Market Overview August 2018 Indian Equity & Fixed Income Market Overview Rebound in Mid and Small Cap performance During July 2018, markets saw a recovery in the performance with both market indices and the broader market indices gaining on a month on month basis (MoM). The market indices however, continued to outperform the broader market counterparts, a trend that was visible all through 2018. The mid and small cap indices saw a mild come back considering the sharp correction these indices have witnessed on a calendar year to date basis. Market indices, S&P BSE Sensex and NSE Nifty were up 6.4% and 6.2% respectively while S&P BSE Midcap and S&P BSE Smallcap indices gained 4% and 3.7% respectively (returns on Total Return or TR variants of indices on a MoM basis). The macro headwinds which had underpinnings in the higher global crude prices, eased a bit as the oil prices cooled off by 6.5% MoM. Given this backdrop, the currency market trends also stabilised with INR broadly remaining the same on a MoM basis. These factors helped the broader market performance to pick up during the month. Government announced the Minimum Support Price or MSP for Kharif crops and as stated in this year s budget document this was fixed at a minimum of 1.5 times the cost of production. Accordingly, some of the Kharif crops saw material increase in MSPs and in certain cases, the increase in price exceeded the floor of 1.5 times of the cost of production. Higher MSPs are inflationary in nature and is expected to add close to 40bps to Consumer Price Inflation (CPI) at the base level. However, depending on the mechanisms adopted to ensure MSPs are passed on to farmers efficiently (E.g.: quantum of direct procurement of crops by the government), the inflation expectations could vary. This has added to an expectation of a higher interest rate environment over the next few quarters and the RBI has already announced the second consecutive repo rate increase of 25 bps during the bi-monthly policy held on 01 Aug 2018. As per the Indian Meteorological Department (IMD) data, the cumulative southwest monsoon rainfall this season (01 Jun 28 Jul, 2018) saw a 4% deficit. The region wise distribution of the rainfall is uneven with East and North East India at below normal, while Southern India and Central India regions have received above average rainfall. The April June quarterly earnings season is currently underway and the trends so far are broadly on the expected lines. The aggregate earnings delivery has been impacted by higher provisions at corporate focused banks and in select companies. The earnings momentum is expected to pick up through FY19.
The GST council reduced tax rates on 88 items largely in the consumer segments, majority of which saw the tax rate getting reduced from 28% to 18%. The council also eased compliance requirements such as simplified filing process for small businesses and deferred the implementation of the reverse charge mechanism among others. This could put some pressure on the GST revenues (impact expected to be tune of INR 100 bn). However, the fiscal impact is not estimated to be that meaningful at this juncture. Institutional Fund Flows The Foreign Institutional Investor (FII) segment turned net buyers after seeing net outflows for the past three months. The segment net bought Indian equities worth about USD 208 mn during the month and for the 7 months during the calendar year, the net outflows from segment stands at about USD 414 mn (about USD 7.71 bn of net inflows in CY2017). The Domestic Institutional Investors (DII) segment continued to see net inflows (about USD 655 mn, as on 20 July 2018) driven by net inflows from the domestic MFs. The MF segment net bought equities worth about USD 802 mn (as on 20 July 2018). On a CYTD perspective, the MF segment has seen net inflows of about USD 11.9 bn, while at an overall DII level, the net inflows stood at about USD 10.1 bn, accounting for the net outflows from the domestic insurers (data available as on 20 July 2018). Global Economic Scenario Global trade conflict noises refused to die down as the US threatened to extend tariffs on all Chinese exports to the US. However, US President and European Commission President agreed to work towards finding a solution in their ongoing trade dispute. The European Central Bank (ECB) kept interest rates on hold during its July meeting which was on expected lines. The first estimate of the US second quarter GDP came in at 4.1% QoQ annualised, while first quarter GDP growth was revised higher to 2.2% from 2% earlier. During the second quarter, the personal consumption segment showed growth traction along with positive contribution from net exports. Global crude oil prices fell during the month on the back of an increase