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THE MONTH THAT WAS Posted: 29 Sep 2012 09:20 PM PDT
What a month this was. As I wrote
at the beginning of the month, there seemed to be too much pessimism going
around in the markets, both domestically as well as globally. As such positive
outcomes of key events always had the potential of creating a strong market
upmove. Cash positions were high and derivative markets were oversold at the
end of August.
The month started off with the
much anticipated meeting of the ECB where the contours of the bond buying
programme were to be announced. The “Outright Market Purchases” announced by
Super Mario were taken positively by the markets and it led to a significant
upswing in the bond prices of Spain & Italy with long term bond yields
falling between 5-5.5% for both the countries. Given that the focus of the
purchases was on buying shorter term bonds the short term bonds had already
rallied pre ECB meeting with the yields on these bonds nearly halving from
where they had reached a couple of months back. However the rally in the bonds
also happened with the expectations that Spain will ask for a bailout in
some form after the ECB announces the bond purchase rules. However, as
politicians are the Spanish PM seemed to be getting into the false impression
that the bond rally has happened due to some reforms that they have announced
and bailout can be postponed. This is clearly dangerous, as we have seen in the
case of Greece.
Excessive delays in asking for a bailout when you are clearly stressed will
ultimately cause more pain. By the end of the month the Spanish government also
came out with its budget where they have proposed significant deficit control
measures and some reform measures. In case they go in for support from the ECB
now things could be manageable in that country, however delays could be
dangerous as the long term bond yields have again gone above 6%. Following the
ECB meeting there was the German
Constitutional Court ruling on the legality of
German contribution to the bailout funds, which was a last hope that bears were
betting on. However that also went on the bull side and strengthened the market
upmove.
Then came Mr. Bernanke where the
FED was clearly under pressure to do another QE and they obliged. Although
personally I believe that the FED is building up excessive risk on its balance
sheet by more and more asset buying, the markets seem to believe otherwise. Most
of the long duration bonds are now being increasingly held by the FED which
exposes them to huge interest rate risk if bond yields shoot up at some stage.
QE3 was announced as an open ended measure with a focus on the housing market
& buying of Mortgage Backed Securities to the tune of $ 40 billion per
month for as long as it is required (the cue was obviously taken from the open
ended announcement of the ECB and the positive market reaction to the same). In
the immediate term it did have an affect with the long term mortgage rates
falling to new record lows. Signs of the housing market revival are on in the US and this
move should accelerate the pace of revival. However as a side effect it could
also lead to a spike in the CPI where housing has a big component in the United States.
The weightage that food has in the Indian CPI is almost equal to the weight of
Housing in US CPI i.e. 40%. Given that
the economic data coming out of the US has been mixed and on policy
there is likely to be a standstill till the presidential election, it seems
that the FED had little choice but to act. The important thing in all these
bond buy programmes will always be the exit strategy on which there is no
clarity at this stage. Post elections in the US the entire issue of Fiscal Cliff
also needs to be dealt with, which could create volatility in the markets going
into the end of the year and early next year.
Now coming to the domestic side
of the market. After the new Finance Minister had taken over there were lot of
expectations that got built up. The draft Shome panel recommendations were very
positive with their recommendations to do away with capital gain taxes
altogether on listed stocks. This and the recommendation on GAAR have the
potential of creating a huge incentive to invest in equities in India which is
an under owned asset among domestic investors. It will increase the
attractiveness of equities significantly on a post tax basis. This move by
eliminating the potential of taxation disputes could also move the offshore
fund management industry onshore and create a huge new market in India. The
numbers on inflation as well as Industrial Production growth that came out were
not great with IIP being lower than expectations and Inflation higher. The
generation of junk data from Indian statistical offices continue with the spike
in inflation for this month being singularly contributed by the much delayed
revision in the index of electricity cost. By the middle of the month the government
also suddenly got into the reforms mode with announcements on FDI policies for
Retail and Aviation as well as subsidy reforms. This started a virtuous cycle
with bond yields getting capped, the rupee starting an appreciation cycle and
stock markets moving up. More reforms are likely moving forward as the
Trinamool Congress that was singularly holding back most reform measures now
out of the government. The INR has already appreciated by 5% over
the last month and is looking to move to around the 50 levels by the end of the
year. INR depreciation has been one of the major reasons for high reported
inflation. With the fall in a majority of global commodities, INR
appreciation and a decent monsoon in the end we should see a rapid fall in
inflation in the year 2013. Government subsidies on imported petro products and
fertilizers will also see a significant reduction if the INR appreciation
sustains.
The announcement on the setting
up of the National Investment Board is a very significant and positive
development which could push the investment cycle and lead to higher GDP
growth.
MARKETS
The markets did well during the
month and we also saw a shift in leadership from defensives which are over
owned and over expensive into interest rate sensitive stocks. Most Fund
Managers have been taken by surprise with the developments during the month and
still continue to have disproportionate allocation towards fear i.e.
defensives. The real shift still needs to take place and should happen over the
next few months as the confidence grows on the economy. The 0.6% August
phenomenon worked with the markets rallying over 8%. A large number of banks
have announced deposit rate cuts subsequent to improved liquidity, slower
credit off take and the RBI policy. This will ultimately lead to lower lending
rates and create a boost to the economy as well as earnings growth of
corporates. Mid caps have continued to lag large cap performance; however this
should change going forward. Technically, as the chart below shows the BSE Mid
Cap Index has seen a clear move above the downward sloping trend line over the
last couple of weeks.
The overall outlook continues to
be constructive with the potential that Euro zone will continue to create volatility
at different points of time. With
interest rates trending down the potential of stock picking being rewarded will
increase going forward.
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