Markets to take cue from global economic scenario

Equity market update

In the month of August 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 270.2 points (or 1.50%). However, the Indian equity markets remained nervous on account of the global economic worries and southward movement in the IIP number to 7.3% in June 2010 (data released in August 2010), from 11.5% reported in May 2010.

(Source: ACE MF)

The graph above clearly depicts that, being concerned about the domestic factors such as southward movement in IIP number and inflation, the Foreign Institutional Investors (FIIs) turned cautious and bought lesser amount i.e. net Rs 11,688 crore in the Indian equity markets; as compared Rs 16,617 crore (net buying) in July 2010.

According to the quick estimates released by the Central Statistical Organisation (CSO), the main reason for the southward movement in the IIP growth was on account of:

• Decelerating manufacturing growth -The manufacturing index, which is the principal component of the IIP, decelerated to 7.3% in June, when compared to 12.3% in the previous month (May 2010).


• Loss of growth in sectoral output - The growth in the output of capital goods mellowed to 9.7% in June 2010 (from 34.3% in the previous month) along with the output of consumer non-durables mellowing to 1.3% (2.4% in the previous month). However, the output of consumer durables grew to 27.4% (23.7% in the previous month), with the overall growth in consumer goods being at 8.3% (8.2% in the previous month).

Finance Minister - Mr. Pranab Mukherjee also expressed disappointment on the IIP number by saying, "I expected it to be a little better". Meanwhile Mr. Montek Singh Ahluwalia - Deputy Chairman of the Planning Commission said, "For a year as a whole it (IIP) does not necessarily have to be in double digit... to achieve 8.5% GDP growth. But we do want double digit industrial growth".

What should equity investors do?

In our opinion, at present the Indian equity market are experiencing a consolidation phase, thereby not ruling out the fact that valuation in certain stocks and sectors are looking over-stretched. And if these stocks and sectors further move up, there are chances that we may see a sell-off in those stocks and sectors.

Moreover for the near-term, the markets may also take cue from the global economic scenario, and accordingly take its course. So, in that sense not much decoupling can be seen.

But having said that and despite the southward movement in the IIP number for June 2010, we believe that the Indian economy poses strong growth prospects for the long-term. Infact in the Q1 (April 2010 to June 2010) of FY 2010-11, India’s Gross Domestic Product (GDP) grew by 8.8% (data released on August 31, 2010), as against 8.6% growth rate posted in the previous quarter (January 2010 to March 2010). The GDP (for Q1 of FY 2010-11) at the constant prices of 2004-05 is estimated at Rs 11,32,778 crore, as against Rs. 10,40,949 crore in Q1 of 2009-10.

(Source: CSO)

It is noteworthy that this upward move was despite the concerns of inflation in the domestic economy and possibility of the slow-down of the recovery in the global economy; and was fuelled by robust growth (12.4%) in the manufacturing sector (in Q1 of FY 2009-10 it was 3.8%).

On the Q1 GDP number, Finance Minister, Mr Pranab Mukherjee has also exuded confidence and expressed that the economy will grow by not less than 8.50% - 8.75% this fiscal year.

Also, the fact monsoons have progressed well for India this year, the chances of WPI inflation as well as food price inflation mellowing down, stand high. This will also be a positive factor for the Indian economy.

Hence, taking into account the domestic economic scenario, we believe that Indian economy will continue to attract FII inflows, which will thus augur well for the Indian equity markets. 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

Although the liquidity situation eased up a bit by the end of this month, due to higher government spending, interest rates continue to be on the rise. The 3 month Certificate of deposit (CD) rates continue to hover in the range of 7.00% - 7.25% mark, while the 1 year rates have inched up to 7.80%.

The 10-Yr G-Sec yield also inched-up from 7.60% levels (seen in July 2010) to 7.95% on the likelihood that the Reserve Bank of India (RBI) may increase policy rates by another 25 basis points (in its mid-quarter review of monetary policy scheduled for September 16, 2010), to make policy rates more relevant to current economic growth rate and curbing inflationary situation.

