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Equity & Debt Strategy
Mid Nov – Dec’ 2017
Equity Market Update &
Equity MF Strategy
Confidential | 3
Equity Markets benefited from announcement of PSU Recap and Bharatmala
17,000
17,500
18,000
18,500
19,000
19,500
20,000
9,600
9,800
10,000
10,200
10,400
10,600
29/09 05/10 11/10 17/10 23/10 29/10 04/11
NIFTY Index Nsemcap index
Govt announces PSU
Bank Recap plan and
Bharatmala
2,529
-11,258-10,764
1,976
-7,157
-1,7361,664
-468
11,980
18,187
21,450
12,597
-15,000
-10,000
-5,000
0
5,000
10,000
15,000
20,000
25,000
Jul 17 Aug 17 Sep 17 Oct 17
FII DII excl MF MF
Nifty was up ~6%, PSU Banks and Road Construction
stocks ralliedFII flows returned post Bank recap announcement, Mutual
Funds net buying falls in October
Indian markets have been broadly following the Emerging
market returns even in 2017
Source: Bloomberg, Kotak Institutional Equities (KIE)As of 9th Nov 2017
INR cr
Monthly Equity MF inflows have reduced from peak levels
5.6%
-10%
-5%
0%
5%
10%
15%
Ja
n 1
6
Feb
16
Mar
16
Apr
16
May 1
6
Ju
n 1
6
Ju
l 16
Aug
16
Sep
16
Oct 16
No
v 1
6
De
c 1
6
Ja
n 1
7
Feb
17
Mar
17
Apr
17
May 1
7
Ju
n 1
7
Ju
l 17
Aug
17
Sep
17
Oct 17
1m Nifty Return 1m MSCI EM Return
INR cr
12,078
26,07124,228
19,835
0
5,000
10,000
15,000
20,000
25,000
30,000
Jul 17 Aug 17 Sep 17 Oct 17
Confidential | 4
0.5
0
0.1
0.2
0.3
0.4
0.5
0.6
Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Oct 17
Fed plans to trim USD 4.5 Tn balance sheet by decreasing
the reinvestment of principal payments
Bank of England hiked rates by 25 bps for first time in a
decade, however clarified that further increases will be limited
Brent Crude has been inching up on Middle East tension
however US rig count has not increased
Source: BloombergBrent Crude data as on 13th November, 2017
63.49
860
880
900
920
940
960
980
40
45
50
55
60
65
Jun 17 Jul 17 Aug 17 Sep 17 Oct 17 Nov 17
Rig Count RHS Brent
Low cost capital and cheap crude, showing early signs of reversal
USDtn
$/bbl
%
0
0.2
0.4
0.6
0.8
1
1.2
4,420
4,430
4,440
4,450
4,460
4,470
4,480
4,490
4,500
Oct15
Dec15
Feb16
Apr16
Jun16
Aug16
Oct16
Dec16
Feb17
Apr17
Jun17
Aug17
Oct17
Fed Total Assets Fed Funds Rate rhs
1.71.5
1.4 1.4 1.41.6
0.0
0.5
1.0
1.5
2.0
Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17
USA Inflation has inched up to 1.6%, though below 2%
target
%
Confidential | 5
17972110
580
1350
180
0
1,000
2,000
3,000
CapitalRequired*
TotalRecapitilisation
Recap Bonds Govt Budget Capital Raising
92.4
0.2
20.2
(27.6)(40.0)
(20.0)
0.0
20.0
40.0
60.0
80.0
100.0
May 17 Jun 17 Jul 17 Aug 17
Total Bank recapitalisation announced by government is
sufficient for both provisioning and growth capital requirement
Government capex has slowed since Fiscal deficit target, already
at 91% in H1, however Bharatmala provides visibility to future
order flow
90 Stocks in BSE200 mostly from sectors like Pharma,
Auto, Banks have seen trend reversal** in last 1 month
Indian markets witnessed mild trend reversal, with PSU Banks and export oriented stocks outperforming
Rsbn
Source: KIE, Nomura, CLSA, Bloomberg*Assumptions – 30% lower PPoP than KIE estimate to be conservative, 10% Tier 1 Ratio for Basel 3 , 40% Recovery rate **Trend reversal is change in performance in 1 month vs CYTD2017, As of 20th October 2017
Telecommunication Services
Utilities Health Care Consumer
Staples
Consumer Discretionary
Information Technology
FinancialsIndustrials
Energy Materials
Real Estate
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Telecommunication Serv ices Utilities Health Care Consumer Staples Consumer Discret ionary Information Technology Financials Industrials Energy Materials Real Estate
% of stocks in sectors which have seen trend reversal
52.5 52.7
46.0
49.0
51.1 51.3
42.0
44.0
46.0
48.0
50.0
52.0
54.0
