Market and economic outlook report june

Market and economic outlook reportMarket and economic outlook report

June 2013

Summary: Positive factors affecting

the markets

�Strong FII inflows in May due to QE by Japan and US.

�GDP growth has bottomed out.�Improving growth-inflation dynamics.�Rate cuts likely to continue.�Rate cuts likely to continue.�Declining commodity prices.�CCI pushes through projects�Monsoon on schedule.�Reliance’s KG-D6 find.

Summary: Negative factors

affecting the markets

◌ः Talk of withdrawal of QE spooks Indian markets.

◌ःDeveloped markets now getting more inflows than EMs.

◌ः Strong supply of paper caps possibility of upside gains.

◌ःWeak corporate earnings.◌ःWeak corporate earnings.

◌ः Revival of private capex still distant.

◌ःWeakening rupee.

◌ः Political stagnation.

◌ःOther negatives.

Market outlook

Asset Class Current Levels( as on May 31, 2013)

Summary View

Why Risk to our View

Equity Nifty: 5,985.95

Sensex: 19,760.30

Markets will

be under

pressure.

High supply of paper.

Sensex PE stretched at

17.55 (May 31, 12-

month trailing).

High inflows

due to high

global liquidity.

month trailing).

Gilts G Sec ( 8.15% 2022) –

7.35

G Sec ( 7.16% 2023) –

7.15

Likely to

soften

Easing Inflation

RBI to focus on Growth

RBI likely to announce

25 bps cut in

forthcoming policy

Sharp Rupee

Depreciation

Index Watch

Index Name %age change in May YTD (%)

S&P BSE SENSEX 1.31 1.72

S&P BSE Mid-Cap 0.72 -10.17

S&P BSE Small-Cap -1.29 -19.46

S&P BSE TECk Index 3.69 5.09

S&P BSE Consumer Durables 3.53 -0.31

S&P BSE FMCG 3.41 14.47

S&P BSE AUTO Index 1.90 -2.27S&P BSE AUTO Index 1.90 -2.27

S&P BSE Health Care 1.79 8.79

S&P BSE Power Index -0.39 -11.84

S&P BSE OIL & GAS Index -0.65 1.60

S&P BSE BANKEX -0.71 -0.58

S&P BSE METAL Index -1.71 -23.19

S&P BSE PSU -3.04 -9.26

S&P BSE Capital Goods -3.20 -13.44

S&P BSE Realty Index -11.38 -20.18

YTD figures are till May 31, 2013

P: Strong FIIs flows during the

month

MonthFII investment (Rs-

cr)MF investment (Rs-

cr)

Jan 22,059.2 -5,212.4

Feb 24,439.3 -847.9

March 9,124.3 -1,613.6

April 5,414.1 -1,422.9

May 22,168.6 -3,490.1

Cumulative YTD 83,205.5 -12,586.9

P indicates positive factor

P: Strong FII inflows in May

◌ः The Bank of Japan (BoJ) announced a massive balance sheetexpansion (bond buying program), by 1% each month, in the firstweek of April.

◌ः With Japan also joining the queue of central banks engaging inquantitative easing (QE), a lot more QE is happening now than afew months ago.few months ago.

◌ः The central banks of US, Europe and Japan are determined to getgrowth back on track and have consumer price inflation of around2%.

◌ः High liquidity will drive asset prices, including that of equities,higher in developed markets (which are now receiving moreinflows) but also in emerging markets.

P: GDP growth has bottomed outGDP growth-Sector wise

Sector FY12 H1FY13Q3FY1

3Q4FY1

3 H2FY13FY13FY14 *

Agriculture 3.6 2.3 1.8 1.4 1.6 1.9 3.5

Industry 3.5 1.5 2.5 2.6 2.6 2.1 4

Mining and quarrying -0.6 1 -0.7 -3.1 -1.9 -0.6

Manufacturing 2.7 -0.5 2.5 2.6 2.5 1Manufacturing 2.7 -0.5 2.5 2.6 2.5 1

Electricity, gas and water 6.5 4.7 4.5 2.8 3.6 4.2

Construction 5.6 5.1 2.9 4.4 3.6 4.3

Services 8.2 7.7 6.7 6.6 6.6 7.1 7.2Trade, hotels, transport and

communication 7 6.4 6.4 6.2 6.3 6.4Financing, real estate and

business services 11.7 8.8 7.8 9.1 8.5 8.6Community, social and personal

services 6 8.6 5.6 4 4.7 6.6

GDP at factor cost 6.2 5.3 4.7 4.8 4.7 5 5.8

*These are estimates by HDFC Bank

P: GDP growth has bottomed out

◌ःThe Q4FY13 GDP growth figure, which waspublished on May 31, came in at 4.8%, whichwas in line with market expectations.