in production from Saudi Arabia, Russia and US and also due to resumption of Libyan supply post-temporary shutdown as geopolitical issues receded there. Key risks and challenges From a macro backdrop point of view, some of the variables have worsened at the margin after seeing significant improvement post the 'taper tantrum' phase in 2013. The fiscal deficit may move marginally higher while inflation expectations have inched up. On the external front, the Current Account Deficit has widened while exports growth momentum is yet to pick up sustainably. Higher global crude oil prices are a headwind in this connection. Having said that, all of these macro variables are in a far better shape when compared to bouts of crises phases we have witnessed in the past decade. The Central bank is also acting proactively and decisively to manage the inflation effectively as demonstrated by two consecutive rate hike decisions. On the global front, the rate hike process is expected to continue in the US and while this is broadly priced in as far markets are concerned, there could be some impact of external flows drying up for emerging markets. The US - China trade spat has been in a threatening mode for some time now, though the issue snowballing to a full blown trade war would not be in the best interests of both nations and hence is likely to be avoided. The US - N Korea historic summit has cooled down the heat on geo-political concerns which was lingering earlier. Going forward Month of July saw a rebound in performance in Mid and Small Cap indices, while the Large Cap market indices continued to touch all time high levels. However, if we analyse the equity market performance on a calendar year till date basis, a dichotomy is clearly visible in the performance of market indices to that of Mid and Small Cap indices. Even after the rebound in July, S&P BSE MidCap and SmallCap indices are down 9.6% and 13.4%, whereas the market indices S&P BSE Sensex and NSE CNX Nifty have climbed to record highs to register gains of 11.3% and 9% respectively during the past 7 months (returns on Total Return or TR variants of indices). However, it has been a concentrated performance on the market indices with a few stocks contributing to the bulk of the gains generated on a year till date basis. As a result, the Nifty 50 Equal Weight index is down 0.6% on a year till date basis, underperforming the free float counterpart meaningfully. The cycle of re-rating in Mid / Small Caps seen during 2017 and the subsequent correction in the space was as a result of valuations in the space running ahead of actual earnings delivery / expectations coupled with headwinds from increase in commodity prices especially global crude oil and INR depreciation. With crude oil prices cooling off a bit along with a stable currency, we saw a rebound in the performance of Mid and Small Cap indices during July. Valuations at an aggregate level and for individual stocks within the Mid / Small Cap space have moderated from the peak levels, as the premium of Mid / Small Caps over Large Caps had reached unsustainable levels at the start of 2018. However, this phase of correction in Mid / Small Caps is throwing up good opportunities as some quality names are now available at reasonable valuations 2
Going forward We remain constructive on the India story from a medium to long term perspective. Looking ahead, the GST regime will lead to faster formalisation of the economy, broaden the tax base, improve the fiscal situation and ease of doing business. Insolvency and Bankruptcy Code or IBC is another key reform that will lead to a structural repair in the banking industry and this may go a long way in reviving the credit offtake in the economy, early signs of which we are already witnessing. Government has taken some steps to address the growth issue and the bank recapitalisation and infrastructure push announced are to tackle growth challenges and that will help in hastening the overall economic growth revival process. GDP growth rebound after the twin disruptions of Demonetization and GST implementation provides the optimism and we are entering a high growth phase again. Also, the corporate earnings recovery cycle is already underway as the trends from the ongoing earnings season suggest. We are likely to see meaningful acceleration in corporate earnings growth over the next 2 to 3 years driven by a favourable base as well as genuine uptick in the domestic demand and consumption. The factors to closely track in the near to medium term would be corporate earnings, RBI s policy actions, election calendar culminating in the general elections, global crude price dynamics, rising trends of protectionism in the developed economies and the interest rate actions in the