Advice for the Wise August 2015

Contents

From the desk of the CIO

Did you know?

Domestic Equity

Outlook

Global Equity Outlook

Domestic Debt Outlook

Domestic Debt Strategy

Global Debt Outlook

Global Economy Update

Foreign Exchange

Commodities

Real Estate Outlook

What’s Trending?

From the desk of the CIO

Dear Investors,

The purportedly Chinese expression “May you live in interesting times!” seems to apply to most of humanity in the last decade. Lately however, the source of such interesting influence has also been Chinese. Notwithstanding the massive and perplexing government support of the stock markets in China, investors in Chinese stocks have started to panic again. It is actually beside the point whether the Chinese equity markets are over-valued or undervalued.

In another part of the world, a historic nuclear deal (or is it accord?) finally concluded between Iran and the so-called P5+1. Understandably, this pushed the prices of crude oil down. Speculation is rife again if this time the price drop will surpass the recent lows. In a close but still another part of the world, the Greek government strangely enough agreed to reforms worse than those it had walked out of a month before. It seems like Greece blinked in the war of nerves between Eurozone and itself. Investors watching the developments nervously till then cheered the outcome and hailed the continuation of Greece in Euro (for now at least!). That seemed to send the price of gold south and that of emerging markets equities north. Risk, it seems, was “on” again. The “off” did not seem very far – as by the end of July the Chinese jitters mentioned above returned.

This investor behaviour bordering on split personality is probably why it is apt to call our times ‘interesting’. Admittedly it is a mistake to generalize investor behaviour under one big trend in some direction or other. At all times, specific investors have divergent views and that is what brings about the so-called price discovery in the capital markets. However, in recent years, the causality of

investment attractiveness of an asset class and fund flows into that asset class has become lot less sharp than it used to be say 50 years ago (or maybe it was always this way and our understanding of this reality is finally catching up with the way of the world!)

The linear picture of ‘fundamentally sound’ investments attracting fund flows and ‘fundamentally weak’ investments experiencing exits is overly simple to describe any of the above phenomena. More realistically, in absence of any objective measure of fundamental soundness, investors are increasingly watching everybody else to determine their own plans. It partly makes sense from liquidity point of view. However, if an increasingly large proportion of investors are making decisions based on behaviour of other investors, the fund flows in and out of different asset classes are likely to become extremely volatile. This behaviour is typical of non-linear systems. An important characteristic of such systems is oversensitivity to small perturbations. In non-technical terms, it simply means small triggers can set off large panics (or euphorias).

A potential response to such non-linearity can be use of investment rules instead of guidelines. Diversification is not merely ‘sensible’, it is an absolute must. Likewise, it is not merely advisable to rebalance but so important that it may drive large part of the final performance. It probably makes sense to track the panic period correlations amongst asset classes to study risks. Lastly it is probably a good idea to focus on costs of investing rather than just returns.

Equally important is probably an attitude to live with the volatility rather than hiding behind illusory determinism (of returns, risks, performance etc.) which only camouflages it. Maybe it is time to focus on woods and give the trees a miss!

Did You Know?

#Source: CheatSheet

The term “Blue Chip” comes from the colour of the poker chip with the highest value, blue

May 26 is celebrated as the Science Day in Switzerland in honour of former President Dr. APJ Abdul Kalam, because on the day, Kalam visited the country

John D. Rockefeller, who revolutionized and dominated the oil industry in the late 19th and early 20th century, had a net worth measuring $1.4 trillion (today’s dollars) at the time of his death.

Domestic Equity Outlook

As on 25th July 2015

1 month change

1 year change

Equity Markets

BSE Sensex 28112 0.80% 7.60%

CNX Nifty 8521 1.50% 9.40%

BSE Midcap 11147 4.30% 20.00%

BSE Smallcap 11668 5.00% 14.10%

Equity markets were broadly range bound for the month of July; with mid caps showing better strength compared to large cap stocks. A ‘No’ vote to impose greater austerity measures at the Greek referendum unperturbed global stocks, as lawmakers later passed bailout agreements for receiving further aid and thus avoid debt default. However, the positive rally was short-lived. Global markets got a scare from plummeting Chinese stocks as large number of local investors had to unwind their leveraged positions on account of margin calls getting triggered. Slowing Chinese economy and centre’s intervention casts doubt on the longevity of sustainable rally. Meanwhile all eyes have been on the onset of monsoons. After an above average June rainfall, July has been relatively disappointing. Quantum and distribution of rainfall plays an important role for agri output. Crop sowing has improved and better monsoons will boost chances of higher farm produce. It would also result in lowering food inflation and thus help the economy to grow faster as interest rates would trend lower.

