Market Mantra – January 2014.
– Vishal Dhawan, Chief Financial Planner, Plan Ahead Wealth Advisors.

The start of 2014 saw good news flow in on possibly the largest concern for Indian investors, Indian consumers, the Reserve Bank of India (RBI) and the government alike – ‘inflation’. Whilst Consumer Price Inflation (CPI) numbers continue to be elevated, both CPI and WPI numbers showed a sharp correction over the previous month. RBI, contrary to the broad consensus view of no change on interest rates, however went ahead and raised interest rates once again by 0.25%. The statements from the RBI governor were far more muted though indicating that if inflation continued to fall, interest rates would either be maintained at current levels or could even fall moving forward. In addition, there was a clear indication that the CPI data would be used to make future decisions on interest rate direction. The clarity on parameters driving policy decisions that are being brought about by the RBI governor is a welcome change, and we hope this process of greater transparency continues moving forward

The US Federal Reserve reduced its monthly fiscal stimulus by another USD 10 billion to USD 65 billion per month from February 2014. In spite of weak economic data of emerging economies, Federal Reserve maintained its decision to reduce the bond buying program and is also expected to continue the same going forward. Whilst there has been volatility on the back of this announcement in global markets, the impact of this reduction is likely to be limited as liquidity flows will continue at an elevated level globally due to liquidity infusions from other parts of the globe as well.

The impact of FEDs monthly fiscal stimulus reduction is likely to be limited as liquidity flows will continue at an elevated level globally due to liquidity infusions from other parts of the globe as well.

Domestic Equities: From the start of 2014 till the 28th of January, the BSE SENSEX is down approx 2.30 percent; whereas CNX Midcap declined 7.88 percent. BSE SENSEX touched its all time high of 21373.66 on 23rd January 2013.

Whilst domestic equities still continue to be stuck in a broad range, there seems to be great disparity between different components of the SENSEX. Thus, whilst the average SENSEX levels are close to their all time high, the underlying components are showing divergent trends – with defensive/consumption oriented stocks at premium valuations and cyclicals at year lows.

Falling subsidies and improving Tax to GDP ratio are already starting to create a slowdown in consumption oriented components of the economy and premium valuations expose investors to higher risks from holding defensive stocks in their portfolio.

Source: RBI, CITI, Morgan Stanley.

Cyclical stocks are currently at a discount of approx 40% to defensives. Most of these cyclical stocks are trading at multi year lows and provide significantly more value than defensives as the economy starts to show early signs of a recovery.

Deep cyclicals – Consumer discretionary, Energy, Material, Corporate Banking;

Defensives – Consumer staples, Healthcare, Retails Banking and Financials.

Political events and elections continue to dominate investor concerns and its outcome and implications on equity markets seems to be a topic of much discussion. The election year data shows that there does not seem to be any negative implication of an election outcome over a period of 1 year on equity markets. Thus, long term investors should refrain from worrying about this event excessively, and focus on valuations that are currently at reasonable levels of 13.5 to 14 times forward P/Es. Of course, short term volatility cannot be ruled out, but that should be a larger worry for traders than investors

 

 

Year Ending March 31st SENSEX** 1 Year Absolute Returns
1980 354 29%
1985 129 44%
1990 781 9%
1992 4285 267%
1997 3361 0%
1998 3893 16%
2000 5001 34%
2005 6493 16%
2010 17528 81%

Source: SENSEX: www.bseindia.com, Election commission of India for election years.

On Fixed Income: From the start of year 2014 till date, 10 year Government security yields fell by 0.79 percent from 8.82% to 8.75%. The annual consumer price inflation reduced to 9.87 percent in December 2013 from 11.24 percent in November 2013, driven by falling vegetable prices. Also, WPI Inflation reduced to 6.16 percent in December 2013 from 7.52 percent in November 2013. The gap between WPI and CPI is now close to a peak excluding the 2008 financial period.

Thus, whilst headline inflation has fallen and may fall further, core CPI has remained flat and core WPI has in fact risen. With CPI targets in the range of 8%, it remains well above the central bank’s policy repo rate of 8%, a number also coinciding with the first year ‘inflation target’ as mentioned in the Urjit Patel Committee report. Thus, whilst the CPI number needs to be watched carefully, this could well be the last interest rate hike by RBI for the year 2014. Investors looking to add fixed income into their portfolio can continue to do so as bond valuations look attractive. Source:

Source: Bank of America Merill Lynch; Core CPI excludes housing price distortion of 2006.

Short term rates which are elevated create an opportunity to add further to accrual and short term bond portfolios. Longer term bonds can be added into portfolios with a 18-24 month view. A strategy that is composed of a blend of long term and short term bonds is most suited to portfolios, as there is a tendency for portfolios to move completely towards a particular type of portfolio maturity, which we believe is not justified in the current environment.

Gold: Gold prices in Indian rupee gained close to 2.50 percent from 1st January till 28th January, 2014. The Finance minister indicated that restrictions to curb gold imports are likely be reviewed by March end. He added a caveat that these restrictions will only be removed when there is a clear grip on the current account deficit. Whilst the current account deficit is now expected to be in the range of 2.5% of GDP, which is significantly lower than expectations that were held last year of close to double that number, the tradeoff is likely to be made between the import duty on gold which is at a record high of 10 percent against the significant increase in gold smuggling activity that is being reported.

If the government reduces the import duty on gold in future, gold prices are likely to correct. However, one needs to remember that most Indian portfolios have very little protection against a falling currency, and thus gold needs to continue to find a place in a portfolio to the tune of 5-10% of the overall portfolio.

International Equities: From the start of year till 28th January 2014, the Dow Jones and Nasdaq have lost close to 4 percent and 2 percent respectively. Last week saw a sharp fall in global equities, and emerging market bonds experienced volatility not seen since May 2013. The catalyst for the sell off seems to be concerns over inflation and balance of payment issues in emerging markets – specifically in Argentina, Turkey and Venezuela. Emerging markets are dealing with a liquidity squeeze that has in part been caused by Fed’s tapering decision of monthly asset purchases and worries that emerge from specific emerging markets have the risk of impacting other emerging markets concurrently. The benefits of running a globally diversified portfolio across developed and emerging markets continues to be very strong, and with Europe also showing early signs of a recovery, and valuations that are relatively attractive vis a vis the US, there is merit to look at adding exposure

Source: MSCI, OECD, Morgan Stanley, Factset, J.P. Morgan Asset Management “Guide to the market – Asia.