◌ःQ3FY13 GDP growth was revised upward to◌ःQ3FY13 GDP growth was revised upward to4.7%. This confirms the belief that theeconomy bottomed out in the third quarter.

◌ःGDP growth for the whole of FY13 came inat a 10-year low of 5%.

P: GDP growth has bottomed out

◌ः Private services held up well: trade, hotels,transportation and communication came in at 6.2%,while financial services came in at a rather high 9.1%.

◌ः It remains to be seen whether these figures will besustainable in the light of slowdown in industrialsustainable in the light of slowdown in industrialactivity.

◌ः Industrial growth in Q4FY13 was lower than expected,chiefly due to lower-than-expected growth inconstruction (4.4%). With many road projects gettingbunched up in Q4 FY 13, the uptick in construction wasexpected to be sharper.

P: GDP growth has bottomed out

◌ःThe winter crop was good. Nonetheless,agricultural growth came in lower at 1.4% inQ4 compared to 1.8% in Q3. This figure mayget revised upward in future.get revised upward in future.

◌ःLooking at these numbers, the green shootsof recovery, which are talked about somuch, are not evident, says HDFC chiefeconomist Abheek Barua in a recent report.

P: GDP growth has bottomed out

◌ः Next, let's look at the GDP growth figures from thedemand side.

◌ः Consumption is weakening: private consumption fell from4.2% in Q3FY13 to 3.8% in Q4 FY 13.

◌ः So is investment: gross fixed capital formation slowedfrom 4.5% in Q3 to 3.4% in Q4 FY 13.from 4.5% in Q3 to 3.4% in Q4 FY 13.

◌ः Exports might revive in future but their impact will belimited.

◌ः The pullback in government expenditure, which has beensharp over the last couple of quarters, has affected GDPgrowth.

P: GDP growth has bottomed out

◌ःAccording to Indranil Sen Gupta, IndiaEconomist, DSP Merrill Lynch, India might see ashallow recovery in the second half of 2014based on a normal monsoon and interest ratecuts.

◌ः

cuts.◌ःBut the liquidity situation remains tight andthat has prevented lending rates from falling.

◌ःGupta has revised his FY14 growth projectionfrom 6% to 5.8%. His FY15 growth projection is6.8%.

P: Improving growth-inflation

dynamics

◌ः India’s fundamentals are improving.

◌ः Currently growth is low and corporate profitability ispoor. Expectations from India on the policy front arealso low.

◌ः But fiscal deficit is being reduced through measures◌ः But fiscal deficit is being reduced through measuressuch as reduction in diesel subsidy.

◌ःNow lower growth is also resulting in lower inflation.

◌ः India’s ratio of inflation to growth is 1.2, which isbetter than Brazil's 2.8 and Russia's 1.7.

◌ः The central bank now has more room to cut rates.

P: Rate cuts likely to continue

◌ः The sharp depreciation of the rupee and the possibilityof another large trade deficit in May could weigh onGovernor Subbarao's mind.

◌ः There could be a pause in the policy easing cycle inJune.

◌ः◌ः But weak growth prospects and falling inflation couldcreate conditions for further easing in July with a 25basis points rate cut.

◌ःMost experts expect incremental cuts of 50-75 basispoints between now and March 2014.

◌ः Rate cuts, if passed through by banks, could spurconsumption and investment.

P: Declining commodity prices

◌ः Commodities may be divided into four groups: agriculture, energy,industrial metals and gold.

◌ः All four did well between 2002 and 2008.

◌ः Commodities faltered in 2011 and fell further in H22012.

◌ः Between 2002 and 2008 industrial metals did well because of theglobal growth boom. The Chinese economy was doing well andglobal growth boom. The Chinese economy was doing well anddemand for industrial metals was high.

◌ः Industrial metals are suffering now because of excessive supplycaused by heavy investments in mining, based on anticipation ofChinese demand. But the Chinese boom has faltered.