US. Equity Funds - Investment Strategy Our investment philosophy and portfolio construction follows the proprietary profitability and valuation framework. The emphasis is on identifying companies that are attractively valued relative to their sustainable profitability. In the Large Cap and Multi Cap portfolios, we continue to remain overweight on materials, consumer discretionary, industrials and financials. However, we have been moderating the extent of our active positioning on sectors as well as on selective names, in conjunction with our overall market view. We are mindful of the concentrated performance on a YTD basis in Large Cap indices and there could be a case for wider participation to the indices performance going forward. The Small Cap strategy continues to be more bottom up and the sharp correction in some of the Small and Mid Cap names during the year is throwing up some investment opportunities that are now available at more reasonable valuations. 3
Fixed Income Update Fixed income markets have been largely driven by the direction of oil and currency. Markets were helped by MSP announcement being on the expected lines, while crude inching downwards a bit also helped market to stabilise. Also, OMO announcement led to some positive sentiment. Towards the end of the month, market was largely on the sidelines awaiting clues from the policy. Policy being on expected lines with neutral stance should provide some balance going forward. RBI Policy RBI s Monetary Policy Committee or MPC hiked policy rate by 25 bps, while keeping its stance neutral. In line with the market opinion, RBI has hiked repo, reverse repo and MSF rates by 25 bps while keeping a Neutral stance. The key driver of the rate hike seems to be driven by two key factors: a) closing of output gap and b) increase in domestic activity. Policy notes that economic growth is strong and output gap has virtually closed. The forecast for GDP growth for FY19 has been retained at 7.4% with 1H growth in the range of 7.5-7.6% and 2H 7.3 7.4%, with risks evenly balanced. Five MPC members have voted for the hike with one member voting against the decision. Two consecutive hikes with neutral stance may indicate that probability of further hikes in the near term is very low. Policy has been a relief to fixed income markets as the rate hike was well priced in and a no change stance has been viewed positively so far. Going forward the key risks to inflation emerge from: a) volatility in crude prices b) geopolitical tensions c) spatial distribution of monsoon and procurement policy d) fiscal slippage at center/state and e) second round impact of state HRA revisions GDP Q4 GDP growth came in 7.7% y-o-y in Q4 FY18, above a downward revised 7% in Q3 and higher than consensus estimates of 7.3%. Full year GDP came in at 6.7%. Gross Value Added or GVA growth also improved to 7.6% y-o-y from 6.6% in Q3. The strong pick-up in growth was driven by agriculture, manufacturing and some services segments like construction. On the demand side, government spending has helped the growth. Exports however continued to drag growth lower and was at 3.6% v/s a 10.6% growth in imports. GST GST collection for the month of June 2018 (collected in July 2018) was INR 964 bn with a run rate of about INR 980 bn for the first three months continuing to remain a tad lower than the INR 1 trillion per month target. GST rates for certain items were lowered further in the month. Going forward improved compliance on GST and e-way bill rollout is expected to bring the desired results. Inflation Consumer Price Index or CPI Inflation for June 2018 came in better than expectation at 5.0% YoY from 4.87% YoY in May, driven by muted food inflation. Food inflation has remained consistently softer than seasonal, with back-to-back normal monsoon. The marginal rise in headline inflation is due to fuel and miscellaneous, in addition to an adverse base. Wholesale Price Index or WPI inflation came in at 5.8%, higher than 4.23% in momentum, driven by an unfavorable base effect and increase in fuel prices. A sequential momentum in core and food prices also affected WPI inflation. Primary food inflation at WPI level however, remained subdued at 1.14% while core WPI is at 4.8% (up from 4.4% y-o-y) even as fuel inflation remained higher at 16.2% y-o-y. IIP India s industrial production for May 2018 was modest at 3.2% YoY compared to a 4.8% in April 2018 marking the slowest pace of growth in the last 7 months, the weakness being led by manufacturing output on the sectoral side. While it was understandable that the investment related sectors of capital goods and infra/construction goods saw some contraction from high growth in April, but more worryingly production of consumer non-durables slipped into contraction after a gap of 16 months, strikingly in contrast to a healthy growth over the last one year (average at 10.3%YoY). However, we expect this to be a one-off and growth is expected to pick up post normal monsoon heading into an active festive season. 4
