Equity: Review and Outlook
The damage done across stocks in 2018 has not been reflected in the Nifty’s 6.4% drop in Sep 2018, over even in the current level of 10,473, which is 10% below the Aug 2018 closing level.The Nifty Midcap 100 index reflects the real decline better, as it plunged 14% in Sep 2018, and was 24% below its Jan 2018 peak.

In this summary, we are not going into the anatomy of the decline or the reasons attributed to it, because the reasons are force-fitted to the circumstances.As an example, you may remember the Nifty’s 13% decline over Jan-Feb 2018 (worse than the Sep-Oct 2018 decline of 10%). The reason attributed to that decline was ultra-low oil prices with just-visible NPAs as a secondary reason. The recent decline is attributed to high oil prices, weak currency and again, fears over the health of NBFCs.

Our view is that stretched valuations, which we have been highlighting for months, had to come off; and any or all of the above reasons were just triggers for normalizing valuations.In retrospect, our decision to significantly cut midcap exposures in early Feb 2018 has proved to be wise. But did we err by not cutting exposure further after the gains till Aug 2018, especially in large and multicap portfolios?

This is related to what happens next. Is this a ‘bull market correction’, or do we expect stock declines to continue and intensify, plunging us into a bear market like in 2008? The first week of Oct 2018 saw panic selling, best reflected in the plunge in oil marketing companies, when a Rs.1 excise cut was foisted on them by the government. This typically happens in the last leg of a sell-off, and the subsequent recovery in those stocks is indicative of the return of reason, which heralds a phase of consolidation.

The return of stability to two main reasons for the panic selling- oil prices and the rupee (Brent Crude has moved down to ~$81 from a peak of ~$87, and the INR closed Oct 12^th at 73.56 from a peak of 74.69) further reinforces our view for an upward consolidation to happen.

But what about the over-valuation, which caused this decline in the first place? The Nifty is till at a PE of 25 and the Nifty Midcap 100 at 46 even after the declines.How ever, when we look at a broader index like the BSE 500 (our sample of 375 non-BFSI non policy-dependent PSU companies), we see that the market cap (as on Oct 5^th) to trailing year earnings is at 19.27 (assuming 15% earnings growth in trailing year earnings ended Sep, over July).

In Sep 2013, again, at the bottom of a decline led by high oil prices and a steep fall in the rupee, the same ratio was at 17.97, just 7% below the Oct 5^th level. And many stocks moved up between 3 to 10 times from that 2013 low, aided by a boost in earnings thanks to low oil prices and declining commodity prices.

While oil and commodity prices may not oblige profit growth by falling steeply, broad market valuations have normalized, and this may result in a trend of Nifty and Nifty Midcap 100 being range bound, where funds that smartly pick value in this market race ahead of the indices.

Given the above considerations, and the fact that we believed this was a regular market correction, we chose to stay invested during this phase.For those who have raised cash, and do not have systematic transfers happening to equity this may be a good time to allocate more to equity. We will be in touch to advise you, in case we believe that a higher allocation is currently warranted.Otherwise, please stay invested, and avoid sensational headlines. These are often misleading, and rarely present a true picture of events on the ground.

Debt: Review and Outlook

After jumping to a peak of 8.2%, the 10-year GSec yield has stabilized around 8.1% by end-Sep 2018, and traded at 7.98% on Oct 12^th, partly helped by the RBI decision not to defend the rupee by hiking rates, as they saw inflation up to Mar 2019 being less than their earlier projections, in spite of a depreciating currency.

Yesterday also saw CPI inflation for Sep 2018 come in at 3.77%, which is lesser than the 4%+ consensus estimate on the back of a depreciating rupee and stubbornly high oil.With some stability to the rupee and oil prices, some stability in bond prices and yields is also expected.Net yields of our recommended AAA medium to short-term debt portfolios (gross yields less stated expenses) are around the 8% mark, and some stability in yields should be reflected in returns around these levels over the next three years.

We view the current debt market valuation as attractive and going forward, we will work on individual portfolios to increase the allocation to these short-term funds.We will also monitor our exposure to dynamic bond funds with a view to selectively paring some funds which have crossed the three-year mark.