July view: Concerns take a backseat
Markets rally on expectations of economic reforms
Q1FY13 result preview: Not yet out of the woods
Liquidity blues; efforts to tame the dollar crunch
Crude: On the boil again
IT: Volume growth a key driver
Auto: Widespread slowdown
Nifty on the fifth gear after a high voltage month
June began with a big bang with events such as Greece elections, declaration of India
IIP numbers, monetary policy review, FOMC meet and the European Summit. Though
the policy review was a dampener for the markets, fresh cues on stimulus from the
European Summit has set up a relief rally in global equities. Also, the FOMC meet was a
non-event, considering murmurs around QE3 were put to rest and the existing
“operation twist” was extended.
Domestic earnings season will kick off in July, and all hopes are pinned on a likely rate
cut in the RBI meet on July 31. We expect 25bps cut in repo rate and no change in cash
reserve ratio. Over the near term, markets are looking forward to key decisions from
govt, targeted at putting the economy back on the growth track. The underlying thrust
is likely to be on reviving foreign flows to aid deficit reduction. An action in the same
direction may involve the passage of foreign direct investment in retail. Key reforms
related to the financial sector (pension and insurance) and agriculture (fertilizers and
urea) are also on the anvil. Further, softening crude has given enough reasons to cheer,
as it brings with it possibility of partial decontrol of diesel prices. Disinvestment buzz is
gaining grounds once again. We strongly believe that once these aforesaid reforms
materialise, they will reinvigorate the sagging investor spirits. Moreover, any
incremental stimulus from Europe also augurs well for markets in the near term. Key
levels for the Nifty in July are 5100-5200 on the downside and 5440-5500 on upside.
Against all odds, Nifty gained ~7.2% in June. The rally was backed by dipping industrial
production numbers, which presented a strong case for reduction in key rates. IIP
barely grew (0.1% YoY) in April. Sensing a steep cut, the markets saw a brisk rally.
Attaching more importance to sticky inflation, the central authority left rates
unchanged, which did not go down well with the markets. The rally resumed as
positives emerged from the European Summit. The reversal of seniority status assigned
to Spanish debt reigned over the rising yields. Further, reports suggest that EFSF/ESM
instruments would be utilized to lend stability to the region. Other positives that
emerged from the Summit were talks of a common banking supervision in Europe, a
common deposit insurance scheme and direct injection of capital into the EU banking
system. Incremental cues on the GAAR also aided market participation.
Q1FY13 result preview: Not yet out of the woods
Q1FY13 earnings are likely to be weak, marking yet another lackluster quarter in a prolonged slowdown phase. Apart from the bleak
growth, equally disconcerting is the breadth of negative earnings revision as almost a quarter of companies may post an earnings decline
of more than 20%. A weak rupee, which has depreciated 8% against the USD in Q1FY13, could suppress reported profit growth on top of
weak core earnings outlook. The revenue trajectory continues to moderate. Among major sectors, IT, auto, pharma and utilities are
likely to post healthy topline growth, while growth for metals, construction and real estate could be relatively lower. However, despite
the slowdown in topline growth, sequential recovery in EBITDA margins is expected as businesses (not confident of sustainable demand)
shift focus to profitability via cost rationalisation.
EPS estimates continue to be downgraded, with FY13 estimates being cut 2% during Q1FY13 alone. Consensus FY13 and FY14 EPS
estimates for Sensex now stand at INR1,275 and INR1,450, respectively (Edelweiss: INR1,280 and INR1,430). Based on our macro
assessment, we believe there are further risks to the earnings trajectory, but we do not foresee FY13 Sensex earnings falling below
INR1,220
Liquidity blues; efforts to tame the dollar crunch
To address the USD demand crunch, global central banks have initiated coordinated efforts by setting up foreign currency swap lines in
the past. This basis swap is an instrument by which a European entity is able to swap its EUR denominated debt into USD denominated
debt and measures the cost of this USD funding. It is tracked as a spread below the Euribor and is a measure of the premium for the
USD—an intuitive and easier way to read this measure is the cost of setting up the swap for the Euro zone entity. In December, 2011, on
the back of the global central bank coordinated action, the Euro-Dollar basis swaps sharply retracted down. Within just two weeks of the
global central bank coordinated action, the Euro-Dollar basis swaps dropped back to the levels seen before the action was announced in
end November, 2011. As observed in the first
leg of this effort in September, 2011, the 3-
month swap retraced strongly by ~50bps to
110bps in the week following the
announcement. The recent spike in the basis
swaps reaffirms the solvency risks faced by
the economies in the region and only goes to
reinforce the need for immediate liquidity
resurrection measures to avert a crisis.
