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MARKET STRATEGY
Lower-than-expected IIP growth, stubbornly high inflation as well as
negative global cues from US and Europe kept markets fairly volatile during
June, 2011. Fall in crude oil prices and initial signals of reforms (hike in fuel
prices) in India provided some support to the markets, late in the month.
Crude oil prices moderated after International Energy Agency announced the
surprise release of 60 million barrels of oil in a bid to rein in prices, before
moving up again. Though crude oil prices have moderated slightly from
highs, the hike in diesel, LPG and kerosene prices may keep inflation high in
the near term. We expect RBI to continue with the policy tightening
measures in its next policy meeting in July.
Global markets remained weak due to disappointing set of economic data
from US and concerns regarding approval of second bailout package for
Greece. Due to poor set of lead economic indicators, Fed also reduced the US
economic growth forecast for 2011. Federal Reserve's asset buying program,
known as quantitative easing (QE2) ended in June but it would continue
buying treasuries with the proceeds of maturing securities. China also
continued its tirade against inflation by raising reserve requirements. The
Parliament in Greece adopted the austerity measures, thus avoiding a
catastrophic default. However, the economic situation in most developed
economies remains weak.
We have been continuously stating that markets may remain side-ways till
the time concerns coming from global markets ease off or commodity prices
and inflation cool down. We have seen initial signs of reforms and on the
other hand, commodity prices have also moderated, though marginally.
Going forward, we expect government to further the reforms process
(especially in the upcoming monsoon session) which would be positive for
the markets, we believe. Monsoons are expected to be only marginally
below LTA and weakness in global economy may keep commodity prices
subdued. Though in the near term, inflation and interest rates are likely to
remain high, but any correction due to adverse global cues or hike in
interest rates should be used to buy attractively valued stocks.
Thus in near term, markets may remain sideways till the time above stated
concerns are addressed. However, based on longer term, valuations have
already corrected to reasonable levels. We remain selectively positive on
stocks in sectors like Banking, IT, Capital Goods, Infrastructure, FMCG, Media
and Logistics. We have a cautious view on Automobiles, Metals and
Cement
Indian markets remained volatile on negative global cues and
high inflation
Indian markets in the beginning of the month cheered the GDP data which came at
8.5% for full year FY11 higher than 8% growth in the previous fiscal year. But lower
than expected IIP growth for April, higher inflation, hike in interest rates as well as
negative global cues weighed down on the markets. Along with this, cut in the
monsoon forecast by IMD and news that India and Mauritius are in talks to revise
the existing tax treaty also kept the markets volatile.
Indian Meteorological Department had earlier predicted normal monsoon rains and
expected the south-west monsoon season to be 98% of the long-term average. But
now it has downgraded its estimates and expects rainfall during the current South-
West monsoon to be 'below normal' at 95% of the long term average. The Indo-
Mauritius tax treaty which originated in 1983 spares investors based in Mauritius
from paying capital gains tax on the sale of shares of Indian companies. News regarding
re-working of this treaty to tax gains of foreign funds registered in Mauritius
triggered a sell off in markets and especially in companies where Mauritius based
funds holds a significant share. Though no conclusion has yet been reached on revision
of this treaty, an over-reaction impacted major indices adversely.
Government also postponed the monsoon session of Parliament by two weeks to
give the Centre more time to deal with the proposed Lokpal bill. Government wants
to reach some consensus on controversial issues before commencement of the session.
But in a positive move on reforms, government has taken a decision to hike
diesel, kerosene and LPG prices. EGOM raised diesel price by Rs. 3/ltrs, kerosene by
Rs 2/ltrs and domestic LPG cylinder by Rs 50/cylinder. Though it will result in increasing
inflation but government has also reduced customs duty and excise duty on the
petroleum products.
Global markets remained weak due to euro debt issues as well
as poor economic data from US
US markets declined by nearly 3% during last month as investors were looking out
for a direction for markets post completion of QE2 as well as due to ongoing euro
debt issues. Fed's $600 bn round of government buying program, known as QE2
ended in June, 2011. Federal Reserve also acknowledged that pace of recovery in
economy was slower than expected and thus poor set of lead economic indicators
led to a downgrade in economic growth forecast for 2011 by 0.5 percentage. However
it said that it will maintain interest rates at exceptionally low levels for an extended
period. Retail sales slid 0.2% in May and existing home sales fell 3.8% to an
annualized rate of 4.81 million in May, from a rate of 5 million in April. A continued
soft patch of economic data and no indications for QE3 also deepened the concerns
across commodity markets leading to fall in crude prices.
