Connect for the Month of February 2009 - Birla Sun Life Mutual Fund

F e b r u a r y 2 0 0 9
Market Outlook
Equity Market
Indian equity markets started the year positive on the central government's second fiscal
stimulus package. The RBI also chipped in through monetary stimulus that helped the
market earlier in the month. However, the effect was nullified by the shock the markets
received from the Satyam scam after the initial euphoria. The absence of another round of
rate cuts in the RBI policy review also did not help the already damp sentiment. BSE
Sensex ended with a loss of 223.07 points or 2.31% to end the month at 9424. The sectors
that were hit the most included Real Estate that melted 26.65% followed by Bankex, which
fell 10.17%. Among the gainers, Oil & Gas was up 3.35% and Auto was up 2.27%,
supported by the cut in the motor fuel prices that raised anticipation of higher demand.
Power stocks gained after the Central Electricity Regulatory Commission (CERC) upped
return on equity on power companies to 15.5% from the existing 14% - applicable on
projects from 2009 to 2014.
The Satyam financial fraud bodes ill for liquidity and specifically for sentiment. Focused
investors are likely to scrutinize corporate governance, disclosures, composition of
boards; use of cash proceeds etc. & stay invested or switch into perceived high quality
companies.
We believe that the long term consumption/ urbanization theme as India is less dependent
on global growth than other Asian economies. Though, some impact on domestic
consumption is inevitable, India is in much better shape with high forex reserves and much
lower consumer gearing. It is important to acknowledge that business cycles and asset
markets tend to overshoot and undershoot, and some of the recent slowdown in economic
activity, which only a short time ago seemed highly improbable – now might have a chance
of transpiring. However, going forward we are keenly watching certain key developments
which are likely to impact course of markets.
On global front, confidence was further shaken when Chinese exports, after growing by
more than 20 percent a year over the last few years and being seen as a key growth
engine, reported collapse in growth. It is believed that the Chinese the economy is highly
dependent on exports, where tens of millions of workers are employed. The millions of new
migrant workers that flock to export factories every year have been driving the urban
housing boom. Now with the export engine down, the scale of job losses from Chinese
manufacturing sector would be unprecedented, causing social unrest.
Global developments provide clear feedback to markets in terms of financial flows both into
secondary market and capital financing (in primary debt and equity markets), in turn
impacting underlying economic activity. It would also be crucial to monitor how the current
risk aversion trade reverses. In this context corporate bond spreads are vital. A sustained
rally in equity markets is more likely to be led by falling corporate bond spreads than better
economic data in the short-term. Recently, the Fed's action in the commercial paper market
has dramatically reduced yields and spreads in that market in recent months. More
recently, the BoJ and BoE have also hinted that they may be willing to consider buying
corporate debt which is likely to ultimately start to bring down spreads.
On domestic front, upcoming general election could sway the markets either way. The
uncertainty and possibility of a large coalition government at the centre would create
ambiguity over future policy actions and hence business sentiments.
Corporate earnings scorecard for the December quarter was uninspiring on overall basis.
The BSE500 members that reported results (total 322), non-banking companies registered
a decline of 37% yoy while banks showed a 24% yoy increase for Banks in Net Profit.
Overall sales growth stood at 4% yoy while EBITDA declined 20% yoy signaling a margin
compression. On sectoral basis, Banks, Telecom and IT were the only positive surprises
while on the flipside Capital Goods, Construction, Commodities and Real Estate showed
poor numbers. As the current financial year comes to a close, after the fourth quarter, there
is a risk of further downgrades to consensus earnings expectations for the coming fiscal.
Although, while, much of the negatives are already in the current stock prices, in an
economic environment like the current one, sentiments may overrule the underlying
fundamentals. Then again, precisely such scenarios yield attractive opportunities.
Our assessment of the opportunity present for the Indian economy remains unchanged. If
and when right policy levers are used, it would not be difficult to match the potential either.
In the short term, though, the markets may behave in unpredictable ways as various
participants weigh their tactical moves. As a strategy, we consider it prudent to gradually
invest incrementally into equities through 2009 with a 3 to 5 years investment horizon.
Corporate performance is likely to look up from the later part of the fiscal 2009-10 and the
equity markets should bottom out some time before that.
