Equity: Review and Outlook

The Nifty ended a 2-month consolidation with a 6% return in July 2018, closing at 11,356- a level higher than the previous Jan 29 peak of 11,130.But this up-move has come based on very few stocks, and index returns, to that extent, remain something of an optical illusion, compared to broad markets.The index PE also moved to 28.2, higher than the PE in Jan 2018, even as the US 10-year treasury yield continued to hover between 2.9% and 3%.

While our core large/multicap funds have delivered returns of 6.3% to 7% over the month, high PEs and continually rising interest rates globally are warning signals that we ignore at our own peril.This is not a time to go for returns, but a time to preserve historical returns, and, going forward, keep some reserve handy to allocate when our much-anticipated correction finally happens.The wait can try our patience, but long-term returns will come if we can exercise caution and patience now.

The month also finally saw some respite in the midcap space, with the Nifty Midcap 100 index moving up 3.8% to close at 18,877, which is still 13% below its Jan 2018 peak.While the Nifty Midcap 100 PE, at 55 indicates that the space is still overvalued, and much more so than largecap stocks, a quick aggregation of earnings for the stocks of 91 companies in this index, excluding the PSU banks for Mar 2018 indicates that year-on-year profit growth has been good at 58%.

The bad news is that this profit growth seems to have come through operational efficiencies and cost control; year-on-year sales growth for these companies stood at a miserable 1.4%.While better earnings, combined with declining oil prices, and continued buoyancy in mutual fund inflows should mean that the midcap space may be near the bottom for now, the long-term sustainability of any rally would be predicated on demand growth (sales growth) revival. This has eluded us for a long time now, and a continued lack of improvement in this measure can cause significant volatility.

We continue to maintain our view that the time has not yet come to reduce equity allocations, even as interest rates across the world are rising- but it is surely close, and we continue to monitor our model parameters closely.

Debt: Review and Outlook

Over June, the 10-year GoI Security moved around the 8% mark, but moved down to 7.75%, on the back of declining oil prices over the last month.

We also had an RBI monetary policy committee meet early in August, that raised benchmark rates by 0.25% proactively, to counter the risks of higher inflation, volatile oil prices, and possible fiscal loosening through farm loan waivers and higher minimum  support prices.The committee also continued its ‘neutral’ stance on liquidity, which has led participants to conclude that this rate hike cycle is probably near an end now.

We remain cautiously optimistic for stable to mildly rising rates (at worst) or some decline in rates (at best) over the next year, as strength seems to have dissipated in the oil rally. Inflation should also show some improvement in the second half, owing to a favourable base effect.

However, the downsides we have highlighted would still cause volatility- mixed signals from the RBI, and possible fiscal extravagance in an election year.GST collections, on the other hand continue to stabilize, and recent measures indicate some comfort on the fiscal front.As highlighted in the last review, portfolio yields for bond funds have moved up sharply over the last year, and, AAA bond yields have moved up more than sub-AAA bonds.

Keeping this in mind, we continue to recommend allocation to the higher credit-quality funds with reasonable expense ratios, and these now stand to deliver the best returns, going forward from here. Some of the credit risk funds may look good from a historical performance standpoint, but we now need to look forward to see which funds will deliver over the next three years.

To reiterate, as most dynamic bond funds seem to have adjusted their portfolio maturities towards the shorter-term bonds, we also do not see an advantage in churning out of these funds and into other funds.These funds have risen by ~1% over July 2018, even though the 1 year return is negligible.We will monitor our chosen dynamic bond funds for any signs of undue risk taking to capture declines in bond yields, and unless this happens, would recommend holding on to these fund.