Equity: Review and Outlook

The Nifty continued to consolidate through June 2018, ending the month with a small loss of -0.2%. However, July has seen a rally which has taken the Nifty past the 11,000 mark again.So why is nobody happy? And why would our portfolios not reflect much of this up-move?

A graphic from one of the fund houses points out that while the Sensex went up 18% over the last year, only 8 companies contributed to this return, with 22 (or over 70% of the Sensex) contributing -0.4%.Add to this the woes in the midcap space. Even as the Nifty went back to 11,000, the Nifty Midcap 100 ended lower than its previous Mar 2018 low. From the peak of Jan 2018, the midcap index is down 17.1%.And, like the Nifty, even this number flatters to deceive; many hitherto fancied stocks have shed more than 30% in this space.

In spite of the decline, and an improvement in earnings, the midcap index’s PE currently stands at 48.36. In Jan 2018, the Midcap index was at 52.8 compared to 27.7 of the Nifty. But this, in our view, accentuates the results of companies suffering extraordinary losses- like many public sector banks have, thanks to NPAs. Declining oil prices, prospects of better earnings, and continued buoyancy in mutual fund inflows should mean that the midcap space may be near the bottom for now.Given this, our view is that the time has not yet come to reduce equity allocations, even as interest rates across the world are rising.

However, we must note that markets are complacent regarding valuations. 27 PE is still high, whether it is the Nifty or the Nifty Midcap index. In an era of rising interest rates, and tighter money signals from central banks, valuations would need to adjust down.

For now, we hold on, and see if a broader rally can take us back beyond Jan 2018 levels at which point we will actively consider reducing allocations to equity, across the board, as risks have considerably increased in large cap stocks also.

Debt: Review and Outlook

Over June, the 10-year GoI Security moved around the 8% mark, but of late, has moved down to 7.75%, on the back of declining oil prices.Like the midcap index, bonds seem to be signalling a bottoming out, and we remain cautiously optimistic for some decline in rates over the next year, as strength seems to have dissipated in the oil rally.

However, the downsides we have highlighted would still cause volatility- a central bank that sends out mixed signals, big hikes in kharif procurement prices, farm loan waivers are all party poopers. GST collections, on the other hand seem to be stabilizing, and are mitigating fears of a runaway deficit to some extent.

Portfolio YTMs for bond funds have moved up by over a percentage point over the last year, and as highlighted in the last review, AAA bond yields have moved up more than sub-AAA bonds.

To reiterate, our stance has always been towards the higher credit-quality funds with reasonable expense ratios, and these now stand to deliver the best returns, going forward from here.Higher interest accruals in these funds, and a possible end to expectations of higher rates later this year should help debt funds do well from here.

Given that 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.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 funds.For fresh allocations to debt funds, we continue to advise allocations into good credit quality medium-term bond funds.