European markets remained weak due to S&P's downgrade in credit ratings on
Greece to CCC, as it was battling for a second bailout package. European Union
(EU) and IMF agreed to provide the much needed support to Greece provided it
goes ahead with tough austerity measures such as deep spending cuts, hike in taxes
and sell off of assets. Without its next 12-billion euro tranche of funding from the
IMF and European Union, Greece could have become the first euro zone country to
default, thereby impacting the global financial system. But Greece's parliament approved
a five-year austerity plan and thus added some buying support to the markets.
Approval of austerity package paved way for much needed 12 billion euros in
aid in early July and provided the basis for a second rescue package backed by the
EU and the International Monetary Fund.
China's central bank further raised the banks' reserve requirements by 50 basis
points, its sixth increase this year. This resulted in increasing the short-dated swap
rate levels above longer-maturity contracts, causing a slump in the bank lending.
Though Chinese consumer inflation came in at 5.5% in May 2011, much ahead of
the government's 4% target but weakness in global economy and slower bank lending
may make it tough for further increase in interest rates.
Oil prices declined on assurances of incremental supplies but
moved up after Greece approved austerity plan
Higher oil prices till earlier last month had been threatening the global economic
recovery and OPEC talks also could not reach any conclusion to increase oil supplies.
However, Saudi Arabia pledged to lift oil output by planning to lift oil output by
500,000 bpd this month to between 9.5 million and 9.7 million bpd in a bid rein in
prices. Due to middle-east crisis and division among OPEC countries over whether to
raise production, the International Energy Agency announced the surprise release of
60 million barrels of oil from the strategic petroleum reserves of 28 nations over a 30
day period. This, along with no indications of QE3, resulted in decline in oil price to
nearly $90 per barrel (WTI crude). But oil moved up after Greece approved the austerity
plan and averted a default.
IIP moderation continues
IIP for the month of April grew by 6.3% as per the new series which was below our
expectations. According to old series (base year: 1993-94), growth was more tepid
at 4.4%. In terms of sectoral classification - manufacturing, electricity and mining
segments witnessed 6.8%, 6.5% and 2.1% growth, respectively. As per the new
series, basic goods and capital goods grew at 7.3% and 14.5%, respectively.
Although moderation has been visible in these two pivotal segments, the overall
growth has been more or less satisfactory. However, slackening in intermediate
goods (3.5% YoY) and consumer durables goods (3.8%) are disheartening.
We believe, intermediate goods segment is important as it typically tends to exhibit
3-4 months of lead period over headline IIP number and maps the future growth of
production cycle. Output of Intermediate and basic goods are used for production by
the final user sectors like capital goods and consumer goods.
Impact of increase in interest rates is already visible on consumer durables segment.
Further increase in interest rates would hit the capacity creation and may result in
higher inflation.
We believe that that the best of IIP in growth numbers is well behind us and going
forward, for next few months IIP numbers would continue to edge lower and may
disappoint if the economic growth moderates from here on due to high base effect.
In light of slowing economy and higher interest rates, we place a downside bias for
GDP growth in FY12, which is largely expected to be around 8% levels.
Inflation continued to stay at higher levels
India's wholesale price index (WPI) rose an annual 9.06% in May, driven by higher
manufactured goods prices and petrol prices. This was much higher than the
consensus estimates and came higher despite RBI's efforts to cool down inflation.
Manufactured goods index shot up 7.27% while primary article index rose by
11.3%. Inflation above 9% was without a diesel price revision and in a month when
global commodity prices were softer. This highlights the underlying inflationary
pressure in the economy and thus prompted RBI to further hike the interest rates by
25 basis points.
