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MOSL: BULLS & BEARS (October 2018)- India Valuations Handbook — Markets stranded in a whirlpool of macro headwinds

BULLS & BEARS (October 2018): India Valuations Handbook — Markets stranded in a whirlpool of macro headwinds

 

Strategy: Markets stranded in a whirlpool of macro headwinds

• An eventful month – sharp sell-off sparked by macro concerns around liquidity: Market volatility last month reminds us of the Green Day band’s title song “Wake me up when the September ends.” The market performance was a tough pill to swallow with the odds that something could jolt the bull-run increasing throughout the month. The whirlpool of macro headwinds – rising crude prices, depreciating INR, tightening liquidity and ILFS debt default – became extremely prominent, driving one of the biggest market corrections in many months (Nifty down 6% MoM in September, after rising by 3% in August and 6% in July). FIIs sold USD1.3b, while DII inflows spiked to USD1.7b (v/s USD0.4b in August and USD0.6b in July). Mid-caps resumed their underperformance after briefly outperforming large-caps in August. Mid-caps lost a massive 13.9% in September, underscoring elevated market volatility and panic. On a 12-month basis, mid-cap returns (down 5%) have now turned negative and continue lagging the Nifty’s returns (up 12%). Consequently, valuation premium of mid-caps v/s large-caps has moderated to 19%.
• List of concerns mounting; valuations still expensive: Rising crude price, coupled with currency depreciation, has been the key macro concern for the market as it can make the task of fiscal management challenging amid rising bond yields. We also note that the ILFS debt default and concerns about liquidity tightening and potential funding cost impact have resulted in a significant correction in Financials. To alleviate liquidity concerns, the RBI recently announced open market operation (OMO) of INR360b for October. Concurrently, the government has reduced the borrowing target by INR700b for 2HFY19. We believe that this can cool off bond yields marginally. However, the risks pertaining to unabated crude inflation can limit any meaningful correction in bond yields. The bond and earnings yield spread has increased to 2.8%, highlighting the expensive equity valuations even after the recent correction.