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.