Against the backdrop of the European summit,
the interbank risks have receded (with talks of
EFSF channel likely to be used for
recapitalization of banks); the euro dollar
basis swap has been inching lower since May-
2012.
Commodity prices factor in fresh deluge of cheap money
Globally, in the past few days, prices for
commodities have started rallying in
anticipation of fresh stimulus from Europe. In
a recent announcement as per market
expectation, Bank of England increased its
asset purchase program by GBP50bn, while
keeping in rates unchanged. It is interesting to
watch commodities to follow an inverse
relationship with the Dollar Index. Investors
prefer holding commodities against USD,
fuelling a rally in commodities. When the USD
starts gaining muscle, it starts exerting selling
pressure on commodities. We further believe
the commodity rally will sustain for a couple
of more months with the DXY view still held
bearish.
Crude: On the boil again
EU sanctions on Iran gained full force yesterday, after exemptions on some contracts and insurance ended. According to IEA, the
reduction in Iran exports may become the biggest supply disruption since the Libyan crisis. Also, a strike by Norwegian workers is
curbing flows from North Sea fields. Full implementation of sanctions will remove 1 mbpd in H2CY12 as buyers disappear and
Iranian storage tanks become full, the IEA said. Iran said it has USD150bn of forex reserves to weather the sanctions. We believe if
Iran’s supply is completely cut off from global markets, it will definitely put pressure on crude as global spare capacity will fall.
However, it needs to be seen if Iranian crude will find its way into the oil market through countries not under pressure of
sanctions. OPEC will hold a special meeting if crude prices continue to slide, Algeria's oil minister said, a day after his Iranian
counterpart urged OPEC to hold an emergency session. The same was agreed upon in the last OPEC meeting. However, OPEC has
been targeting crude at USD100/bbl and, thus, could see production reverting to its ceiling of 30 mbpd if prices were to fall
further. With signs of improvement in global demand, along with rise in U.S. factory orders for the first time in three months,
there is sharp rise in crude prices. Iran’s Revolutionary Guard Corps “successfully” fired several long and shorter range missiles
during war games that began July 2. Also, Iran's parliament is working on a legislation to close the Strait of Hormuz.
Brent Crude is back on the bullish path after a sharp fall in the past few months. The recent upmove could take it up to
USD103.75-105.30 on the upside, whereas the downside seems protected at USD95 levels.
IT: Volume growth a key driver (Our IT analyst Sandip Agarwal)
We expect a muted June quarter due to slow ramp ups, further impacted by cross currency (CC) impact of 0.5-1.0%. We forecast
0-3% Q-o-Q growth in USD revenue for Indian large cap IT players with TCS and HCL Tech leading the pack with 3% MoM growth.
Infosys is expected to post muted growth of 0.6% in USD terms, in line with its guidance of 0-1%, slightly impacted by CC impact.
Volume growth guidance for 2Q and pricing trends would be the most influential share price drivers through this earnings season.
Among large caps, sequential pace of volume growth to achieve the current FY13 volume growth targets needs to be raised by
both Infosys and Wipro. Street will also be looking at qualitative comments from TCS and HCLT. Any commitments for a 2H
recovery and slower 2Q outlook might be discounted by the Street. We remain cautious on the demand environment and believe
companies may find it tough to raise their FY13 volume growth expectations. The INR has depreciated 7.5% versus the previous
quarter (INR/USD from ~50.3 to ~54.0), which in our view will positively impact margins by ~225bps. This, in our view, will largely
absorb the impact of both wage hikes (TCS full quarter impact and Wipro one month) and H1B visa costs. We expect TCS’ and
HCLT’s revenue growth to outperform both Infosys and Wipro in the current year due to past wins and relatively higher traction
in growth verticals. We also expect Infosys’ and Wipro’s margins to improve in the current year even excluding currency impact.
Auto: Widespread slowdown (Our auto analyst Sachin Gupta)
For June 2012, automakers posted poor volumes, largely on the expected lines, amid slowdown in economic activity and negative
consumer sentiments fuelled by higher inflation and increasing cost of ownership. The slowdown in demand is now clearly
evident across most product segments (ex. LCV and UV), which continues to impact overall growth. Capex-linked segments like
MHCVs are showing the sharpest declines; diesel-linked UVs and cars are outperforming the industry. Slowdown has permeated
rural demand as well, as reflected in weak tractor and two-wheeler demand. LCVs and UVs in auto and inverter in batteries
segment are the exception, where demand is still robust. Falling sales, rising discounts/promotion costs and weak INR is likely to
take toll on margins. Companies stuck with high inventories are likely to be more affected in Q1 than others. Tata Motors’
domestic business and Maruti Suzuki are likely to suffer due to inventory rationalization efforts. Bajaj Auto’s poor show on the
export front and forex contract is likely to put pressure on margins. We prefer M&M which is likely to benefit from strong UV
demand and discipline shown by tractor industry amidst the ongoing slowdown. Market would closely watch out growth outlook
for the tractor division and new launch schedule in automotive segment would be a key monitorable.
