Empower for the Month of February 2013 - Birla Sun Life Mutual Fund

Investment Outlook
Equity Investment Outlook
The benchmark indices, Sensex and Nifty rose 2.4% and 2.20% respectively over the last
month. This was aided by gains in sectors such as IT, Oil & Gas, Realty and Banking. On
the other hand, Metals, Auto, Pharma, Capital Goods and Infrastructure bore the brunt of
investor selling. Broader market indices were little subdued with BSE500 gaining by 1.1%
only. This was mainly on account of poor show by mid caps which fell by 1.7% (CNX Mid
cap Index).
FIIs started the year with stepped up pace of buying in Jan with net purchases to the tune
of $4.1bn. Note that we had finished CY12 with $25bn of FII inflows into equities. Domestic
Institutional Investors (DIIs) once again remained firmly positioned on the other side of the
trade, notching up another $3.2bn in net selling. Among the DIIs, Insurance companies
were by far the bigger sellers ($2.3bn) with the Mutual Funds adding another $870mn.
Key point to note is the continuation of reforms with announcements on fuel subsidy
reduction by tackling contentious issue of diesel price deregulation – allowing Oil Marketing
Companies (OMCs) to raise diesel prices in small steps every month. Controversial
tax proposals under GAAR were also deferred by 2 years and will be implemented on
prospective basis, increasing railway passenger fares etc. The FM has been on a roadshow
meeting foreign investors across geographies and sending a categorical message that
fiscal prudence would be maintained. To this end, we expect the divestment activity to
continue following stake sale in Oil India. We expect policy action would continue in form of
project clearances coming through (Cabinet Committee on Investments to play key role in
this), establishment of coal price pooling mechanism to enable supply of imported imports
to stranded power plants, implementation of State Electricity Board (SEB) reforms etc.
As the earnings reporting season is progressing, we are witnessing more positive surprises
than negative ones, leading to net positive revision in earnings. This is in line with our view
that earnings growth is likely to see an upward trajectory going forward. Further, RBI’s
decision to reduce Repo rate and CRR by 25 bps each should also help lower interest rates
for borrowers and eventually provide some relief on corporates’ bottom lines.
Another important point is that equity deals have started picking up as we saw deals
totaling $1.1bn during the month. This includes fresh equity raising as well as stake sales.
As per media reports there is a strong deals pipeline for the next 2 months. We think this
would help repair some of the broken balance sheets and provide capital for growth to the
corporate sector.
We maintain our positive stance in equity markets for the year and beyond. The returns
would be governed by earnings growth revival. The trajectory is unlikely to be linear as
market sentiments may oscillate with policy actions or events. As we have seen any such
volatility presents opportunity to pick up stocks at attractive levels, investors should allocate
incremental capital to equities in such situations. This is part of market psyche where the
effect of such transient issues diminishes over medium term and the market eventually
resumes its trajectory towards underlying earnings growth.
Debt Investment Outlook
Domestic Growth Outlook
As we complete the first month of 2013, our base case remains that GDP growth in 2013
will pick-up to 6.5% from the 5-5.5% GDP growth we expect in 2012. The biggest comfort
we draw in this conclusion is that India’s industrial growth as reflected by IIP seems
to have bottomed out. After averaging close to 0% in the Mar’12-Sep’12 (on a 3mma
basis), 3mma IIP has picked up to 2.4% in Nov’12. Moreover, we expect the reforms
initiative started by the current finance minister in Sep’12 to further boost the industrial
cycle. According to us, the most important reform in the last few months from a growth
perspective is the formation of a Cabinet Committee on Investments (CCI) which can help
resolve the almost 8 trillion rupees worth of large projects (based on CMIE data) that have
been stalled due to environmental and regulatory clearances.
On a fundamental level, there are 2 key reasons why we expect growth to pick-up in CY
2013. Firstly, the reforms momentum initiated by the government which can help restart
the investment cycle of the country and resolve the backlog of stalled projects. Secondly,
we believe RBI will be cutting rates by 50-75bps in CY 2013. And this will have a positive
effect on GDP growth by boosting consumption. RBI has already started this cycle by a
25bps rate cut in January 2013. Unfortunately, if the CAD (current account deficit) and
fiscal deficit of the country were not in such a bad state, the central bank could have taken
much more stronger steps in re-invigorating growth.
That said, we remain cognizant of incoming data and are always on the look-out for
data that might challenge our above view. For example, some of the recent data points
such as January PMI data and December credit growth are concerning from a growth
perspective. Moreover, RBI in its latest monetary policy talked about continued slowdown
in the services sector – a key reason RBI has downgraded FY13 GDP growth to 5.5% from
its earlier estimate of 5.8%. Finally, we are closely watching the fiscal consolidation efforts
by the government which also have a short term negative effect on growth.
Overall, we retain our view that growth can recover to 6.5% in 2013 but are closely
watching the economic trends that might change our forecast.
Domestic Inflation Outlook
One of the key economic puzzles for us in 2012 was the stubbornness in India’s inflation.
