In the month of July 2010, the Indian equity markets (BSE Sensex) continued to show its indecisive movement depicting a consolidation, but nonetheless ended the month in green by mere 167.4 points (0.9%). The cool-off in the Index of Industrial Production (IIP) number to 11.5% in May 2010 (data released in July 2010), from 16.5% in April 2010 also attributed in this lacklustre upside movement. Moreover, the talks of a double-dip recession in the global economy also caused this jittery movement in the Indian equity markets.
The markets also remained under the influence of Q1 earnings expectations and the results. However this time, the reactions from Q1 results were less volatile (in cases where the announcements were better or worse than expectations) and the marginal increase by Reserve Bank of India (RBI) in policy rates (repo by 50 basis points and reverse repo by 75 basis points) also didn’t surprise the Indian equity market.
(Source: ACE MF)
The graph above depicts that despite the cool-off in IIP number and the indecisive movement of the Indian equity market, the Foreign Institutional Investors (FIIs) continued to exude confidence on the long-term prospects of the Indian economy, and bought net to the tune of Rs 16,617 crore in the Indian equity markets; as compared Rs 10,508 crore (net buying) in June 2010.
According to the quick estimates released by the Central Statistical Organisation (CSO), the main reason for the slowdown in the IIP growth was on account of:
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Decelerating manufacturing growth -The manufacturing index, which is the principal component of the IIP, decelerated to 12.3% in May 2010, as compared to 17.9% in the previous month (April 2010).
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Loss of growth in sectoral output - Output of capital goods grew only at 34.3% in May 2010, as compared to 69.9% in the previous month. Similarly, the output of consumer durables and consumer non-durables also slowed down to 23.7% (37.0% in the previous month) and 2.4% (6.6% in the previous month) respectively, with the overall growth in consumer goods also going down to 8.2% (14.5% in the previous month).
What should equity investors do?
In our opinion, at present the Indian equity market is showing some resistance from moving up, not ruling out the fact that valuation in certain stocks and sectors are looking expensive. And if these stocks and sectors further move up, there are chances that we may see a sell-off in those stocks and sectors.
However, it is noteworthy that long-term earnings growth still looks good. Moreover, GDP growth projection of 8.5% (for fiscal year 2010-11) from the Finance Ministry also seems achievable given the recovery in our economy. Moreover, to tame spiralling inflation, RBI may continue to adopt the calibrated exit path and thus increase policy rates, without hurting economic growth.
We therefore recommend investors to stay invested and invest more (in a phased manner) in equity funds which focus on India’s strong domestic fundamentals. In fact, any decline in the equity market should be used by investors to buy, as these are opportune times to invest in funds which are driven by strong investment processes and fundamentals.
One should not look at the immediate index levels, as they do not matter for a long-term investor.
Debt market update
In a move to tame spiralling double-digit inflation, the RBI increased the key policy rates (repo and reverse repo) twice in the month of July 2010.
(Source: Reuters website)
At the beginning of the month (on July 2, 2010) the central bank increased with immediate effect, the repo and reverse repo each by 25 basis points, thus placing them at 5.50% and 4.00% respectively. But, taking into account that deregulation of fuel prices (in the last week of June 2010), would further stimulate inflation for July 2010, the central bank continued to adopt the calibrated exit path in its first quarter review of monetary policy for 2010-11.
The Repo rate was increased by 25 basis points, from 5.50% to 5.75% and
Reverse Repo rate was increased by 50 basis points, from 4.00% to 4.50%
However, taking into account the liquidity situation, the Cash Reserve Ratio (CRR) was kept unchanged at 6.00%.
But, not ruling out the progress of monsoon, (which will improve the chance of good harvest), and domestic macroeconomic scenario, the RBI projected headline WPI inflation to settle down to 6.00% by March 2011 (thereby revising its earlier projection of 5.50% as given in April 2010 policy review), and made it within the forecasted inflation range of 5.00% to 6.00% given by the Finance Ministry.
What should debt investors do?
In our opinion RBI will certainly continue adopting the calibrated exit path by raising policy rates by 25 basis points at each step, to normalise policy rates and make it more relevant to the current high economic growth and spiralling inflation. Hence, RBI in its next mid-quarter review of monetary policy (scheduled for September 16, 2010), may increase the policy rates again by another 25 basis points.
Hence as the repo rate is increased, cost of borrowing for individuals and corporate may move up, as lending rates may move up marginally. Similarly, the interest rates on fixed deposits may also start firming up. But, we think that interest rates on fixed deposit may become attractive (when above 7.50%) only after the next mid-quarter review of monetary policy, scheduled for September 16, 2010.
Hence in such a scenario, debt funds are not the ideal investments in a rising interest rate scenario. This is because the bond price and interest rates are inversely related to each other. In the current scenario, we recommend that investors stay away from pure income and government securities funds till September 2010.
Investors with a short-term time horizon would be better off by investing in liquid and liquid plus funds for the next 2 months; while the medium term investors with an investment horizon of over 6 months can allocate their investments to floating rate funds.
Investors should refrain from investing immediately in fixed deposits till a further increase in deposit rates is offered by banks. One year bank FDs would be attractive only above 7.50%. One year FDs are currently available at 5.75% to 6.50%.
Gold market update
(Source: World Gold Council)
As gold prices continued to escalate in the earlier months, the demand for gold dropped thus leading to correction in prices in July 2010. Also as fears of sovereign debt disaster receded and the Euro strengthened, investors’ risk appetite was renewed and in bargain gold was hit hard.
Increased optimism on economic recovery also resulted in higher risk appetite which curbed the demand for gold as a store of value. This was also reflected in the rising stock markets. The risk trade seemed to be back. Investors chased higher returns moving to stocks, equity funds and commodities and shunned safer assets. Thus, gold perceived as the ultimate "safe havens" lost ground.
In July 2010, gold price fell by -5.3%, thus breaking the USD 1,200 per ounce mark. Gold prices in USD as measured by the London AM Fix also corrected by -5.8%, as the U.S. dollar weakened.
In the Indian Markets, we saw prices following international cues falling below Rs. 18,000 per 10 grams mark (at Rs 17,870 on July 31, 2010), down by 5.4% from its month’s opening value (Rs 18,850 per 10 grams).
What should investors in gold do?
In our opinion fundamentally, nothing has changed for gold. The huge debt issues and structural fiscal imbalances still remain largely unresolved. The key gold price drivers this year remain the difficult economic situations in both the United States and Europe.
Hence during such times (economic uncertainties), we think that gold will be a classic safe haven. Gold should be seen today as an “insurance policy”, due to the rising concerns of “currency devaluation”, “sovereign debt crisis” and “inflation”. Hence in such situations, we suggest that investors should gradually keep allocating to gold and make the most of any declines by increasing allocations to this asset class.
At PersonalFN, we recommend that every investor should have a minimum of 5%-10% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years.
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For Debt Market Update, the inputs were taken from the Fund Manager - Fixed Income of 'Quantum Mutual Fund'."
For Gold Update, the inputs were taken from the Fund Manager - Commodities of 'Quantum Mutual Fund'."
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