MSP Indian government announced Minimum Support Price or MSP rates. The MSP rate was largely on expected lines as per the formula specified in the budget. Overall MSP rates for paddy, which is the most widely sown kharif crop was increased by 13%, pulses by around 9%, while few of the other crops saw higher increases. On a weighted average basis (considering weights in CPI index), the MSP increase was around 14% on an average. The overall inflation impact is expected to be between 25 to 60 bps as per estimates of various economists but much will depend on procurement policy. Trade deficit India trade deficit was at USD 14.72 bn in May v/s USD 13.7 bn. However on a y-o-y basis, exports saw good growth at 20% y-o-y while import growth was at 13.8% y-o-y, primarily led by oil import growth of 49.5% y-o-y Fiscal deficit For the first quarter of FY19, government stood at 68.7% of its fiscal deficit target as compared to 80.8% last year. While it is better than last year driven by higher revenue receipts, some portion of this is driven by March GST (collected in April). Currency Rupee was range bound for most part of the month touching highs of 69.1 and lows of 68.3 largely driven by oil and geo political factors and dollar strengthening. In terms of flows while most of the month was negative, towards the end of the month it turned positive with marginal net positive on the debt side and INR 11 bn net flows on the equity side. Liquidity Liquidity hovered between being neutral to deficit. Towards the end of the month, some government spending has brought the system back to neutral. RBI Open Market Operations or OMO helped liquidity easing in the middle of the month. Going forward, RBI has indicated that it would balance liquidity actively with choice of instruments depending on whether the action is to tackle durable or transient liquidity. Going Forward 10 year G-Sec is likely to trade around 7.70% in the near term. With immediate policy action out of the way, market will look for cues from currency and oil. 5
Fixed Income Funds - Investment Strategy HSBC Short Duration Fund (HSDF) Focus on attractive segment - The fund is largely positioned in 1 to 3 years duration bucket to derive benefit from carry in yields with lesser volatility Duration - HSDF has an underweight duration bias largely through corporate bonds Selective credit approach - Unlike pure AAA or A rated fund, HSDF tries to achieve balance of credits with a prudent credit process. Through in house credit process, we are able to identify new and reasonable credits Focus on low volatility - Fund has been focusing on lower volatility investments with bonds in shorter end of the curve tend to be relatively less volatile in interest rate cycle Potential opportune time to invest - Investment in HSDF makes sense given the higher rates (YTM June end was 8.71%) and view that large part of negatives including higher crude, rates and inflation are priced into the bond prices HSBC Flexi Debt Fund (HFDF), HSBC Debt Fund (HDF) and HSBC Regular Savings Fund (HRSF) In HSBC Flexi Debt Fund and HSBC Debt Fund, we have reduced our underweight duration positions. G sec exposure is likely to benefit with some stability in rates HFDF is likely to maintain appropriate duration from both G-sec, SDL and corporate bonds With overnight at 6.50%, bond offers value at current levels HSBC Low Duration Fund (HLDF) Neutral to positive liquidity offers good opportunity to lock-in higher short term rates The fund is largely exposed to shorter end of the corporate curve, which offers attractive value as compared to overnight rates. It offers significant value for short term investors at current yields The fund would look to increase its accrual via selective and considered exposure to credits 6
Disclaimer: Expressions of opinion are those of HSBC only and are subject to change without any prior intimation or notice. It does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies that may have been discussed or recommended in this report and should understand that the views regarding future prospects may or may not be realised. Neither this document nor the units of HSBC Mutual Fund have been registered in any jurisdiction. The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions. Mutual Fund investments are subject to market risks, read all scheme related documents carefully. HSBC Asset Management (India) Private Limited, 16, V.N. Road, Fort, Mumbai-400001 Email: hsbcmf@camsonline.com www.assetmanagement.hsbc.com/in 7