Local and Global Macro & Micro

Q3FY14 result season has ended on a positive note largely driven by export oriented sectors. The domestic currency has been under pressure from the beginning of 2013 and in the middle of 2013 it plunged by around 30% on backdrop of steeper current account deficit. However, RBI has arrested the fall by implementing various measures and from then onward rupee has stabilized to some extent. This led export related sectors such as IT, Pharma and Auto post significant performance during the quarter. Almost similar kind of performance by India Inc had been seen during Q2FY14, in which rupee depreciation gave a big boost to the earnings. Improving macros in western economy is also a reason for strong export growth. However, companies exposed to domestic economy reported soft numbers owing to sluggish domestic economic growth, persistent higher interest rates and slowdown in investment cycle. The aggregate revenue of CNX 500 companies (excluding Banks, NBFC & Oil Companies) during Q3FY14 registered a growth of 11% yoy, led by export sectors. However, sequentially the revenue growth was muted at 1% as the similar trend had been witnessed during Q2FY14. Operational efficiency for Indian companies has improved considerably as the firms learned to work with tighter budgets and how to cope with economic slowdown. This led Indian companies to post strong Operating profit growth during Q3FY14, where EBITDA for CNX 500 companies surged by 23% YoY, while sequentially the growth was 7%. It is expected that some positive signs witnessed in operational front during Q3FY14 would be carried forward in coming quarters also, where cost rationalization would reap benefits. Learning and benefit from cost cutting could lead to accelerate margin expansion in growing economic environment. Companies which have posted stellar performance during the quarter, the gains have arrived from overseas operations. Consistent slowdown in capex is again reflected in depreciation cost, which grew at much slower pace at 17% YoY compared with 28% YoY in Q2FY14. However, interest cost has shown improvement during the quarter by increasing 17% YoY against 45% in Q2FY14, while sequentially interest cost has declined by 4%. Led by strong operating profit gain along with reducing interest costs, net profitability for CNX 500 companies surged by 25% YoY and sequentially the growth was 8%. Export led sectors such as Auto, technology and healthcare reported strong earnings growth in last 21 quarters. Whereas the core sector such as cement, power and mining still remains in trouble owing to sluggish consumption demand. FMCG sector whose growth is based on consumption, witnessed moderate growth during Q3FY14 as the rural market is weakening owing to loan government spending in rural areas and MSPs (minimum support price) is no longer rising as fast as it was in past. Going ahead, it is expected that post strong Q4FY14 results, India Inc will end FY14 on positive note and the probability is high that it would meet the market expectation.

 

 

The GDP figures for India came in flat at 4.7% for Q3FY14 supported by better numbers from service sector while industry growth continues to disappoint. The interim budget presented during the month also lacked any vigor as first of all it being an interim one, secondly, there is a growing consensus feeling that the UPA2 will not make the final cut for UPA3 and pave the way for BJP. Thus, in any case a new budget will be presented by the new Government with more realistic assumptions. As anticipated, the finance minister has forecasted for a lower fiscal deficit at 4.6% of GDP for FY14, while lowering it even further to 4.1% of GDP for FY15 by cutting down on the planned expenditure and aiming for better disinvestment receipts. Since, the start of UPA2, the economic growth faltered and one of the primary reason being decline in infrastructure led growth (by cutting down planned expenditure) while pushing for populist measures (allocating more to subsidies thus fueling the non-planned expenditure). One of the major reasons for aversion to UPA has been the way the economic prospects have been throttled to death. BJP on the other hand has been portrayed as more pro towards economic growth focusing on infrastructural facilities rather than being populist. A recently conducted poll done by US based Pew Research found out that Indian voters are leaning heavily towards BJP with almost three times the preference over Congress. Pew interviewed 2,464 randomly selected adults in states and territories that are home to roughly 91% of the Indian population. Out of 2,464 respondents in the poll, 63% are of the view that they would prefer BJP to lead the next government while only 19% said they would prefer the Congress to remain in power, 12% support other parties. Although, the sample is too small in respect of the population, however, the sentiment is clearly evident. No wonder, the foreign investors are also eyeing for a political change taking cues from the Gujarat model

     

               

Globally, the US continues to keep the emerging nations guessing with its quantitative easing taper plans however, broadly, there has been a revival in growth in the developed nations and among emerging nations India and China are still favourites as expressed in the recent report by the IMF after the G20 meet. The same is reflected in the performance of the stock indices with the stock markets for US and Germany trading near highs. The report also highlighted that economic distress in the Eurozone region is turning the corner. PIIGS (Portugal, Ireland, Italy, Greece, Spain ) are in better shape and in fact Ireland and Spain have been learnt to have left the bailouts and Portugal is about to follow suit in May while Greece is beginning to recover and might emerge out of recession this year. No wonder the same have been captured in the 10 year bond yields for the nations which peaked during 2011. One of the reasons also being that the ECB has kept the rates at 0.25% and promised to keep it low. The ECB in a way is encouraging banks to borrow more and the same is probably reflected in higher bond purchases in PIIGS nations in lure of higher bond yields. Probably, this is another reason which is driving the bond yields lower