◌ः With the global economy doing relatively well now (Europe has notimploded and the US economy is on the path of recovery), the safehaven demand for gold has also declined.

P: Declining commodity prices

◌ः Investors have gone back to investing in financial assets.

◌ः Moreover, the anticipated supply risk did not materialise.

◌ः The Arab Spring or the Iran-Israel stand-off did not lead todisruption in supply of oil.

◌ः The US has reduced its dependence on imported oil◌ः The US has reduced its dependence on imported oilbecause it has discovered its own oil and gas reserves.

◌ः Despite bad weather, supply of agricultural commoditiesdid not fall off precipitously.

◌ः Lower commodity prices offer India, which is a heavyimporter of oil, gold and coal, a temporary reprieve.

P: CCI pushes through projects

◌ः There has been some pickup in public-sector capex.

◌ः The Cabinet Committee on Investment (CCI) has◌ः The Cabinet Committee on Investment (CCI) hascleared projects worth about Rs. 70,000 crore over thelast three months.

P: Monsoon on schedule

◌ः A bad monsoon this year will truly harm India's cause.While the rivers in the east and north of the countryare well stocked, those in the west and south havedried to drought levels.

◌ःOnly if the monsoon is normal will agricultural inflation◌ःOnly if the monsoon is normal will agricultural inflation(especially food inflation) decline, creating room forRBI to cut rates more.

◌ः The monsoon hit the coast of Kerala on June 1.

◌ः India's meteorological department has forecast anormal monsoon (98% of long-term average).

P: Monsoon on schedule

◌ः The Australian Met also expects the Pacific to remainneutral between the La Nina (which brings rain clouds toIndia) and El Niño (which drives them away).

◌ः India usually experiences normal rainfall in such years .

◌ः But it may be too early to say anything about the◌ः But it may be too early to say anything about themonsoon.

◌ः It lasts for four months from June to September. Usuallythere is a dry spell in July and August. How long it lastsand how much area it affects is difficult to predict.

◌ः Besides the overall quantum of rainfall, its distributionacross the country also matters.

P: Reliance’s KG-D6 find

◌ःIn May several brokerage houses such asGoldman Sachs and Deutsche Bank upgradedReliance Industries after it reported asignificant gas find in the KG-D6 basin.significant gas find in the KG-D6 basin.

◌ःReliance Industries is India's biggest company bymarket capitalisation with a weightage of 8.62%in the Sensex.

N: Talk of withdrawal of QE spooks

Indian markets

◌ः In May the markets took a beating due to fears of an earlywithdrawal of the US Fed’s QE program.

◌ः In his testimony before the Congressional Joint EconomicCommittee, US Fed chairman Ben Bernanke said that heneeds to see more signs of improvement before he rolls backthe stimulus program.the stimulus program.

◌ः What spooked the markets was the minutes of the FederalOpen Market Committee (FOMC) meeting held on 30 Apriland 1 May.

◌ः Many committee members expressed willingness to reduceasset purchases as the economy recovered.

◌ः In the Bank of Japan (BoJ) meeting held on 26 April,members expressed doubts about the efficacy of QE.

N: Talk of withdrawal of QE spooks

Indian markets

◌ःThe Bank of Japan is targeting a 2% inflationrate. Some members voiced concern that if therate turns out to be lower than projected, itwould affect the bank's credibility.would affect the bank's credibility.

◌ःIf inflation rises to 2%, people will want higheryields on their debt investments.

◌ःRising yields could damage the financialsector’s balance sheet and chances of recovery.

N stands for negative factor

N: Talk of withdrawal of QE spooks

Indian markets

◌ः What is likely?

◌ः The likelihood of an early withdrawal of QE is small. The Fedwon’t act until the US unemployment rate falls to 6.5%.

◌ः Reduction in bond buying by the Fed may begin by Decemberthis year, according to Adrian Mowat, Chief Emerging Marketand Asian Equity Strategist at JP Morgan. The reduction willand Asian Equity Strategist at JP Morgan. The reduction willbe moderate rather than sharp.

◌ः Impact on India

◌ः In the near term, prospects of liquidity flows remain sound.

◌ः If the US Fed withdraws QE, it will definitely affect fundflows into emerging markets.

N: Talk of withdrawal of QE spooks

Indian markets

◌ः Though the withdrawal of QE will be very gradual so asnot to have a destabilising effect, some negative impacton the financial markets will definitely be there. Allfinancial instruments have gained from low interest rates.