May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
India’s PMI remains stable post fall seen post GST
introduction
%
Confidential | 6
Outlook for FII inflows look benign, remain important factor due to high Equity issuances this year
India’s allocation for FIIs has come down since beginning
of year levels
Due to high Equity Issuance* in FY18, FII outflows can
easily offset domestic inflows
India’s earnings has seen highest downward revision in
CY17, other EM looking attractive to FIIs
FII flows can be largely attributed to EM ETFs
2.3%
6.9%
20.9%
1.8%
0%
5%
10%
15%
20%
25%
India ETF India Non ETF EM ETF EM Non ETF
Source: CLSA, KIE*Assuming 14k cr monthly flow of Domestic MF, Dividend as 1.5% of AUM,
2624 25.5
22
8 8
21.5 3
14
0
5
10
15
20
25
30
Domestic MF DomesticInsurance
Dividends paidby MF
Buyback ofNon-Promoters
Totalv Inflow EquityIssuance
Already Issues Expected tocome
USD bn
10.8%
14.0%
10.0%
12.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
EM Asia ex Japan
Jan-17 Sep-17% Inflow/AUM
Last 12 month USD mn
-10%
-2%
3%
10% 11%14%
26%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
MSCI India MSCI Indo MSCI Thai MSCI China MSCI EM MSCI AXJ MSCI Korea
% revision in earnings
Confidential | 7
Earnings and Valuation –Liquidity and Hope of strong Earnings growth has led to slightly expensive valuations
Bloomberg Consensus FY18 Nifty EPS estimates have fallen since beginning of the Year mostly due to GST and Demon impact
Nifty 50 Q2 Earnings so far* has been as expected with 7% yoygrowth, Auto and IT results were better than expected
42.0%
32%
36%
40%
44%
48%
Nov2017
Oct 2017Sep2017
Aug2017
Jul 2017Jun2017
May2017
Apr 2017Mar2017
491
460
470
480
490
500
510
520
530
540
May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17
12M Forward PE
10
1312
-
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Better than Expectation As Expected Worse than Expectation
18.0
22.3
15.1 15.3
0.0
5.0
10.0
15.0
20.0
25.0
Large Cap Mid Cap
Current 12M Forward PE 5 Year Average
24% Premium
Bloomberg Estimate
Source: BloombergActual/Expected >1.05 – Better , Actual/Expected <0.95 – Worse*At the time of preparation of this report, only 35 companies had declared results.
Mid Cap Index consensus earnings expectation has seen recent downgrade leading to widening premium over large cap
MSCI India P/E Premium over MSCI EM is above long term average of 35-40%
Confidential | 8
Key Triggers – Resolution of NPA & Earnings
• Global Economic data : World economy improving
• Lower Domestic Interest rates: Many Banks have cut their MCLR sharply which should help in reviving credit demand
• Resolution of NPA: Effective addressal by government of NPA issue in Indian Banks
• Weaker Rupee: Benefit IT and Pharma
Positive Triggers
• Trump Trade Revival: US Tax reforms could again trigger capital flight back from EM to US
• Earnings: Consensus estimates of earnings growth for domestic equities is high at around 15-20%, any downgrade would make the valuations more expensive
• Geo-Political Risk: Uncertainty in Middle East, North Korea
• Monetary Policy: Faster than expected global monetary tightening
• State & General Election: Increase in volatility during such times
Risks
Confidential | 9
India Equities: Valuations & Strategy – Maintain Neutral Stance
For the month of October, Indian Equity markets continued its rally to make new life-time highs. Nifty grew ~6% for the month ofNovember. With this gain, for calendar year 2017, markets stand at a gain of 26%. FII inflows turned positive after 2 months ofoutflows on account recap announcement. Inflows by mutual funds continued albeit at a marginally lower level.
At current levels of approx. 10,118 (15th November, 2017), Nifty is trading at a 1 year forward PE of 18.7X. In the current scenario,we continue to maintain a Neutral stance.