The WPI inflation data for July 2010 (data released in August 2010) has slipped into single-digit territory at 9.97% and has provided some relief to the Government, which had come under severe pressure of managing escalated prices. It is noteworthy that, since September 2009 the WPI inflation was showing an upward trend and was hovering in double-digits for the last five months.

(Source: Reuters website)

On the single-digit inflation number, Finance Minister, Mr. Pranab Mukherjee has also wisely commented saying, "Policy rates had some impact but there are also base factors".

Moreover, not ruling out the progress of monsoon, (which will improve the chance of good harvest), and domestic macroeconomic scenario, the Finance Ministry has also set expectations that WPI inflation would moderate in the range of 5.00% to 6.00% by end of the fiscal year.

We expect inflation to start moderating by October 2010 and to have eased substantially by December 2010.

What should debt investors do?

In order to manage inflationary situation in the country, the RBI would continue to adopt the calibrated exit path and increase policy rates by 25 basis points at each step, to normalise policy rates and make it more relevant to the current high economic growth. Hence, RBI in its mid-quarter review of monetary policy (scheduled for September 16, 2010), may increase the policy rates (both repo as well as the repo rate) again by another 25 basis points. So, we think the debt markets will continue to reel under the impact of managing inflation.

But having said that, we believe that the possibility of a policy rate hike in the mid-policy review meeting is already factored in, and thus we expect short-term rates to increase only marginally from current levels. We opine that any rise in short term rates, also due to advance tax outflows should be looked at as a good buying opportunity.

For the longer tenor rates, the extent and level of bank credit growth in the next 3 months would be most crucial to determine its movement. If the pace of credit growth is more than expected, then banks will have to sell a part of their excess holdings of government bonds to meet the credit demand, thus leading to selling pressure in medium to longer tenor bonds. Also, the trend of inflation for the next 3 months, will also decide the movement of the longer tenor rates.

Hence in a scenario where interest rates are expected to rise, debt funds are not the ideal investment avenue. 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-end 2010 till the impact of mid-policy review is factored in by the debt markets.

In our opinion at present, investors’ should focus on liquid and ultra short term (liquid plus) funds and not invest in longer tenor funds - to benefit out of the increase in short term rates and also to shield themselves from the loss in value of longer tenor funds due to increase in interest rates. Fixed Deposit (FD) rates are just beginning to rise - as banks seek funds to meet their credit growth. But we believe, it would be prudent to wait till mid-September to lock your funds into FDs at more attractive rates.

Gold Update

(Source: World Gold Council)

After showing a correction in the earlier month, gold prices once again escalated in August 2010 on the concerns of slow-down in the global economic recovery (which was triggered by the down-beat economic releases). Moreover, the weakness in the dollar also supported this up-move in the precious yellow metal.

At every lower level (of gold price), support was seen in the form of good physical buying, as investors’ preferred to take refuge in this safe asset class, as the down-beat economic releases from the U.S. followed this tip.

In August 2010, gold price rose by 3.9%, thus breaking the USD 1,200 per ounce mark on the upside. Gold prices in USD as measured by the London AM Fix also leaped higher by 5.6%, as the U.S. dollar weakened.

In the Indian markets too, gold prices surpassed the Rs 19,000 per 10 grams mark, as demand was highly robust despite high levels of gold prices. Moreover, the depreciation of the Indian rupee also added to the gains. Gold prices in rupee terms increased by 6.9% in the month of August 2010.

What should investors in gold do?

In our opinion fundamentally, nothing has changed for gold. Negativity in the U.S. housing market, slowdown in the recovery of global economy and consolidating equity markets will be the key drivers to gold prices in the future.

Hence during such times, we think that gold will be a classic safe haven. Gold should be seen today as an "insurance policy", and investors’ in such a situation 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.

Address questions or comments to: research@personalfn.com

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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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