Technical view: In the midst of a purple patch (Our technical analyst Tejas J Shah)
Coming off from a sharp sell-down in May (the worst month of the year), the markets were poised for a technical rebound earlier
in June due to oversold conditions and signs of positive divergence. The first week of June saw the index breach the low of May at
4770, followed by the beginning of a superb rally that lasted throughout the month. Nifty appreciated by ~7%, marking June as
the second best month of the calendar year after January. The 78.6% retracement of the Dec 2011-Feb 2012 rally was well
respected and was also supported by the 200-week SMA that has always acted as a key pivot in a structural trend. Nifty’s inability
to breach that level and the subsequent rally thereof is a signal of the bulls still keeping the upper hand in the market since
registering a low in December 2011. Although volumes remained lower compared witt the previous month, we have seen a
notable pick up in the second half that should support price uptick.
Volatility tracked by the India VIX, has crashed down below 20 and is nearing the yearly lows of 17.50 levels. Interestingly, Nifty
has managed to stay afloat the breakout of the falling trend line from the Feb high of 5630 that helped it catapult higher above
the 200DMA barrier of 5075. On the momentum front, the indicators that had rolled bearish on weekly (intermediate) charts
have turned bullish in June and the short-term oscillators too are in sync with the bullish price action. Even the trend strength
indicator ADX has got into an upward trending mode. On the candlestick charts, a ‘bullish engulfing’ candle pattern has formed on
the monthly charts indicating bullish reversal. The coming weeks are likely to see the index move higher towards the key
resistance of 5440 i.e. the trend line falling from the November 2010 high to February 2012 high.
On the downside, the immediate support is pegged at the 10-DEMA of 5215, whereas the 200DMA now at 5090 will be the trend
reversal pivot. Sectorally, June was more of a “risk on” rally led by capital goods, banking, metals and autos. Even the FMCG
stocks participated well to help lead higher. The typical defensives - healthcare and IT sectors - underperformed the overall
markets. Even the broader markets failed to keep pace with the swift moves in the frontline stocks. Going forward, we expect the
uptrend to continue in the high beta names, notably realty, banking and metals in the first half. The second half is more likely to
witness profit taking that could favor the defensive names to attract buying interest.
Global events
Euro zone took a breather after Greeks voted in favour of center-right New Democracy party. The results are likely to keep
Greece and its ailing economy in the euro zone and at least temporarily ease fears among the world's financial markets of the
economic turmoil.
FOMC in its last meeting had left policy rates unchanged and only made a modest move on extending Operation Twist. The
Fed kept fed funds target at a range of zero to 0.25%. Guidance was left unchanged with policy rates expected to be
exceptionally low through 2014. The meeting statement downgraded the status of the economy-notably for the labor market
and consumer sector. Again, Richmond Fed President Jeffrey M. Lacker dissented. The vote for the statement was 11-1.
EU leaders in their last EU Summit agreed to let their rescue fund inject aid directly into stricken banks from next year and
intervene on bond markets to support troubled member states. Member nations pledged to create a single banking
supervisor for euro zone banks based around the ECB.
Buying seems to be in flavour for markets with improved global sentiments post FOMC meeting. In developed markets, major
movers were CAC 40 (up ~6.0%), Nikkei 225 (up ~5.4%) and FTSE 100 (up ~4.7%).
Reversing the May month trend, Nifty and Sensex posted positive returns of ~7.2% and ~7.5%, respectively.
Among other emerging markets, Shanghai (down ~6.2%) was the biggest loser, followed by flat Bovespa (down ~0.2%) and
Taiex (down ~0.1%).
STI (up ~3.8%), SET (up ~2.7%) were gainers in the emerging markets.
FII flows have turned positive
FIIs were net buyers in India (cash + futures) in
June. Philippines, among emerging markets,
posted the highest FII inflow of ~USD873mn.
In India, FIIs were net buyers of ~USD0.864bn (cash
+ futures) in June. In the cash segment, FIIs bought
~USD26.33mn while in futures they were net
buyers of ~USD0.838bn.
Domestic funds have turned into buyers
In contrast to May trend, domestic mutual funds
were net buyers in June.
They were net buyers of ~USD54.4mn of Indian
equities in June.
Capital goods, banks top performers; defensives like consumer durables, IT among laggards
The CNX 500 gained ~6.6% in June.
Prominent gainers were capital goods (up ~13.7%)
and banks (up ~9.4%).
Laggards were consumer durables (down ~0.1%)
and IT (down ~1.7%).
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