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Global markets advanced early in the month as the fresh round of quantitative easing (QE2) in the US boosted risk appetite. Economic data was by and large positive which added momentum to global markets. Commodities (mainly precious metals and Crude) rallied in anticipation of weakness in US dollar post the Federal Reserve’s USD 600 bn QE plan. The IPO of Coal India Ltd sailed through smoothly and also ensured handsome listing gains for investors.
However, fresh concerns on some of the smaller European economies, potential further monetary tightening in China and sharp fall in some of the Asian markets led to a fall in markets in second week of the month.
In the US, the much anticipated QE2 was announced wherein the Fed Reserve said it will buy back bonds worth USD600bn from the markets. The idea is to keep bonds yields under check and stimulate inflation through infusion of liquidity in the financial system. From a market viewpoint, the QE2 provides a further boost to emerging markets as fresh liquidity will flow into them in search for higher returns. However, from an economic viewpoint, the QE2 may throw several challenges for India, especially in containing inflation. Following the QE2 announcement, there has been firming up in the prices of Crude oil, which has reached USD 87 per barrel. For India, this would mean upward pressure on inflation (not to mention further subsidy losses for oil marketing companies like HPCL, BPCL and IOC).
The Reserve Bank of India (RBI) raised repo and reverse repo rates for the sixth consecutive time this year by 25bps to 6.25% and 5.25% respectively. This was largely in line with street expectations. With spiraling prices, the housing sector caught attention of the regulator and it has tightened lending norms further for this sector. The policy statement has also made a reference to the liquidity and has made it clear that RBI is not very comfortable with the liquidity situation and may act to actively manage the same. However, the RBI's statement on a possible pause on interest rate hikes under prevailing circumstances, came as a mild surprise and likely indicates its comfort with the prevailing domestic inflation - growth balance.
The industrial output for the month of September rose at a much slower-than-expected 4.4% from a year earlier figure of 8.2%. Industrial production for the month of August had come in at 5.6%. The sluggishness in IIP was partly due to base effect as also the poor performance of core sector industries (2.5% growth in Sep 2010, ~26% weight). There was a moderation in manufacturing and Capital Goods indices which grew 4.5% and (-)4.2% respectively. Electricity production was stagnant and growth in consumer goods was also remained modest.
Results for the quarter ended September 2010 have been largely either in line with estimates for most companies. However, one other trend, which has been noticed has been the intense pressure on margins for the manufacturing companies. According to industry data, a sample of 600 manufacturers' operating and net profit growth was in single digits for the second consecutive quarter. Metal, auto and cement companies have been the most impacted in terms of margins - either due to higher raw material prices or reduced realizations. One positive aspect in our view was the execution and order bookings by the capital goods companies. 1Q was disappointing but September numbers have matched up with expectations, in most cases, we believe. Performance of the construction and infra companies will be important to keep a track of.
The recent correction and consolidation in markets is healthy, according to us. Going forward, inflation (led by commodity prices) and interest rate movements will be important. We maintain that, at the current levels, we are fairly valued based on FY11 numbers but there is a potential upside based on FY12 numbers. In-line quarterly results and continued fund flows may take markets higher. Investors entering at current levels must be prepared for a longer time horizon for making gains. We recommend exposure to domestically focused sectors like infrastructure, capital goods and financial Services. We also like select mid cap stocks and some large companies in IT.
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