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Investment Strategy

Jan 9, 2017

Performance Attribution Q4 2016 & CY 2016

The Domestic Investor Steps Up

Equity mutual funds saw an inflow of more than Rs. 10,000 crore in December, making it the highest in 18 months, underpinned by investor optimism and regular contributions to savings plans.

It may also be an indirect impact of demonetisation, as some of the cash that entered the financial system ended up in financial assets, providing key support to the market.

This marks the ninth straight month of positive inflow in equity schemes. SIP volume appears to be running at 3,900 crores a month. This will act as support for the market. It translates to $6.9 billion in regular inflow into equity funds this year. That is a staggering number. We have never been believers that price can be driven by flows, but certainly in a short term and relatively illiquid market such as India, it needs to be factored into any analysis.

Indian Markets Treading Cautiously

Consensus appears to be that Q4 CY2016 will not be as bad as Q1 CY2017. We tend to think that things are settling down and normalcy will return and the trough will be Q4 CY2016, not Q1 CY2017.

Earnings Revisions 60% Negative for FY17E

Earnings revisions for Nifty 50 constituents in the past three months do not paint a pretty picture. 60% of revisions have been to the downside. Sectors that have escaped the revisions axe are Utilities, a traditional safe haven with highly predictable flows, Energy, and Industrials.

Earnings Revisions for the Nifty 50 In the Past Three Months Have Been to the Downside

Performance Attribution for 2016

We review the performance of the Nifty 50 and CNX 500 to review what worked and did not work in 2016 and Q4 CY 2016.

Earnings announcements start this week with IndusInd Bank and Infosys slated to kick things off amongst the large caps.

Nifty 50 Performance Attribution

Nifty 50 Performance Review – 2016

Only 20 stocks out of the Nifty 50 delivered hurdle returns of 12% or higher in CY 2016. Materials and Energy were dominant in the winners table while Telecomm, Information Technology and Health Care were the biggest losers.

Nifty 50 Best & Worst Performers

Notable top performers for 2016 were Yes Bank, BPCL, PowerGrid and Eicher Motors. Auto stocks besides Eicher did well, led by Tata Motors, Maruti Suzuki and Hero Motocorp.

The worst performer was Idea Cellular, down 48%. Stellar pharma companies took it on the chin, including Sun Pharma, Aurobindo Pharma, and Lupin. IT majors Infosys and Wipro were the other major underperformers.

Nifty 50 Sectoral Performance

Utilities, Energy and Materials dominated the quarterly performance for Q4 CY2016 as well. Consumer discretionary stocks suffered during the quarter as these stocks were punished by investors in the wake of demonetisation.

CNX 500 Performance Review – 2016

Trends seen in the Nifty 50 held true for the broader index as well. 189 stocks out of the CNX 500 delivered hurdle returns of 12% or higher in CY 2016. Materials, Financials and Energy were the sectors with top performing stock returns, while Telecom, Information Technology and Health Care had the biggest losers. One in ten stocks – or 50 stocks – in the CNX 500 delivered a 45% plus return. Only 9 of these 50 stocks were large caps, while 21 were mid caps and 20 small caps.

CNX 500 Performance Attribution

Relative Strength – Sector Trends

Relative strength and investor allocation pre-demonetisation were focused on Health Care, Utilities and even Telecomm Services. Post demonetisation, Industrials, Utilities, Energy, Staples and Financials have attracted flows, while clear weakness is evident in Telcom, Consumer Discretionary and Health Care.

One of the trends we have noticed this year is that relative strength has shifted to the small caps and to a lesser extent to the mid caps. Understandably so. Small caps delivered stellar returns under the radar in 2016 and survived the painful selling in the fourth quarter while mid caps and large caps were mercilessly pummelled by the foreign institutional investor rotation back to the U.S. investors appear to have decided that an allocation to small caps in portfolios is wise diversification.

In the quarter gone by, demonetisation hit the Real Estate sector hardest, with quarterly returns plunging -17% on average. Energy, Utilities and IT remained bright spots amidst the gloom. IT stocks after having suffered a prolonged beating through the year, finally appeared to have held stable ground during the quarter.

Relative Strength Is Shifting to Industrials, Financials, Staples, Energy and Utilties
While Telecomm, Consumer Discretionary, and Health Care Are Weakening

Relative Strength Has Been Strongest for Small Caps, Followed by Mid Caps

Outlook

Unforeseen Impacts from Demonetisation

It is likely that we are going to see some unforeseen events in 2017. For instance, we could see a dramatic increase in financial flows. Or an acceleration in Digitalisation. Digital payments and digitalisation appear to be gaining traction with consumers and businesses. The government has announced measures to boost digital payments across all parts of the economy.