Debt Market
Bond market
The 10-year yield rose to as high as 6.18% during the month after making a historical intraday
low of 4.86% at the start of the month. The 10 year yield on AAA corporate paper
moved from 8% to a high of 9.15% during the month making it one of the most volatile
month. Money market yields maintained a downward trend on back of easy liquidity with 1
year CDs coming down from a high of 8.50% to making a low of 6.90%.
Macro factors overall supported the debt market but bonds appeared to have hit a ceiling
on concerns of overwhelming supply. Government is expected to come up with an
additional borrowing requirement for FY09 which will flood the market and thus an upward
pressure on the yields. The government on January 6th raised the borrowing target for the
fourth quarter to garner funds for meeting rising expenses.
Exports dropped 1.1% yoy in December, a third consecutive drop as the global slowdown
dampens demand. The trade deficit narrowed in December due to a sharp drop in the cost
of oil imports. The industrial output rose 2.4% in November y-o-y, rebounding from the
previous month's revised decline of 0.3%. Fiscal deficit during April-December stood at
2.18 trillion rupees, ($44.5 billion) or 163.8% of the annual target. The government has
borrowed INR 2.15 Tr as against budgeted INR 1.45 Tr.
Yields on government securities across the globe came off from the lows reached during
December despite macro factors being in support of the debt market. European bonds
faced selling pressure with several European countries facing sovereign rating
downgrades. Central banks still continue on rate cutting spree with BoE bringing down its
policy rate to historical low. ECB, Australia, Bank of Korea and Taiwan also cut their policy
rates. Fed maintained the target rate near zero and in addition announced the extension of
swap lines with various central banks across the globe and continuation of existing liquidity
facilities in domestic markets. IMF has cut down the global growth forecast to 0.5% from
2.2%, the lowest ever since World War-II. The outlook remains bleak for the current year.
On January 2, the RBI had cut the LAF rates by 100 bps and eased CRR by 50 bps,
releasing Rs.20,000 crores into the system. Later in its Policy review meeting, Reserve
Bank of India kept all its policy rates unchanged. Though, policy stance remains
considerably dovish and paves way for further monetary easing as and when required.
RBI's stance on growth and inflation matches the market consensus as they expect both
the economic indicators to ease substantially. We expect RBI to ease further over next few
months as economic news gets gloomier. RBI acknowledges that non-banking financial
resources for banking system have dried up causing increased demand for credit from the
banking system. This remains a key reason for elevated bond spreads. We expect the
credit growth to slow down considerably over next two quarters, easing pressure on
banking system to industry's financing needs.
We don't think that RBI is pausing in easing rates, and the current stance of 'hold' is only to
accommodate the transmission of deep rate cuts RBI has orchestrated over last three
months. Since RBI has extended the refinance window for MFs and NBFCs till September,
it augurs well for further easing in the money market rates. 10-year Gsec is trading at
5.80/85 and is likely to take fresh cues from IIP, GDP, export-import data and unscheduled
auction announcements in the coming weeks.
Bond yields are likely to be choppy in the near-term owing to the prevailing uncertainty over
additional government borrowing. Macro factors support bonds but those aspects have
been fully factored in and bonds remain bogged down by short-term uncertainties. The
vote-on-account to be held on 16th February is much awaited for. Current scenario
remains a tug-of-war between unprecedented monetary easing and huge bond supply
causing the volatility. We expect the markets will remain volatile till the issue of additional
borrowing is resolved.
Our Investment Team (In alphabetical order)
A. Balasubramanian Chief Investment Officer
Achala Kanitkar Research Analyst - Equity
Ajay Argal
Co - Head Equity
Ajay Garg
Fund Manager - Equity
Ankit Sancheti Fund Manager - Equity
Atul Penkar
Hemang Dagli
Hina Sampat
Lokesh Mallya
Mahesh Patil
Fund Manager - Equity
Sr. Dealer - Equity & Deri. Specialist
Executive - Knowledge Management
Credit Analyst-Fixed Income
Co - Head Equity
Maneesh Dangi
Paresh Khandelwal
Prasad Dhonde
Sanjay Chawla
Co - Head Fixed Income
Equity Analyst
Fund Manager - Debt
Fund Manager - Equity
Satyabrata Mohanty
Sujit Patki
Sunaina da Cunha
Vineet Maloo
Co - Head Fixed Income
Dealer-Equity
Fund Manager - Debt
Fund Manager - Equity
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