While India has its own sets of problems, the recent rebalancing of the China’s economy to consumption led one, doesn’t seem to bode well with the world markets. Unlike other emerging nations, China has a current account surplus and doesn’t have to worry of the funds flowing out of the nation. However, there are concerns that the long standing stories of a hard landing of the Chinese economy have intensified. The China’s economy is finally slowing but there are fears that it might be a prelude to more disappointing stories. The monetary system is believed to be hardest hit if the fears of housing bubble and shadow-banking blow up. The Chinese yuan had to face the wrath of the global investors besides widening spread between sovereign yield to interest-rate swap (hovering at 2007 levels). The currency has so far appreciated against the US dollar when currencies from other emerging nations were falling like ninepins (particularly in August 2013). The concerns are further aggravated by comments from eminent investors, George Soros and Bill Gross highlighting that the China’s situation is similar to the US crisis in 2008. The facts were further corroborated by the weakening manufacturing PMI and industrial production data. 

While it seemed that the worst is over for the world economy, there has been a new kid on the block, Ukraine. The country is heading for a financial collapse with almost a quarter of its estimated $73bn due for repayment over the next 18 months. Ukraine relied on Russia to buy some of its debt, but those bond purchases have been shelved amid tension between the two neighbouring nations. Russia is believed to have declared war and deployed troops in Crimea, an autonomous region of eastern Ukraine with strong loyalty to neighboring Russia. By late night on 2nd March, Russian forces are reported to have completed operational control of the Crimean Peninsula, however a single fire has not been shot yet. The tension started in the region after when pro-Russia leader Viktor Yanukovych was ousted on February 21. The developed nations have been weighing out options to bail out the nation but are skeptical unless Ukraine's new government is established—presidential elections are due May 25. U.S Secretary of State John Kerry condemned this act by Russia terming it as "incredible act of aggression." The present political tension can turn into bitter story after statements that U.S. is "absolutely" willing to consider sanctions against Russia and there is a speculation that U.S. may skip an upcoming G8 preparatory meeting in Sochi, Russia. The present tension might throw unpleasant surprises for the world economy (especially Europe) as Russia supplies about 25% of Europe's gas needs, and half of that is pumped via pipelines running through Ukraine. Thus, disruption and cut off of the gas flow will push up energy prices as Russia being the world’s biggest oil producer. Further, Ukraine being one of the world's top exporters of corn and wheat, the supply of grain to the World will be impacted. Ukraine's currency hryvnia hogged the limelight after falling to 10 year lows and crossing below 10 to a dollar. While Russia’s stocks, bonds and currency fell heavily following the turmoil. The ruble, already down nearly 10% this year, fell below 50 to the euro and 36.4 to the dollar for the first time

Chasing Alpha...

U.S Fed has kept its promise to trim its bond purchases by another USD 10 billion starting from February. The central bank's statement largely mirrored the one it issued after its December 17-18 meeting, when it announced an initial USD 10 billion cut to its monthly bond purchases. With the new set of tapering, the Fed would buy USD 65 billion in bonds per month starting in February, down from USD 75 billion now. There were all rounds of speculations with regards to the extent of tapering as the last reported weekly jobs data was below market estimates. However, US economists clearly are of the view that the core economic data suggest that the economy is on the path of growth and the tapering is a reality. Although, the US central bank stuck to its promise of keeping rates near zero until US unemployment rate (now at 6.7%) falls below 6.5% and if inflation remains below a 2% target. Confidence among U.S. consumers unexpectedly climbed to a five-month high in January as optimism about the economy and labor market improved. The Conference Board’s index advanced to 80.7 from a revised 77.5 in December that was weaker than initially estimated. The 10 year Treasury note yields were at almost two month lows as the tapering of asset purchases have already been factored in even before the actual announcement. The difference in yields between Treasuries maturing in five and 30 years have also widened to more than 2%, the most in more than two years. Historically, a steeper yield curve reflects anticipation of faster economic growth. The reduction in debt level is necessary as monetary stimulus has pushed the Fed’s balance sheet to USD 4.1 trillion, from USD 2.9 trillion at the beginning of last year. The era of easy money is thus coming to an end and there is a growing fear that the emerging nations are the ones to bear the brunt of this fund outflow. However, the adverse effect will be felt by the emerging nations with high levels of external debt. Asian economies are perceived to be in better state compared to Latin American economies and emerging Europe. The Argentinian central bank’s decision to withdraw from currency intervention on 23rd Jan caused a sharp fall in the Argentine peso. The reason for such pressure on the currency being high debt, elevated inflation, low forex reserves and complete economic mismanagement with the Govt losing trust. Most non-Asian emerging-market (EM) currencies are under pressure: the Brazilian real, Turkish lira, South African rand and Ukrainian hryvnia all ended last week on or close to low levels. In Asia, Indonesian rupiah, Indian rupee and Korean won had seen some pressure during the week while the renminbi remains more or less immune. However, relatively Asian economies are in a better state owing to lower external debt, which has serious implications on the currencies of the economies.