Inflation Management

The BJP and RBI have done a stellar job of keeping food inflation in check in 2016 via measures such as restrained hike in Kharif MSPs, imposition of export duty on sugar, online procurement of food grain by FCI, import of pulses etc. It will be essential that the government, and RBI, maintain a laser focus on containing inflation in light of rising commodity pressures and a global recovery to support RBI’s inflation target of 4.0% by Mar-18.

Consumption Will be Aided by 7th Pay Commission Payments

The delayed payment of allowance hikes from the 7th Pay Commission will help to support consumption demand in FY18.

Budget: Tax Sops for the Consumer?

With the massive inconvenience and sacrifice that has been asked of the populace, particularly the rural and poor, upcoming elections, and expected higher tax collections, we would expect the Government to announce some sops for the consumer that would provide a boost to the economy.

The Union Budget is expected to be tax friendly and could turn out to be a catalyst for reviving sentiment and demand for both consumers and business.

As economic growth has been hit hard by demonetisation, the private sector is not in a condition to revive growth; the central government will have to stimulate economic growth most aggressively. Limited funds are a constraint, so SUUTI funds will be a good idea in FY18 to boost economic and political growth.

While the Nikkei India Services PMI remained stable at 46.8 in Dec-16, the Nikkei India Manufacturing Index came in at 49.6 in Dec-16 vs. 52.3 in Nov-16. This resulted in the Composite PMI slipping to 47.6 vs earlier 49.1. The Eight Infrastructure Industries core growth as well dipped to 4.9% in Nov-16 clearly hit by the demonetisation vs. 6.6% in Oct-16.

Rate Transmission and Lower Interest Rates

Finally, transmission of rate cuts by the banks should also eventually revive credit pickup (SBI, PNB, Union Bank, Dena Bank, IDBI Bank, Kotak have cut rates by 15-90bps). The Union budget (on 1st February 2017) will be contingent on: (1) the quantum of savings for the government from lower currency liability after demonetisation, (2) whether RBI can legally transfer these savings to the government, and (3) usage of SUUTI funds.

U.S. Recovery on Track

A pick up in the U.S. continues to be seen with the ISM Manufacturing Index rising to 54.7 vs. 53.2 in Nov-16. The Markit Services PMI further strengthened to 53.9 in Dec-16 vs earlier 53.4. Additionally, the Markit Composite PMI as well was bolstered to 54.1 in Dec-16 against 53.7 in Nov-16. The data points to a sustained recovering of the underlying economy backing the Fed’s hawkish stance.

The Favorable Environment Continues

A declining and low rate environment, increasing flows into the financial system, rising tax base, a populist friendly budget alongside an economy that was chugging along pre-demonetisation and global recovery will be the underpinnings in 2017. Demonetisation will have negative impacts but the market has pummelled stocks aggressively so in the past few weeks. The environment remains largely favourable to bottom up growth investing as we expect things to return to normalcy in coming weeks.

On the fixed income side, rates appear to have stabilised in a range as we expected they would last month. There appears limited impetus for further dramatic moves lower and we continue to favour accrual bonds, income funds, dynamic bond strategies, select corporate bonds and select AT-1 bonds.

Technical Strategy

Last couple of weeks have been positive for the market after testing sub 7900 levels and then smart bounce back to touch 8300 levels on Friday. The Nifty finally settled the week at 8267 with a gain of 0.67%.

On the daily chart index has formed bullish double bottom reversal pattern and closed at neckline i.e. breakout level which is positive for the market. FIIs continue to be net sellers in the equity segment, but last couple of days has seen abatement. But in derivative segment FIIs turned buyers for last couple of trading session in index future to the tune of Rs 2184cr with increase in open interest indicating fresh long formation.

Even in index options buying was seen in call option and unwinding of some long positions in put options. Also overall Nifty Future has also seen 7.35% open interest addition on last Thursday indicating long formation in the market.

But index has reached critical resistance zone. It has closed below falling resistance trend line, which is seen around 8320 levels.

Also Nifty has retraced 38.2% of the fall from Sep-16 high of 8969 to low of 7894 in Dec-16. Momentum indicators have also reached overbought zone. Thus suggesting in the near term market may see sideways to negative action if it fails move above 8320 levels. If Nifty trades above 8300-8320 levels on sustainable basis, then it will see breakout from double bottom pattern and continue to rally towards 8430 and possibly 8560 if momentum sustains. On the downside immediate support for the market is seen at 8220 and then at 8100 levels. Major support for the market remains at 7900.

Earnings Calendar

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