Month gone by – A snapshot
Global equity markets were mixed in September and developed markets outperformed emerging markets. India was a significant underperformer within the Emerging Markets (EM) pack. Nifty ended the month 6.4% lower, while the mid-cap index was down 12.5%. The INR continued to weaken and was down 2.1% over the month, although measures taken by the government to provide support brought some semblance of stability. Fixed income markets remained under pressure on the back of a weaker INR, tightening liquidity, rising crude oil prices, higher US bond yields and hawkish commentary by US Federal Reserve.
Financial sector experienced stress due to liquidity and regulatory issues
Financial sector companies were under significant pressure as one of the large infrastructure companies defaulted on its debt obligations. The company’s credit rating was downgraded to D (default) by the rating agencies (ICRA and CARE). There was panic selling in the debt markets, probably led by redemptions. This impacted equity markets as well, leading to a sharp sell-off in financials. Additionally, regulation related concerns in certain companies added to the weak sentiments and led to further selling in the equity market.
Government stepped in to support INR
Crude oil prices are up by 7% over last one month and 44% over the last one year. Rising crude oil prices adversely impact India’s fiscal deficit as well as current account deficit. Higher fuel prices are likely to dampen economic growth through expected higher inflation and possible demand slowdown. The worsening macro-economic scenario has led to a significant depreciation in INR. The government has announced a ‘Five point Plan’ to support the currency. However, the impact is likely to be marginal.
Fixed income market was volatile, yields continue to move up
10-year G-sec yields inched up by 7bp during the month, ending the month at 8.02%. Fixed income markets came under pressure and yields touched 8.18% during the month on the back of a weaker INR, tightening liquidity, rising crude oil prices and higher US bond yields. However, yields softened towards the end of the month due to RBI intervention and reduction in the government’s borrowing programme for 2HFY19. Foreign institutional investors (FIIs) were net sellers in the debt market ($7bn YTD).
Bond yields may stay firm
The government and RBI have announced several measures to restore liquidity and instil confidence in the market. However, increasing crude oil prices, rising global bond yields, depreciating INR and expected higher inflation are likely to act as dampeners. We expect bond yields to remain firm in the near term.
Equity market correction
Equity markets witnessed a brutal correction in September 2018, mainly due to stretched valuations, panic in the corporate bond market and its subsequent impact on NBFC space. This coupled with regulatory action in certain banks led to significant profit booking in the financial sector stocks. IT, Pharmaceuticals and Oil and Gas outperformed while Banking & Financials, Automobiles and Capital Goods underperformed. Nifty was down 6.4% whereas BSE Midcap was down 12.5%. FIIs sold over $1.1bn in equities in September 2018 ($1.8bn YTD) whereas domestic funds bought equities worth $1.7bn ($11.4bn YTD).
Equity market to consolidate in near-term
Indian equity market valuation remains slightly above its long term average. Moreover, increasing domestic macro-economic concerns arising from surging crude oil prices and weakening INR are expected to create further pressure on fiscal and current account deficit. This could create headwinds for valuation premium that India enjoys over its regional peers. Investors may choose to remain on sidelines, given political uncertainty ahead of the upcoming state and general elections. These factors, coupled with global geo-political issues such as trade war concerns may lead to equity market consolidating in the near-term.