in bond yields as prices fell.

It is too early to determine whether the RBI’s move signals a reversal in the interest rate cycle. Corporate pricing power is limited because of the economic slowdown – this should ease the pressure on inflation. The recent spike in food prices may also be temporary as the kharif harvest is expected to be robust. Furthermore, a stabilisation in the currency may prevent a resurgence of imported inflation. The RBI actually removed one of the rupee’s supports as it lowered the marginal standing facility (MSF) rate by 75 basis points to 9.5% to ease liquidity. On 7th October, the MSF rate was further reduced by 50 basis points to 9%. In July, the central bank raised the MSF rate by 200 basis points to 10.25% prevent the rupee from depreciating.

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No rays of sunshine for corporate earnings

On Friday, Infosys will be the first major company to report results for the second quarter of the current fiscal year. The company is expected to post healthy revenue and profit growth. Its main competitors – TCS, Wipro and HCL are likely to follow suit as these companies will benefit from the sharp depreciation in the rupee.

However, companies in other sectors may not be so fortunate. Over the last few quarters, sluggish demand and higher input prices have eroded profits.

A report published by the Reserve Bank shows that on average, listed non-financial private companies experienced a 10.9% fall in net profit in the first quarter of the current fiscal. The study also indicates that sales growth declined. The findings are based on abridged financial results of 2,768 listed non-government non-financial companies.

This trend may persist in the second quarter of the current fiscal, with the exception of export-oriented sectors such as pharmaceuticals and IT.

According to estimates by Motilal Oswal Securities, only eight of the thirty companies which make up the Sensex may report profit growth rates higher than 15% while twelve companies may experience declines in profits.

Companies in industries such as capital goods, construction, cement and power are likely to see a drop in revenues and earnings. Banks may also be under pressure because of higher provisioning for bad debts (NPAs) as the economic environment has deteriorated. 

The worst-hit companies may be those who have heavily borrowed funds from overseas. According to a study by CRISIL, Indian companies hold foreign currency loans worth nearly $200 billion. These companies may now find it very costly to repay these loans because of the fall in the rupee.

Consequently, any improvement in corporate profitability may be contingent on an upswing in the economic cycle which does not seem imminent. Hence, one can use market rallies to book profits in equities.

Recovery not yet in sight

In the first quarter of FY14, India’s GDP growth slipped to a four-year low of 4.4%. This suggests that the slowdown has not yet bottomed out. India is unlikely to see a sharp uptick in GDP growth as the services sector - which accounts for nearly 60% of India’s economy – appears to be in negative territory.

In September, India’s services sector shrank as the HSBC Services Purchasing Managers’ Index (PMI) fell to 44.6 – the lowest reading since April 2009. This is the third consecutive reading below 50 – the threshold which separates expansion from contraction.

The HSBC Manufacturing PMI reading was also dismal as it suggests that India’s manufacturing sector contracted for the second consecutive month in September although the latest IIP readings were positive.

In July, the Index of Industrial Production rose by 2.6% (on an annual basis). The rebound was unexpected but the figures do not inspire confidence in the accuracy of the numbers. The rise may not be sustainable as the increase in industrial production was mainly because of a sharp jump in the production of capital goods. The improvement in this segment of the IIP was predominantly driven by an 84% spike in the production of electrical machinery and apparatus. Of this, the volatile category of rubber insulated cables rose by an unprecedented 336%.


There are also headwinds to growth because of the recent increase in the repo rate. Higher interest rates generally persuade consumers to save rather than spend. Car sales – a key gauge of consumption – declined in FY13 and the Society of Indian Automobile Manufacturers expects sales to remain in the red in the current fiscal.

As shown in the graph, private consumption growth is below the long-run average. Investment growth has also stagnated as projects are stalled and new project announcements are negligible. Higher interest rates may also deter firms from borrowing funds for investment. But the investment cycle may recover in the second half of the year if the Cabinet Committee on Investments clears stuck projects and removes the bottlenecks for investment.

According to the Project Monitoring Group, projects worth Rs 15 trillion are stalled for lack of clearances. Half these projects are in the power sector.

The green shoots include the good monsoon which may support agricultural growth and rural consumption. Furthermore, the fall in the rupee may encourage exports and hence support growth. There is already some evidence of this phenomenon as exports rose by double-digits in July and August. The decline in the currency may also discourage imports which may boost India’s GDP if firms choose to rely on local manufacturing instead (import substitution).

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



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