Despite a dramatic slowdown in growth from the 9.3% in FY11 to 5.3-5.4% in first 6
months of FY13, our wholesale price index (WPI) remained pretty range bound in 7.5-8%
range for the first 9 months of the year. But finally, there are some positive signs emerging
on the inflation picture. WPI has moderated to 7.18% in Dec’12 after averaging 7.63% in
the first 9 months of 2012. Moreover, we expect inflation to moderate further to ~6.5% by
Mar 2013 and average 6.5-7% for CY 2013.
Historically, India’s inflation has had a very strong correlation with global commodity
prices. In this regard, the fact that global commodity prices have remained range-bound
despite the significant quantitative easing programs announced by western central banks
(US federal reserve has committed itself to expand its balance sheet by ~$1 trillion in
2013) is a significant positive for our inflation picture. Another big positive is that the
growth slowdown should have resulted in excess capacity In the economy – thus mitigating
inflationary forces in the economy.
One key point to note here is that increase in diesel prices (the steps announced by
government recently) are a significant positive for the economy even though there may be
a 50-75bps incremental impact on inflation of the diesel price hikes in the short run. Diesel
price hikes are a significant positive because it releases our suppressed inflation and thus
removes one of RBI’s key concerns regarding lowering interest rates.
Debt Market Outlook
After WPI printed 7.18% in mid January 2013, significantly lower than market consensus
and much below RBI’s own fan chart on inflation, gilts rallied and 10 year benchmark
briefly touched 7.80% in expectation that RBI may cut repo rate by 50 bps. However after
this brief euphoria, market woke up to the hawkish comments from RBI governor on still
elevated level of inflation in the economy. These comments spooked the bond markets and
reduced the possibility of RBI doing anymore cut than 25 bps on repo. In the monetary
policy, the RBI did stick to only 25 bps cut in repo and also delivered 25 bps cut in CRR.
In its post policy con-call and post policy interaction with media, RBI expressed its
discomfort on the level of current account deficit (CAD) of the country, something that had
made us equally worried in the recent past especially after seeing 5.4% CAD in Q2FY13
especially at a time when domestic growth has slowed down significantly. With CAD ruling
very high, inflation expected to hover around 6.5%-7% in 2013 and domestic growth
bottoming out, we feel it is a highly unlikely that the RBI will deliver aggressive rate cuts in
this cycle something that was seen during 2001-03 and 2009-10.
We believe that terminal repo rate in this interest cycle, may at best be 7.25% and that this
repo rate will be visible not before H2CY13. The anomaly is that by the time the terminal
repo rate will drop to 7.25% the worries on fiscal account due to nearing General Election
would begin to resurface. We may see the ruling party being aggressive on social spending
(e.g. a big push on food security bill) going into election, we may see some of the current
reforms being halted (e,g, a halt in monthly Diesel price hikes) or even unwound.
Overall CY13 will be a year of 2 halves. In the first half we will have lot of good news on
fiscal front, on reforms front and bit on monetary policy front but it is difficult to say how
many of these fiscal measures will stay as the General election approaches.
In the last 1 year, 10yr gilt has rallied by almost 100 bps. We were at 8.78% in April 2012
and touched 7.80% in Jan 2013. Of this 100 bps, almost 40 bps rally was witnessed in
Dec-Jan itself. If you can recall, we had given a call in the month of August when 10 year
Gsec was hovering at around 8.25%, that 10 yr yield will go to 7.50%. Of the 75 bps rally
that we had talked about, 45bps panned out by Jan 2013. In all our duration portfolios,
viz; Dynamic Bond Fund (DBF), Income Plus (BIP) and Govt. Securities Fund – LT we
played this rally with a very high level of conviction. At peak our exposure to gilts/ SDLs
(SLR securities) across our duration funds was much higher compared to many of our
competitors. In DBF we had a peak exposure of 23%, in Income Plus the exposure was
86% and in our gilt funds the exposure was 95% to SLR securities. We also played this rally
chiefly through gilts than through SDLs.
We reduced our exposure to gilts across our funds in 7.80-84% yield band. This is because
with sharp rally already behind us, quantum of balance rate cut being small and timing of
rate cuts being well spaced out, we believe it may not be possible for 10 year to go near
7.50% anytime soon. From here till April, we do not see any great triggers that may result
into another 20-40 bps rally. At best the market may stay range bound between 7.80-8%
till April 2013.
Going forward, increase in duration in our funds will be based on evolving macro-economic
developments and market technicalities. In our DBF, Short Term Fund (STF) and our other
ultra short term funds, we are readying ourselves to play yield curve inversion going into
March. We will play this opportunity in BIP too, while taking tactical calls in GOIs/ SDLs/
Corporate bonds as and when the opportunity arises.
Our advice to investors would be to stay invested in duration funds at this point of time
as we believe another 25-50 bps repo cut is a good possibility; however we would like
to caution our investors that the past performance, especially the recent one may not be
repeated as we pass through a tumultuous period going ahead.
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