It was a year of two diverse narratives: A buoyant equity market (both domestic and global) and a much subdued domestic debt market. But what made a more interesting narrative was the news and noise about the rise of crypto currencies (read Bitcoin and the lament of missing out on it!). Our news letter would look back at the dominant themes of the year and a peek into what the future may behold.
It was the best of times. It was the worst of times.
We started the year with sentiments quite different - the aftermath demonetization: A cautious equity market and a buoyant debt market .Well, a classical setup for a bull-ish equity market and a bear-ish bond market!
The year was marked by a huge upmove by the equity markets across indices and a disappointing debt market performance. As a classical saying goes: It was the best of times, it was the worst of times.
Who Moved My Markets?
We highlight events which dominated capital market sentiments through the year:
10 Year Benchmark Yield
Source: Bloomberg, Data as on 29 Dec, 2017
Equity Markets: A Perspective
The bulls returned ferociously in the market. What started as a cautious year in the aftermath of demonetization, turned into a year of hitting new highs. And it was a synchronized rise with emerging markets globally scaling new highs, as well. Domestically almost all sectoral indices gave positive returns, with reality and consumer durables leading the pack. Only the Pharma sector played truant and did not participate in the rally. Market was also characterized by huge inflows into the market by domestic institutional investors. With secondary equity markets being extremely buoyant, it was not surprising that the primary capital markets were also buoyant. CY2017 also saw record high equity capital raising. There were 220 capital raising transactions, almost 40% higher than the previous peak in 2010. What contributed to the last one year returns can be divided into equal contribution from increase in multiples and increase in earnings growth.
Thus, we can say that the markets’ strong performance was led by a) Strong flows into the markets by the domestic institutions, b) markets’ continued faith in earnings growth c) Re-rating of multiples after the previous year-end’s fall due to demonetization and d) continued global risk on trade
It was a script gone awry. A large downward movement in yields in the previous calendar year saw a very buoyant market sentiment at the beginning of the year. The mood mellowed substantially in February as the Monetary Policy Committee, contrary to street expectations, changed its policy stance to neutral from accommodative. It was the starting point for a gradual drift upwards. It was a series of bad news for the market - the fiscal concerns, rise of crude and commodity prices, US Fed rate increase, rise in retail inflation, the issue of recaptilisation bonds. While the benchmark ten year gilt rose by around 80 basis points (bps); corporate bonds witnessed a rise of 50-60 bps leading to narrowing of spreads. Liquidity, which was humongous in the beginning of the year, too went into a normalization mode during the year leading to a rise in short term yields.
A Cat among the Pigeons
The charts below track outlier events which occur infrequently and hence have a potential to disrupt markets.
a) Volatilities (lack of fear!) was at multi year low across equity and debt markets in US
b) US 2-10 year spreads at lows (Some read it as imminent recession!)
c) Indian Corporate bond spreads also getting squeezed
After a buoyant year of stock performance, the markets continue to keep faith in revival of earnings growth and continued buoyancy in domestic flows. CY2019 stock performance will depend on a) the trajectory of interest rate movement which may have a bearing on earnings as well as domestic flows towards the balanced category, b) The global growth which could continue to support robust global capital markets and c) the pickup in earnings growth.
The Indian markets in terms of valuation continue to trade at 2+SD across indices, so further movement in markets may depend on specific earnings growth and is likely to trade mostly stock specific.
When we had penned our thoughts at the beginning of last year we opined “ rise in global yields and rise in commodity prices refused to play party poopers. Yet ignoring risks always sows seeds of vulnerability; and as a bond market participant we cannot lose sight of the developments.”
The entire narrative has changed towards a hardening rate bias. And the concerns are well placed: Fiscal slippages during the next budget, crude oil / commodity price hardening and inflation moving gradually up .With corporate spreads narrowing; we feel that Gilts may outperform corporates during this calendar year. On a overall bias, we feel the markets can stabilize at these levels. We see two signs of comfort; the first being spreads between 10 year gilt and repo rates at around 135 bps provides a cushion for further rate increase; the second is more intuitive: when markets turn into “the winter of despair”, it also sows the seeds of “the spring of hope”.
And finally, we wish all our readers and investors a Happy and Prosperous 2018.
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