Rahul Pal

Head - Fixed Income

Little would have the legendary Japanese filmmaker, Akira Kurosawa known that his 1950 classic Rashomon would leave behind a wonderful phrase, Rashomon effect. This phrase is used to describe the circumstance arising when the same event is given contradictory interpretations by different individuals involved.

Two events, almost historic, happened in November; demonetization and a new US President elect, Donald Trump. And both of the events had many contradictory interpretations.This newsletter will attempt evidence based approach to interpret both the historic events.

Demonetization: A fact check

The Prime Minister, in an address to the nation on November 8th, declared that the existing Rs 500 and Rs 1000 notes would cease to be a legal tender. The total value of the affected currency was close to INR 15.44 lac crore forming a bulk of the notes in circulation. The decision was a broadside; against unaccounted money, fake currency, and funding of terror activities in India. There was a political capital, an economic risk and an execution risk.

Bond and Money Market

We present a matrix detailing some movement in some key market rates (domestic and global) and key economic indicators:

Source: Bloomberg

In one fell swoop, the demonetization effect was felt on domestic rates across the yield. The rates across the yield curve fell across by 50-60 basis points(bps).Such was the ferocity of the rally that ignored almost all negative biases prevalent globally; the rising global yield with US sovereign moving up around 50 bps and collateral pressure on other emerging market bond yields, a continued rise of base metal prices and probable pressure on currencies. The overhang of liquidity led to the secular fall in rates.

Equity Markets

We present charts tracking domestic index and sector, and global indices movements:

For the month of November two events dominated the market movements:
  • Demonetisation by Indian Government: The government’s demonetization initiative dragged the indices lower by 4.7%. It was in anticipation of moderation in economic growth and adverse impact on corporate earnings in select sectors. As per channel checks for the month of November and December the demand will fall to the tune of 20-40% based on various channel checks.
  • US Elections: The US elections threw a surprise winner, dragging overall performance of emerging markets and putting pressure on emerging currencies. Post US elections, the hardening of US bond yields and strengthening of the US Dollar resulted in correction in emerging markets. India witnessed FII outflow of USD2.61b in November, even as DII buying of USD2.7bn was the highest since January 2008.

On the earnings front, the second quarter of the financial year met the broad market expectations with the companies in the NIFTY recording Sales/EBDITA/PAT growth of 2.80%/11.50%/6.60% respectively.

Data Hangover
  • Retail Inflation for October 2016 indexed to CPI fell sharply to 4.20% marked by a sharp drop in food price inflation to 3.32%.This drop in inflation continued to be led by the vegetables subcomponent (having a weight of 6.04% in the index) which printed a number of -5.74%. However the core inflation remained flat and the sharp upswing in commodity prices tempered by continued fall in vegetables and other perishables will temper the headline inflation but core inflation remaining flat can pose a challenge
  • The Fiscal Deficit for April –October 2016, was at 79.30 %of Budget estimates as against 83.90% in September and higher than 74% recorded in previous financial year. While it may appear worrisome, we do not think it can move to a position of fiscal slippage. Yet what we cannot ignore is the demand shock caused by the demonetization may potentially lead to a shift in the spending strategy which may find itself manifesting in the Budget of Financial year 2017-18
  • We present a matrix of certain real economy numbers:


  • GDP growth at constant prices in Quarter 2 of 2016-2017 was estimated at 7.30 percent with the Gross Value Added at 7.10 percent. While the numbers were below the market estimates, the worrying part came analyzing the expenditure side of GDP: Gross Capital Formation expenditure (at 2011-2012) actually showed a negative growth of around -5.60 percent. The heavy lifting continued to be increase in Government Consumption expenditure which registered a growth of around 15% in the second quarter.
  • What also was interesting this month was OPEC announcing a production cut, a first in 8 years, of about 1.20 million barrels per day by January 2017 leading to a rise in crude oil prices.
The Donald Trump Effect

Airforce One will have a new passenger, Donald Trump, the new Republican President elect. What was once unimaginable, and for some almost an apocalyptic event, has turned out to be true.

We present a small matrix of market movements in November after the announcement of his victory:

Source Bloomberg. The mentioned returns are in absolute terms for the period from November 8 – 30, 2016

Clearly the best performing index took support from the rise in crude prices: the Presidential election seemed to affect Mexico the most reflecting the President-elect’s continuous tirade against Mexico! Collateral damage, we must say!

Within the Dow Jones and S&P 500,the financial sector moved higher and interestingly some capital goods started trending higher.

Source: Bloomberg.The mentioned returns are in absolute terms for the period from November 8 – 30, 2016

Quo Vadis
Debt Markets:

The narrative for the short term rates have radically altered after demonitisation.With short term rates going below the repo rate , clearly market may be factoring in a permanent liquidity and a possible rate cut. The drop in the long term rates too have been significant .The fact that the market has ignored global yield movement, continued rise in raw industrial prices and commodities has made the rate curve vulnerable. What tempers a sharp rate rise is the lack of capital formation in the economy as evidenced in the First half of the GDP numbers

While there is a demand and a supply shock to the economy, it is entirely a function of speed at which the new currency notes that gets back into the system. The rate markets have not faced such large disruptions and it will take some time before it seeks a new direction. We thus expect both the Government and RBI to take a definitive stance only when all the facts are available post remonitisation.

Equity Markets:

The correction in November has brought valuations marginally below 10-year averages. The Sensex now trades at a P/E of 16.6x, below its long-period average(LPA) of 17.1x.Globally markets in Indonesia, UK, Russia and US are trading at significant premium to their respective LPA. This is also reflected in MSCIIndia trading now at a 37% premium to MSCI EM (historical average premium: 45%). Despite the run-up since February 2016, on CY16 YTD basis, with just 2% return, India lags other emerging markets like Russia, Brazil, Indonesia and Taiwan. MSCI EM has outperformed MSCI India by 4% in the trailing twelve months.

Midcap valuation premium has come off: Midcaps underperformed the Nifty in November and the Nifty Midcap 100 now trades at just 2% premium to the Sensex on a P/E basis (long-period averages indicate that midcaps usually trade at 7% discount to large-caps). After eight consecutive months of positive returns, November 2016 was the first month of negative return for midcaps. On YTD CY16 basis, midcaps returned 11%, outperforming the Nifty by 7%.

The months ahead may be a period of volatility. The US Fed Move, the policies of the President Elect and events in Europe will be watched with anxiety and hope. Domestically the Budget, the remonitization effect and implementation of GST would be keenly watched.
As policies evolve, of the Government and the regulator, the capital markets will seek stability before it firms its future direction.
Till then, fasten your seat belts, turbulence ahead!

The views expressed here in this document are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. This document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. While utmost care has been exercised while preparing this document, Mahindra Asset Management Company Private Limited (Mahindra AMC) does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The data/statistics are given to explain general market trends in the securities market, it should not be construed as any research report/research recommendation.Past performance may or may not be sustained in future.Readers of this document should rely on information / data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.Neither Mahindra Mutual Fund, Mahindra AMC nor Mahindra Trustee Company Private Limited, its directors or associates shall be liable for any damages that may arise from the use of the information contained herein.

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CNo 00045

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