Mutual Funds: As domestic liquidity continues to drive markets, we advise new investments in Mutual Funds to be deployed 25%in lumpsum and subsequent in tranches via SIPs/STPs.
Recommended allocation within equity mutual funds is as under:
• 100% Large Cap allocation (Prefer Large Caps due to relatively Favorable Valuations)
• This allocation to Large caps can also be taken through Opportunistic Funds which currently have a bias towards Large cap
• For investors who want equity exposure but have low appetite for volatility, they can take equity exposure through
Balanced Funds. Balanced funds have around 25% to 30% of their portfolio into Debt instruments which provides cushion
to the portfolio return during market volatility.
Source: EPS Estimates by KIE
Debt Market Update &
Debt MF Strategy
Confidential | 11
Indicators
Policy Action
• We maintain our expectation that the RBI will pause on rate cut
• Tone of the policy seemed little hawkish, emphasis on inflation
• One member pushed for 25 bps cut
Inflation
• CPI increased to 3.6% in October 2017
• RBI increased CPI forecast to 4.2%-4.6% for 2HFY18
• We expect CPI 4.7% for Mar 2018 vs 4.5% estimate of
RBI
10 Year G-Sec Benchmark Yield
• 10 Yr yield likely to remain in range
Liquidity
• Liquidity surplus has reduced to Rs 1 trn plus
• RBI has conducted Rs. ~1 Lakh crore of OMO in 4-7 Year
duration range
• OMO pace remains key, RBI also has to neutralize USD 30
bn+ Forward book
INR
• Weakened to 65 Level
• Will depend on crude price movement and
Equity/Debt flows
Key Risks
• US policies; Fed hikes; Global monetary tightening
• Strengthening of US Dollar, Crude Prices
• Impact of GST revenues and spending on Fiscal Deficit
G-Sec Supply
• The gross G-Sec supply to be Rs. 5.8 trn; details on
Bank Recap bonds will be keenly watched
• SDL issuance of Rs. ~4.25 trn + expected
Debt Market: Key Variables
Confidential | 12
Yields have spiked over concerns on Fiscal Deficit
986
0
1,000
2,000
3,000
01/10 06/10 11/10 16/10 21/10 26/10 31/10
Am
ou
nt
in R
s. B
n
93
6.93
6.00
0
10
20
30
40
50
60
70
80
90
100
5.75
6.25
6.75
7.25
7.75
Spre
ad (
bp
s)
% Y
ield
Spread 10 Year G Sec Repo Rate
G Sec Spread over Repo near highest in last 1 Year over
fiscal concerns
-1 -1
6
9
4
1
156.93
6.78
-2
0
2
4
6
8
10
12
14
16
5.60
6.00
6.40
6.80
7.20
1Y 2Y 3Y 4Y 5Y 8Y 10Y
Sp
read
(b
ps
)
% Y
ield
Change Current G-Sec Yield 1M earlier G-Sec Yield
10 year papers have seen the highest spike
Liquidity has reduced substantially as Credit-Deposit
growth converge
Inflation stabilizing below 4%
Source Bloomberg
3.58%
4.25%
Dec16
Jan 17 Feb17
Mar17
Apr 17 May17
Jun 17 Jul 17 Aug17
Sep17
Oct 17
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
CPI
Core Inflation
Confidential | 13
Indian Bonds are still attractive to Foreign Investors however limits are almost utilized
-409
887
4,026
2,998 2,840
4,057
3,112
2,380
164
2,757
Jan 17 Feb 17 Mar 17 Apr 17May 17Jun 17 Jul 17 Aug 17Sep 17 Oct 17
-1,000
-500
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
US
D M
illi
on
Strong FIIs buying continue, CYTD $23bn inflow from
FIIs
65.19
Dec16
Jan17
Feb17
Mar17
Apr17
May17
Jun17
Jul17
Aug17
Sep17
Oct17
Nov17
63.00
64.00
65.00
66.00
67.00
68.00
69.00
Indian currency also weakened over macro worriesFII Debt Utilization in GSecs and Corporate near 100%,
interest in SDLs increasing
93.2%
94.7%
11.54%
Oct16
Nov16
Dec16
Jan17
Feb17
Mar17
Apr17
May17
Jun17
Jul 17 Aug17
Sep17
Oct17
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
Government Corporate SDL
54.18
63.69
Mar 17Apr 17May 17Jun 17 Jul 17 Aug 17Sep 17Oct 17Nov 17
40
45
50
55
60
65
70
Crude prices have increased over events in Saudi
Arabia
Source Bloomberg
Confidential | 14
Upgrades to Downgrades ratio has improved
Q3 2013 Q2 2014 Q1 2015 Q4 2015 Q3 2016 Q2 2017
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Upgrades have outpaced Downgrades for last 7
Quarters in a row
0.00
50.00
100.00
150.00
200.00
250.00
May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
100.00
3 Year AAA 5 Year AAA SDL Credit RHS
AAA Corporate Curve spreads over GSec have reduce
significantly in last few months
Most Banks Perpetual paper have seen a drop in yield
post Government's Bank Recapitalization announcement
10.10
12.90
11.20
9.00
8.508.20
8.65
10.05
11.80
10.90
8.708.50