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125 S & P BSE Sensex CNX Nifty

BSE Midcap BSE Smallcap

Domestic Equity Outlook

Macroeconomic Outlook (Contd.) One does not expect any rate cuts in the coming monetary policy. However, the rate-cut cycle seems certain and one can anticipate interest rates to converge with the inflation rate in next 5-6 quarters. The focus is also on the ongoing quarterly earnings season. Overall first quarter results are likely to be subdued; similar to march quarter. Single digit revenue growth with some improvement at EBITDA level is expected. Lower commodity prices should aid gross margin expansion for many sectors. Indian markets over past six months have given negative returns. Thus buying quality stocks via bottom-up strategy should be a preferred way to invest over medium to long term.

Government Policy

The monsoon session of parliament has begun. As many as 32 bills are lined up for passage. However, the key bills that have been carried over from previous session are the GST bill and Land Acquisition bill. One can expect a stormy session for clearance of these bills as the ruling government does not have a majority in Rajya Sabha. Some modifications also cannot be ruled out in order to garner support of other parties and have the bills passed.

Domestic Equity Outlook

Wholesale Price Index (WPI)-based inflation for the month of June eased further to quote at -2.4%. The eighth straight decline was mainly on the back of weak fuel prices.

Fuel and power index (15%) on WPI basket rose by 0.6% to 191.0 from 189.8 due to higher price of aviation turbine fuel, petrol and kerosene, lignite, high speed diesel and bitumen.

Consumer price index- (CPI) based inflation for June jumped to a four-month high of 5.4%, mainly driven by higher than expected food inflation dampening the hopes of a further rate cut.

Food inflation for June was 5.4 % compared to 4.8 % in May.

Wholesale Price Index Consumer Price Index

#Source: Business Standard, moneycontrol

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00% WPI CPI

Domestic Equity Outlook

The index of industrial production (IIP) for the month of May came in at 2.7%, falling from 4.1%, led by a sharp fall in capital goods and consumer goods data.

The cumulative growth for the period April-May 2015-16 over the corresponding period of the previous year stands at 3%

Growth rates for sectors stood as 6.4 % for basic goods, 1.8 % for capital goods, and 1.2 % for intermediate goods. The consumer durables and consumer non durables recorded growth of -3.9 % and -0.1 %, respectively.

The Indian economy expanded 7.3% in the year ended March, in line with the initial forecast and marginally higher than 6.9% recorded in the previous year

Financial services reported 11.5% growth while trade and hotels segment was up 10.7%. Manufacturing growth picked up further in the January-March period, rising to 8.4%, but construction slowed to 1.4% and agriculture contracted 1.4% because of the damage caused by unseasonal rains in March.

4.0

5.0

6.0

7.0

8.0

GDP

-6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%

IIP

#Source: Moneycontrol

Sector Outlook

Sector Stance Remarks

BFSI Private sector banks continue to deliver healthy earnings in line with expectations. However,

we expect PSUs to deliver muted numbers on asset quality concerns.

Automobiles Passenger vehicles and CVs to outperform two-wheeler segment. Tractors to continue weak

show. Auto-ancillaries expected to do well due to revival of demand.

FMCG We prefer “discretionary consumption” theme within FMCG. Key beneficiaries such as

durables and branded garments, as the growth in this segment will be disproportionately

higher vis-à-vis the increase in disposable incomes. Gross margin expansion to continue.

IT/ITES Cross-currency volatility has come down. Select verticals displaying better growth. Long term

outlook to improve once global uncertainties come down.

Power Utilities Lack of fuel linkages , poor SEB health, adverse CERC guidelines have compromised the ROE’s

leading to de-rating in near term. In long run, they are core to India’s infra story.

Cement Cement volumes witnessing pressure. Going ahead pricing and realizations would be key for

sector valuations.

Sector Outlook

Sector Stance Remarks

Healthcare Huge global opportunity as a generic and bulk drug supplier. Better placed against peers in terms of technology and labor cost arbitrage. To continue to gain global share and thus generate strong

earnings growth.

E&C Order inflows expected to improve as spending and capital expenditure likely to move up on

economic recovery.

Energy With the price deregulation of diesel, we believe the total subsidy burden on Oil PSU’s will come

down significantly this year. Govt. has decided to pay full subsidy to OMC’s

Telecom Regulatory uncertainties have come down. However, aggressive bids for spectrum has revived

fears of sub-optimal returns on capital.

Metals Lower global growth and Chinese slowdown has kept the growth subdued. Absence of US

monetary stimulus will lead to further downward pressure on prices.

