Indian equity markets outperformed developed markets as well as most developing markets. Nifty was up 7.1% in the first quarter. There was even higher interest in mid-caps with the Nifty mid-cap index up 8.4%. In the first quarter, US markets were up marginally and the European markets managed to contain their fall to 4.5% despite the unexpected vote by the UK voters to leave the European Union. In the first quarter, net foreign investor inflows into equities in India were USD 1.7 billion while domestic institutions were net buyers of USD 0.4 billion. Commodity prices i.e. crude oil and base metals were up through the quarter as China growth concerns abated.
The global macro-economic situation at this point of time is far more complicated as is the current investor mind-set of chasing growth and quality while disregarding valuations. Impact of Brexit and any slowdown in China coupled with an accelerated Yuan depreciation could have serious implications across the globe. As a result of Brexit, UK's unique status is at risk which includes the "passporting" arrangement under Europe's single market rules that allows London banks to do business with clients in the euro zone, even though Britain never joined the common currency. The ratings agency Moody's downgraded its outlook for Britain, saying its creditworthiness was now at a greater risk. Recent spillover of terrorism to the mainland of Europe – the recent Paris instance in July will have ramifications for tighter immigration even as the US presidential election debate also brings up similar issues.
In a world exhibiting weak growth and negative interest rates, India remains an exception. The commodity price slide over the past year has delivered a sharp and positive terms-of-trade and has been instrumental in lowering inflation. This has also led to external sector stability that has supported the currency. Inflation control has been provided an added booster shot with monsoons appearing to be largely normal after two years of deficiency. There is a good chance that India's account deficit will remain manageable (1.5% in FY17 as compared to 4-5% few years back due to these structural adjustments) and indeed in 1QFY17 we may witness a current account surplus as well. A combination of spending on rail, road and defence indigenisation should improve the investment climate in coming quarters. In addition, consumption boosters from the 7th Pay Commission should be a positive. Normal monsoons should also add to farm incomes and improve rural growth spending. Thus despite the recent increase in commodity prices from low levels, the consumption demand in India should continue to do well.
The foreign exchange reserves are healthy at USD360 bn. India is amongst the few countries where growth can potentially move up and interest rates can move down. On domestic front, markets are keenly watching for the announcement of the new RBI Governor and new monetary policy committee (MPC). We believe that some of the changes brought in by Governor Rajan like CPI inflation targeting as the primary objective, rate setting by monetary policy committee are irreversible and Government would like to continue with past reforms in order to maintain its credibility.
Market Outlook- We continue to remain cautious in the near term on account of global volatility. Valuations at a price/earnings ratio are a little expensive, given the expected earnings growth and the global macro-economic construct has turned complicated with Brexit, US Fed rate hikes, US election rhetoric and economic risks in China.
We are positive on Equities and Fixed income asset classes in India. We continue to remain skeptical on residential real estate as price hikes have run ahead of income increases, thus reducing affordability. In fixed income, we prefer to play duration rather than credit at this juncture. We are thus running a portfolio which has a higher duration than the benchmark.
In equities, our investment philosophy is to buy good quality stocks with visible growth triggers, at a reasonable price. We are positive on industrials especially non-leveraged construction companies, private-sector banks/finance companies and auto/auto-part manufacturers. We have identified sectors which are likely to be growth leaders e.g. road-building, railway, defense, financials etc. and have focused on these segments of the market. We are underweight on utilities, consumer staples and telecom sectors.
With warm regards.
Director and Chief Investment Officer