8.108.45
BOI IDBI UCO PNB Axis SBI BOB
8.00
9.00
10.00
11.00
12.00
13.00
14.00
3-Oct-17 31-Oct-17
Aug 17 Sep 17
480,000
485,000
490,000
495,000
500,000
505,000
510,000
515,000
520,000
525,000
530,000
Fiscal Deficit already at 91% of Full Year Target in H1,
reduced last month due to controlled capex expenditure
by the government
Fiscal Deficit
Spread over 10 Year GSec
Rs cr
Source Bloomberg
Ratio of upgrades to downgrades
Confidential | 15
India Fixed Income: Strategy
Substantial part of the portfolio should be deployed through a mix of high rated and credit accrual strategies. Exit from duration funds only for investors who have completed 3 years and can deploy with another 3 years view.
Investment Focus:
Passive Accrual-Oriented Debt funds
High quality portfolios (~100% AAA / Sovereign) Portfolio is run on a passive accrual basis i.e buying a bond and holding it till maturity thereby earning from the accruing of
interest Higher predictability of return, lower volatility & lower interest rate risk
High Yield Credit-Oriented Funds
Low volatility on account of maturity of portfolio between 3 – 5 years, attractive and stable accrual yields Experienced teams to carefully evaluate and tightly monitor high yielding debt instruments
Short Term Bond Funds
Actively managed to run a low avg. maturity of 2-3 years, attractive risk-reward Lower volatility and interest rate risk than Dynamic Bond Funds, better suited from a risk-adjusted basis in volatile markets
Continue to recommend ultra short term relative to liquid funds (up to 3 Months)For short term parking of funds for a minimum of 6 months, Arbitrage funds preferred over ultra short term funds on back of better tax adjusted returns
Source : AMCs, other Financial websites
Confidential | 16
DisclaimerThe aforesaid is for information purposes only and should not be construed to be investment advice under SEBI (Investment Advisory) Regulations.
In the preparation of the material contained in this document, Kotak Mahindra Bank has used information that is publicly available, including information developed in-house. Some of the material used in the document may have been obtained from members/persons other than the Kotak Mahindra Bank and/or its affiliates and which mayhave been made available to Kotak Mahindra Bank and/or its affiliates. Information gathered & material used in this document is believed to be from reliable sources. KotakMahindra Bank however does not warrant the accuracy, reasonableness and/or completeness of any information. For data reference to any third party in this material nosuch party will assume any liability for the same. Kotak Mahindra Bank and/or any affiliate of Kotak Mahindra Bank does not in any way through this material solicit any offerfor purchase, sale or any financial transaction/commodities/products of any financial instrument dealt in this material. All recipients of this material should before dealingand or transacting in any of the products referred to in this material make their own investigation, seek appropriate professional advice
We have included statements/opinions/recommendations in this document which contain words or phrases such as "will", "expect" "should" and similar expressions orvariations of such expressions, that are "forward looking statements". Actual results may differ materially from those suggested by the forward looking statements due torisks or uncertainties associated with our expectations with respect to, but not limited to, exposure to market risks, general economic and political conditions in India andother countries globally, which have an impact on our services and / or investments, the monetary and interest policies of India, inflation, deflation, unanticipatedturbulence in interest rates, foreign exchange rates, equity prices or other rates or prices, the performance of the financial markets in India and globally, changes indomestic and foreign laws, regulations and taxes and changes in competition in the industry. By their nature, certain market risk disclosures are only estimates and could bematerially different from what actually occurs in the future. As a result, actual future gains or losses could materially differ from those that have been estimated
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