Global Equity Outlook

As on 25th July 2015

1 month change

1 year change

Equity Markets

MSCI World 1745 -2.02% -0.16%

Hang Seng 25128 -7.43% 3.77%

S&P 500 2079 -1.08% 5.12%

Nikkie 20544 -1.09% 32.91%

World markets would continue to monitor the stance of US Fed in the forthcoming meeting. Macro data has given a mixed picture till now but the recovery seems on the right lines. Thus, a rate hike in the coming quarters remains probable. On the Greece front, it is no longer in arrears with IMF as June dues have been cleared. The next major payment needs to be made to ECB by August 20. With third bailout talks on, Greece should most likely accept the proposals presented to them. Sharp correction in Chinese markets and lower growth rates is another matter of worry on the global front. However, government seems committed to boost the growth and has taken various stimulus measures. Though, near term pressures persist, there is no change structurally from a long term point of view.

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Global Economy Update

United States

• United States’ unemployment rate fell to 5.3%, the lowest in seven years. However this was driven by an exodus from the work force, rather than more people finding jobs.

• The US economy rebounded to 2.3% annualized rate (adjusted for inflation) in the second quarter of April, May and June.

Emerging Economies

• The country’s exports declined for the seventh straight month, falling 15.82% year-on-year in June at $22.28 billion due to a sharp decline in petroleum products, slowdown in manufacturing and soft external demand, and raising concerns about the economic recovery

• China's consumer price index (CPI) rose 1.4% in June from a year earlier following a 1.2% rise in May

Japan

• Japan's core consumer price index (CPI), which excludes fresh food, rose 0.1 percent on-year in June. The "core-core" CPI, which excludes both food and energy prices, rose 0.6 percent from a year earlier

• Industrial output rose by 0.80% from 2.2% in May but is still 16% below its peak in 2008. Japan’s exports to China fell 2.5% in June from a year earlier.

Europe

• The European economy grew by 1.40% in the first three months of this year based on the GDP measure while consumer spending increased by 1.20% in the same period.

• The Eurozone trade surplus narrowed to €18.8bn in May from €24.9bn in April and €19.9bn in March. Seasonally-adjusted exports rose 3.0% vs. 9.0% prior (y-o-y)

#Source: New York Times, The Independent, The Indian Express

Domestic Debt Outlook

•The yields on 10 Yr G sec closed at 7.83% which is 2 bps higher than with the last months close of 7.81%. •Government bond prices ended steady on amid subdued activity as participants remained on the sidelines in the absence of fresh triggers •Prices remained range bound as caution set in ahead of the outcomes of the US Federal Open Market Committee (FOMC) interest rate decision and the state development bond auction. •The interbank call money rate ended above the RBI’s repo rate at 7.50% as banks with excess funds opted to lend to the RBI via reverse repo auctions.

As on 25th July 2015

1 month change

1 year change

Debt Markets 10-Yr G-Sec Yield 7.83% 2bps (80bps)

Fixed Deposit 7.75% 25bps (100bps)

7.40 7.60 7.80 8.00 8.20 8.40 8.60 8.80 9.00 9.20 9.40

G-Sec

10 YR Gsec Yield 5 YR Gsec Yield 15 YR Gsec Yield

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AAA AA+ AA AA- A+ A A- BBB+

Corporate Bond Spreads

5 Years 10 Years 15 Years

Domestic Debt Strategy

Our recommendations regarding short term debt is that investors with the time horizon of 1 year to 2 years can look for short term debt funds. Even though, most of the short term fund’s YTMs have fallen to sub-9%, our recommended short term debt funds still have high YTMs (8.8%-10.8%) providing interesting investment opportunities.

The corporate bond market segment continues to be attractive over the medium term, especially with expectations of an improvement in corporate profitability and an improved economic outlook. The credit opportunities funds are better placed due to stable returns and a change in taxation warranting a minimum holding period of three years to avail indexation benefits.

Secondly, as we expect RBI to lower policy rates during the course of next 3-9 months, dynamic bond funds are likely to outperform in the due course. Hence one could look at dynamic bond funds having medium term of investment horizon.

G-sec funds may be less attractive now as the longer holding period (more than three years) will neutralise any capital gains in the near term because of lower accrual income. Hence our recommendations regarding long term debt is that investors could look to book profits by reducing long term debt funds / Gilt funds in their portfolio.

Short Term Debt

Corporate Bond Funds

Dynamic Bond Funds

Long Term Debt Funds

Global Debt Outlook

• Outstanding loans for companies and households in China stood at a record 207% of gross domestic product at the end of June, nearly double the 125% level seen in 2008. • Puerto Rico defaulted on some of its debts this weekend after years of battling to stay current on its obligations, signaling the start of a long and contentious restructuring process for the US commonwealth’s $72bn debt pile • China posted a $14.9 billion deficit on trade in services in June and a deficit of $91.6 billion in the first half of 2015, the foreign exchange regulator said on Friday. • Russian banks hobbled by sanctions are exploring funding sources in Hong Kong to help the nation’s companies refinance $117 billion in external debt due in the coming year.

