Equity: Review and Outlook
The Nifty built on the strong showing in July 2018, with a 2.9% return in August, closing at 11,681- 5% higher than the Jan 29 peak of 11,130. Valuation, as measured by the price-to-earnings (PE) ratio was 28.4, compared to 28.29 in Jan 2008.

The PE comparison is important, as the Nifty PE came down to 20 from 28 by the end of Jan 2008- the start of a big downturn, that went up to early 2009, causing significant pain to investors, with the slide from the peak reaching -57% by early-Dec 2008.

But given that this peak comes when earnings growth year-on-year is 7%, compared to the 2008 peak where earnings growth was ~20%, are we justified in such comparisons? The implication here is that low earnings (denominator for PE) exaggerate the PE ratio, making it appear far more over-valued than it actually is.

But this is a theme that has been used to justify valuations for over four years now. And the longer growth is postponed, the more fragile markets appear.Looking at the box alongside, clearly, even earnings recovery is not helping cool down valuations, as they race ahead of earnings.

While earnings growth seems impressive, they are coming through margin expansions and cost-cutting measures. Going forward, raw materials as a percentage of sales will only go up as commodity prices recover, and reverse the trend of fast earnings growth. Sales growth has to pick up for a sustainable recovery.The nature of the recovery itself may be a tad suspect, coming off a low base of the post-demonetization and GST implementation periods.

In the first quarter (Apr-June) of FY 2019, sales growth for the sample is at 7.5% and profit growth is at 16.2%. Clearly, we have not yet moved to a higher growth trajectory, causing a disconnect between valuations and fundamentals (earnings growth)

And if the US 10-year treasury yield convincingly breaks past 3%, at some point in time high valuations would have to come down.We continue to advocate caution in allocating to equities, and persist with the warning that a time may soon come to actually reduce allocations to a minimum.If, after doing this, markets continue to rise and try our patience, we must demonstrate caution and patience keeping the long-term view in mind.

Debt: Review and Outlook

There seemed to be some semblance of normalcy returning to debt markets, with the 10-Year Government Bond trading at 7.75% over June and July; but August saw the yield breach the 8% mark based on a depreciating Rupee and higher-trending oil prices.

Higher oil may cause inflation to move up. There is also speculation that the RBI may raise rates faster to contain Rupee depreciation. Unlike the past, the incremental cost of fuel has been fully passed on, and this avoids a pressure build-up on government finances.Our recent allocations have all been in the medium to short-term debt space, with preference for high credit quality. Net yields of these portfolios (gross yields less stated expenses) are now hovering around the 8% mark.

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 sticking to only the best-managed funds in this period of volatility.