Market Overview

Key Market Levels (as on April 30, 2008)

Fixed Income

Macro Factors

In its annual review of the credit policy on April 29, RBI increased the Cash Reserve Ratio (CRR) by 0.25% to 8.25% while keeping all other benchmark rates unchanged. The hike in CRR is expected to absorb Rs.9000 crores from the banking system. Prior to the policy, yields had risen by 0.20% - 0.30% on expectation of a Repo rate hike. RBI had raised the CRR on April 17 by 0.50% in 2 phases to absorb liquidity from the system. The ten year benchmark government security reached a high of 8.24% from the previous month’s close of 7.94%. Post policy yields fell by 0.10% - 0.20% on buying by market participants.

The inflation for week ended April 19, 2008 was at 7.57% much above RBI’s revised comfort zone of 5.00 – 5.50%. The index increased tracking rise in prices of food and non-food articles, mineral oils, chemicals and metals. The government continued to announce fiscal measures to stem a rising inflation. Corporate bond yields remained range bound on the back of low volumes. Liquidity remained comfortable in the month of April with call rates in the range of 6.00% - 6.50%. The Indian rupee depreciated further in the previous month to close at Rs. 40.51 against the US dollar.

Global Events

The Federal Reserve cut its benchmark interest rate by 0.25% on April 30 to 2.00%, in line with market expectations. Globally, inflation continues to remain an area of concern for all central banks. Internationally crude oil price remained above $110/bbl.

Outlook

In the near term we are cautious on interest rates as Reserve Bank of India could take further monetary steps in the form of further CRR hikes or additional issuances of Market Stabalisation Scheme (MSS) bonds to absorb liquidity from the banking system in case inflation does not fall. Short term corporate bond yields could rise on outflows due to hikes in CRR. Inflation is likely to remain a cause of concern and can expect the government to announce further fiscal measures to control it.

Equity

Market Review and Fund Flows

Post another round of correction during March of 12% driven largely by domestic negative surprises on inflation, market rebounded during the month of April by nearly 10%.  The market moved up supported by similar rise in emerging market indices as well as broader equity market rebounded globally. The perception that the worst is over with regards to the sub-prime crisis seems to be behind this relief move.

The corporate earnings news flows so far have been mixed with banks reporting better than expected numbers where as capital goods companies reporting slippages in execution. In the aggregate, positive surprises have been far and few. However, overall growth for the period ending March 2008 for the companies that reported so far has remained robust. The fund flow activity for the month of April has been rather muted with all institutional participants reporting moderate activity. Net FII flows were positive, but marginally so at around USD200m. Net mutual fund buying activity was also very modest during the month.

Earnings and Valuation 

The corporate performance for the first nine months of the year was strong, with more than 20% growth in net income in Sensex group of companies. For several quarters over last few years, net income growth for corporate India was ahead of revenue growth due to improving margins. However that was not a sustainable trend, and we expected some normalization to happen driven by rising capital expenditures and higher input costs. While earnings growth for full-year FY08 would be close to 20%, in coming few years however it will be somewhat lower on these grounds.

The forward price-earning (P/E) ratio for BSE Sensex currently stands at nearly 16 times 12-month forward earnings. These valuations are close to last five year’s mean but slightly higher than longer-term average. Given that Indian corporates’ medium-term earnings growth is also likely to be above long-term average, despite aforementioned slow down, we believe current valuations would sustain, in our view.
 

Outlook

In the short-term, the markets are likely to remain volatile and range bound as twin forces of attractive valuations and moderating growth balance each other. Besides global news flow also could remain volatile for sometime to come. Over medium-term, factors such as GDP growth and direction of interest rates are the most important drivers for the market. Our medium-term and long-term views are that growth will sustain and interest rates will soften making us retain our positive long-term opinion on the equities.

Key Message

The asset markets are volatile and one can be tempted to avoid the volatile assets till there is stability in markets or things bottom-out. However nobody can predict bottom and one must remain invested even in volatile asset class such as equity at the moment, as per one’s desirable asset allocation.

One should not base one’s financial planning decisions on one’s ability to time the market, but instead must be based on such factors as risk appetite, investment horizon which is best captured in asset allocation decision.