◌ःWhy are Indian markets worried?◌ः India is especially vulnerable as it runs a high current◌ः India is especially vulnerable as it runs a high currentaccount deficit. It needs $ 100 million of annual capitalinflows to fund its current account.

◌ः The rupee could take a severe beating. In the worst casescenario, there could even be capital outflows from thecountry. Both equity and real estate prices would comeunder pressure.

N: Developed markets now getting

more inflows than EMs

◌ःCurrently inflows into developed market equitiesare increasing compared to the inflows intodeveloping markets, due to the improvement in theUS economy.

◌ः In emerging market equities exchange traded fundsare seeing outflows since the EM index is not going

◌ः In emerging market equities exchange traded fundsare seeing outflows since the EM index is not goinganywhere. Investors are taking EM exposurethrough active funds.

◌ःWhile EMs may continue to receive some inflows,more funds are now likely to go into developedmarkets.

N: Strong supply of paper caps

possibility of upside gains

◌ः According to Sebi’s stipulation, listed companies mustensure that 25% of their shares are held publicly.

◌ः A lot of companies are coming into the markets withtheir papers.

◌ः There have been offers for sale (OFS) where stocks are◌ः There have been offers for sale (OFS) where stocks arebeing offered at a discount ranging from 10-40%.

◌ः Rs 13,500 crore worth of OFS to flood the market overthe next few weeks.

N: Strong supply of paper caps

possibility of upside gains

◌ः70 odd private companies have to sell at least 25%of their equity capital worth Rs 9,500 crore tillJune 3.

◌ःPSU companies have to divest shares worth Rs.◌ःPSU companies have to divest shares worth Rs.4,000 crore by August 8.

◌ःFIIs have pumped in about Rs 83,205 crore so far,yet the Sensex is up only 1.72% year to date.

◌ःThe deluge of OFS is likely to cap any upside gainsfor the markets.

N: Weak corporate earnings

◌ः Nirmal Jain, chairman of India Infoline, said in a recentinterview that almost half of the 180-odd companies coveredby his firm have disappointed.

◌ः Sectors like consumer, pharma, IT, telecom and private bankshave done well.

◌ः But sectors like capital goods, infrastructure, cement, utilities,◌ः But sectors like capital goods, infrastructure, cement, utilities,energy and PSU banks have disappointed.

◌ः Consensus estimate for year-on-year earnings growth in FY14 iscurrently 16%. This is optimistic in view of the fact that it istwice the likely y-o-y growth for FY13.

◌ः Downgrades of FY14 earnings estimates are likely to continue.

◌ः No upgrades are expected in the near term.

N: Revival of private capex still distant

◌ः In India it is conventional wisdom to blame the growthslowdown on local factors, such as lack of environmentclearances, lack of reforms in land acquisition, etc.

◌ः But capex has slowed down across all BRIC countries due tothe global business downturn.the global business downturn.

◌ः The capex cycle will not turn until the general elections inMay 2014 are over and the global business cycle bottoms out(by 2015).

◌ः Private capex will also not happen so long as capacityutilisation remains subdued. Many companies also have toreduce their level of debt.

N: Weakening rupee

◌ः The rupee has weakened against the dollar.

◌ः But the euro, yen, Brazilian real, South African randand Korean won have also weakened against the dollar.

◌ःWe are entering a strong dollar environment which willbe difficult on all emerging market currencies.

◌ः

be difficult on all emerging market currencies.

◌ः A weakening rupee makes imports more expensive forIndia.

◌ः It also affects FIIs’ returns adversely and couldpotentially lead to a pull-out of funds.

N: Political stagnation

◌ःSeveral state elections are scheduled in thenear term, culminating in the general electionsin May 2014.

◌ःProgress on critical reforms like land acquisitionis unlikely in the near term.

◌ः

is unlikely in the near term.

◌ःMining and infrastructure will continue to sufferdue to lack of decision-making.

◌ःMarket volatility will be high in the run-up tothe general elections.

Other negatives

◌ःConsumption is moderating, as is evidentfrom declining retail sales.

◌ःAuto sales, credit card usage, and domestic◌ःAuto sales, credit card usage, and domestictravel are all declining.

◌ःThese factors limit the likely upside gainsfor the Indian equity markets.

Thank youThank you