Food article inflation inched to two and a half month high of 9.13% for the week
ended June 11 from 8.96 per cent for the previous week. This was on the back of
costlier fruits, milk, onions and protein-based items. Inflation of non-food primary
articles stood at 18.43 per cent for the week ended June 11 as against 20.20 per
cent during the previous week.
During June 2011, EGOM also raised diesel price by Rs. 3/ltrs, kerosene by Rs 2/ltrs
and domestic LPG cylinder by Rs 50/cylinder. Government also reduced customs duty
on crude oil from 5% to nil and on all petro-products (petrol and diesel) by 5% to
2.5%. Excise duty on diesel (HSD) has been cut from Rs.4.6/ltrs to Rs.2/ltrs. This is
expected to further stoke up inflation by 60-75 bps.
Thus we believe that going forward, food, non-food manufactured product and fuel
inflation would continue to pose a concern and may prompt RBI to further hike the
interest rates to control the inflation. We continue to maintain our expectations for
further 50 bps hike in rates during fiscal year FY12.
RBI continued monetary tightening - hiked key rates by 25 bps
In order to control inflation, RBI hiked the repo and reverse repo rates by 25 bps.
Repo rates have moved up to 7.5% while reverse repo has moved up to 6.5%. RBI
also stressed that upside risks to inflation continue to remain as fuel pass through
has not yet happened. The RBI appeared particularly concerned about the trends in
the non-food manufactured products inflation which stood at 7.27% for May. This
indicated that pricing power is still intact within corporate India. Recent softening in
the commodity prices is likely to be positive for domestic inflation but last week's
increase in diesel prices may have a spiraling impact on overall inflation, thereby
prompting RBI to further increase the interest rates.
The statements of the RBI clearly indicate that it will continue to remain focused on
containing inflation and inflationary expectations even if it has to sacrifice some
growth in the short term. Thus, the monetary policy stance is expected to remain
firmly anti-inflationary even at the cost of some short-run deceleration in growth. We
continue to maintain our expectations for further 50 bps hike in rates during fiscal
year FY12, out of which 25 bps hike may come on July, 26th.
Negative global cues and news regarding revisiting Indo-
Mauritius tax treaty impacted FII flows but they turned net buyers
after fuel price hike
Foreign funds continued to remain net sellers till 24th June, 2011 but they turned net
buyers after hike in diesel prices and kerosene prices. Net FII inflows in the cash
market stood at about Rs30bn while mutual funds remained as net buyers with net
inflows standing at Rs.12bn. FII selling was prompted by negative global cues
coupled with news regarding revisiting Indo-Mauritius tax treaty. Higher than
expected inflation and expectations of further rate hike also weighed on the
markets.
Recommendation
We have been continuously stating that markets may remain side-ways till the time
concerns coming from global markets ease off or commodity prices and inflation
cool down. We have seen initial signs of reforms and on the other hand, commodity
prices have also moderated, though marginally. Going forward, we expect government
to further the reforms process (especially in the upcoming monsoon session)
which would be positive for the markets, we believe. Monsoons are expected to be
only marginally below LTA and weakness in global economy may keep commodity
prices subdued. Though in the near term, inflation and interest rates are likely to
remain high, but any correction due to adverse global cues or hike in interest rates
should be used to buy attractively valued stocks.
Thus in near term, markets may remain sideways till the time above state concerns
are addressed. However, based on longer term, valuations have already corrected to
reasonable levels. We remain selectively positive on stocks in sectors like Banking,
IT, Capital Goods, Infrastructure, FMCG, Media and Logistics. We have a cautious
view on Automobiles, Metals and Cement.
Preferred picks
Sector Stocks
Automobiles Bajaj Auto
Banking Axis Bank, Bank of Baroda, ICICI Bank, SBI, Union Bank
Construction IRB Infra, BGR Energy, IVRCL Infra, Unity Infra
Engineering L&T, Greaves Cotton, Tractors India, Cummins,
Diamond Power, Voltas, Bajaj Electricals
FMCG ITC
Information Technology Infosys, TCS, KPIT, NIIT Tech
Logistics & Transportation Mercator Lines
Media HT Media
NBFC IDFC, LIC Housing Finance
Oil & Gas IGL
Other Midcaps Time Techno
Source: Kotak Securities - Private Client Research
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