Equity: Review and Outlook

In the Dec 2017 review, we had mentioned that “At current levels of earnings (not factoring in Dec 2017 quarter results) and macro-variables, anywhere upwards of 11,000 levels on the Nifty would mean significant downsides, and reducing equity allocations to the lower end of our allocation range may be wise.”

While we were able to reduce equity allocations in early-Feb 2018, and cushion the fall somewhat, we are still not down to the lower end of the allocation range.

This month may be volatile, with a cap on index gains largely due to expected profit taking on every rise, before the new long-term gains regime kicks in. However, there should be a good up-move in the Apr-June quarter, thanks to better earnings visibility (Jan-Mar ’18 may look good in comparison to Jan-Mar ’17 which bore the brunt of GST and demonetization).The unknown here is how global markets react to higher interest rates. If they continue to ignore the “party is winding down” message that interest rates are conveying, there may be one rally left to go.

We must however use this rally to bring equity down to the lower end of the allocation range, as a sharp decline may be very much on the cards, if interest rates continue to climb.For now, we must exercise patience in volatile conditions and hold on.

Debt: Review and Outlook

While we speak of ‘corrections’ in equity markets, the debt markets have been in a bear grip over the last few months.And where our equity call was correct, our call on debt in the Dec 2017 review went totally wrong:  “If, (as I expect), the government, in its budget on Feb 1, demonstrates some intent to stick to fiscal consolidation in FY 2019, and delivers a lower-than-3.5% fiscal deficit, there may be a relief rally in yields, with current 7.3%-7.4% coming off closer to the 7% mark.”

The yield of the benchmark 10-Year Government Bond continued to move sharply up to 7.67% (bond fund NAVs go down as interest rates go up), even as oil, a crucial factor in the yield rise has started to moderate.

The move beyond 7% was perhaps intensified by the lack of buying from the largest investors, banks, who have hesitated to add treasury losses to their already dismal results.

Indications are that the ‘fair value’ for 10 year yields are closer to the 7% level, and the current under-valuation is more technical in nature, but it is difficult to predict when a reversion to fair value will happen, given the one major uncertainty still at large- government finances, and whether the revenue projections outlined in Budget 2018 are feasible.

Given that the RBI, through its communication has to manage interest rates in line with its inflation mandate, let us monitor what they say, and the effect it has, over the next few weeks. If the bear grip does not loosen by mid-April, we may have to reduce allocation to dynamic bond funds, and increase the allocation to shorter-term bond funds.