#Source: Financial Times, Economic Times, Bloomberg

Ratings Country 10 Yr G-Sec

Yield 1 month change

AAA

Germany 0.66% 46bps

Hong Kong 1.92% 41bps

Sweden 0.76% 36bps

Switzerland -0.05% 7bps

AA+ USA 2.26% 32bps

AA-

China 3.47% (12bps)

Japan 0.41% 4bps

Commodities

Gold peaked in 2011 and since then it has been on a downtrend. International gold prices corrected further in July and also broke the $1100 mark. Better numbers from US economy and revival in Europe has kept gold in weak zone. One can expect gold prices to remain subdued and in a band of $1000-1200 for next few months. .

As on 25th July, 2015 : `24599 per 10gm 1 month change : (6.55%) 1 year change : (11.27%)

Oil fell to its lowest in six months on Monday, knocked by fresh evidence of growing oversupply and data highlighting slowing demand in China, leaving crude prices set for their weakest third-quarter performance since 2008. The global market is consolidating and commodities prices are at very low levels. Amid a improvement in domestic fiscal situation, low global commodities prices will further support India in the long-term

As on 25th July, 2015 : $54.29per bbl 1 month change : (9.90%) 1 year change : (49.20%)

*RICI: Rogers International Commodity Index – Tracks 38 commodity futures from 13 international exchanges.

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Crude

Foreign Exchange

• The Indian rupee has depreciated against USD & YEN by o.44% and 0.31% respectively. It saw an appreciation of 0.70% against the GBP and 1.49% against EURO.

• The rupee weakened against the US dollar owing to losses in the Asian currencies markets. Since the beginning of this year, the rupee has lost 1.4%

• India's foreign exchange reserves grew by $322 million in the week ended July 24.

Currency As on 25th July 2015

1 month change

1 year change

USD/INR 63.89 -0.44% -5.86%

GBP/INR 99.10 0.70% 3.14%

Euro/INR 70.12 1.49% 15.54%

Yen/INR 51.56 -0.31% 14.64%

USD/Euro 0.91 2.05% 22.78% -0.44%

0.70%

1.49%

-0.31%

-1.00%

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1.00%

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USD GBP EURO YEN

Real Estate Outlook

Tier I

The Reserve Bank of India reduced repo rates by 25 basis points

in January and March and again in June 2015. Some of the banks

have correspondingly reduced the base rates and passed on the

corresponding benefit on home loans. With the reduction in EMIs,

potential homebuyers who have been sitting on the fence may

take a buy decision.

Tier II

Enquiries have started from companies across industries such as

IT, consultancy and e-commerce for leasing and buying office

space in expectations of an economic revival. The change in the

uptake of commercial asset class is slower than residential and it

could take a couple of quarters before commercial asset class

absorption starts increasing.

Rentals are expected to largely remain stable in 2015–16 as

supply pipeline is still strong.

Lease rentals as well as capital values continue to be stable at

their current levels in the commercial asset class. Low unit

sizes have played an important role in maintaining the

absorption levels in these markets.

Demand in Tier II cities is largely driven by the trend towards

nuclear families, increasing disposable income, rising

aspiration to own quality products and the growth in

infrastructure facilities in these cities. Price appreciation is

more concentrated to specific micro-markets in these cities.

Cities like Chandigarh, Jaipur, Lucknow, Ahmedabad, Bhopal,

Nagpur, Patna and Cochin are expected to perform well.

Residential

Commercial

Tier I Tier II

Tier II cities see a preference of hi-street retail as compared to

mall space in Tier I cities. While not much data on these

rentals gets reported, these are expected to have been

stagnant.

Capital values as well as lease rentals continue to be stagnant.

Developers continue to defer the construction costs as absorption

continues to be low unsold inventory levels high.

Land in Tier II and III cities along upcoming / established

growth corridors have seen good percentage appreciation due

to low investment base in such areas.

Agricultural / non-agricultural lands with connectivity to Tier I

cities and in proximity to upcoming industrial and other

infrastructure developments present good investment

opportunities. Caution should however be exercised due to the

complexities typically involved in land investments.

Retail

Land

Real Estate Outlook

EPFO’s debut on the Dalal Street • The EPFO will start this process on 6th August with an initial corpus of Rs. 5000 Cr . EPFO’s Central Board of Trustees has decided to invest 5 per cent of its incremental deposits in ETFs only during the current fiscal. • During April-June, EPFO’s monthly incremental deposit was around Rs 8,200 Cr, which could translate into investments of Rs 410 Cr per month. • SBI Mutual funds has been roped in by the EPFO to help the body for its investments in the ETFs and understand the dynamics of the stock market. • Presently, the Employees' Provident Fund Organisation (EPFO) invests subscribers’ annual deposits as per the investment pattern stipulated by the Union Labour Ministry.

What’s Trending?

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