India, seems to be a in a better state as far as the currency stability is considered with regards the capital flight. With addressing the issue of the current account problem, the vulnerability of the rupee has been checked as of now. Although, fiscal problem still remains an overhang and so does the inflation, nevertheless, there has been positive developments. The suggestions of Urjit Patel Committee report to take CPI as the nominal anchor for the monetary policy framework, is a major step if accepted. In the January monetary policy meet, RBI governor once again surprised the markets with a 25 bps hike in repo rates, thus bringing the repo rates to 8% while keeping the CRR unchanged. The CPI as well as WPI cooled off considerably in December 2013 riding on lower vegetable prices however, the core CPI levels didn’t come down to that extent and still languishes around 8% mark. The rate hike was in line with the guidance provided by RBI itself in its December policy meet can be justified on the grounds that there has been no easing in the core inflation, a pre-condition to maintain status quo. Further, RBI governor also justified on the grounds that without the rate hike, CPI could have overshot the FY15 headline CPI target of 7.5-8.5%. This move suggests that the RBI is gearing towards the Urjit Patel Committee report’s target of containing headline CPI inflation at 8.0% over the next 12 months and 6.0% over the next 24 months. The move to CPI as the nominal anchor will not be easy and RBI will implement the prerequisites that are within the ambit over the next two-year period. Further, it has also the job on hand to convince the Govt to take legal and institutional changes required. With the parliamentary elections round the corner, the focus now shifts to structural policy changes to be brought about and the removal of hurdles and implementation of key reforms to support GDP growth. There is a growing optimism for a pickup of economic activity in FY14-end and the time seems to be ripe to take a call on select mid cap scrips as data shows, midcaps tend to outperform large caps in a growing economy.

Mid cap companies have been gaining investors’ preference since mid 2013 onwards, on the back of strong momentum in the broader market led by expectation of a bounce back in economic recovery and anticipation of a stable government which can execute the reform process to kick start the investment cycle. Moreover, gradual developments in western economy especially in US and Europe, boosts investor confidence towards risky asset class like equity. As the general trend indicates that during the start of bull market or in momentum, investors tend to invest more in high beta asset class, in intention to earn higher return on their investment portfolio. However, the situation was just reverse at the time of downcycle, when the investors preferred large cap and defensive stocks, in order to preserve its capital and earn moderate return. BSE Midcap had underperformed Sensex during the period between 2010 to 2014 (till January), when Sensex has delivered a return of 25% (upto 21st January 2014) and BSE Midcap slipped by 4%. This create a large valuation gap between Large cap stocks with Mid cap stocks and it is expected that after rally in large cap counters, mid cap stocks would have appeared more attractive based on valuation. Mid cap stocks underperformance was attributed to slowdown in economic activity, elevated interest costs, falling sales and corporate governance issue. BSE mid cap is around 46% discount to SENSEX based on price to earnings, which is highest since the formation of BSE Mid cap index (from 2005). Mid cap companies offer better growth opportunities compared to large cap companies as their business continue to grow from less established entities to matured companies. Companies with strong fundamentals and sound management can generate extra ordinary return for their shareholders. Companies such as Ajanta Pharma, PVR, Vakrangee, Eicher Motors, PI Industries, Mindtree, Bluedart, etc are to name a few in BSE Midcap index which have rewarded its shareholders by delivering exceptional return. Improvement in macro economic indicators could drive merger and acquisition activities in India, which has remained lackluster in past three years. Increase in M&A activities in India could yield positive for mid cap companies having strong business growth. Asset buying programme by US Federal reserve has been blessing for the Indian stock market, as the market has witnessed lot of foreign money inflows. The gush of liquidity has seen money flow in the mid cap companies in last couple of months, resulting in spike in stock price. Even during October-December quarter, most of the mid cap companies had seen an increase in FII holdings in their stake. Among 453 mid cap and small cap companies, FIIs has increased their holdings in 190 companies (42%). However, uncertainty over the tapering of the US Federal Reserve’s stimulus programme, has been looming over the stock market of emerging economies. It is expected that tapering of US Federal reserve bond buying programme would shrink foreign money inflows in the stock market, which could result in price correction in mid cap stocks. Moreover with four months remaining for Lok Sabha elections, a lot of action is expected on political front, which is likely to keep markets volatile and the environment uncertain. Hence, Investors should only invest in those mid cap companies which have delivered good Q3FY14 results, strong business growth and valuations seem reasonable and should exit from those stocks which have rallied without any fundamentals. The rupee has depreciated a lot from the beginning of CY2013 and it is unlikely to see any type of appreciation, owing to reduction of asset purchase programme by Fed and strengthening of US economy. Such rupee depreciation would help mid cap stocks of export oriented sectors such as technology, health care and textiles.