Equity & Debt Strategy Mid May – Jun ‘13

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Global: Indices Performance

This year’s global rally has clearly been led by the US, Japan and Peripheral Europe.

Emerging markets continue to face growth challenges and hence continue to lag.

Worldwide rally has been led by defensives and large caps.

CYTD13 Nikkei has posted the highest return of ~25% followed by Dow Jones (~15%).

India has been one of the poor performers in 2013 (YTD returns are ~3.4%)

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India: Sectoral Performance

Consumers (up 17%) and Pharma (up 16%) have seen maximum outperformance in last one year

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India: Indices Performance

This year’s rally is also led by defensives, followed

by IT and private sector banks. Oil & Gas is now

moving up.

Metal, Utilities & Real Estate have been the most

beaten down sectors this year.

Due to the recent rate cuts banking Index has see

the maximum gain in the last one month.

The broader Small & Mid Cap Index have still not

recovered from the Jan-Mar’13 sell off.

Global Growth: 2014 to be better than 2013

Expect mild

recovery in

2013 &

acceleration in

2014

Euro zone

expected to

remain a drag

in 2013.

Asia expected

to be resilient

whereas

Middle East

expected to

slowdown in

2013

Source: Bloomberg

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Global: Commodity Performance

LME prices are closer to their 2009 lows (i.e. copper & aluminium). Steel & coal prices have also corrected.

Brent Crude from the recent high of ~USD 119/barrel has been trading in the USD 100-105/barrel range.

Global: Copper & MSCI World Index

MSCI World Index is closer to its 2007 peak however, copper which is a lead indicator of world growth is still

trading at recent low. This signals that manufacturing sector & China are lagging in this current rally.

For this rally to sustain, copper needs to move up or else global equities might take a pause.

Source: Bloomberg

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International: News

US GDP grew at 2.5% in Q1CY13 (less than forecast of 3%) following a 0.4% growth in Q4CY12.

Unemployment rate fell to a five year low of 7.5% in the US.

New home starts in the US climbed to highest level since Jun’08 whereas home loan defaults fell to

below 1% for the first time since the peak of 2.9% in Jun’09.

US oil exports could reach their highest level in 28 years with the Shale Oil boom. This is narrowing the

premium of Brent Crude over WTI Crude (used for pricing US crude).

Within the S&P 500 index, the 359 companies that declared earnings till first week of May’13, 70%

exceeded analysts’ expectations, while 46% missed revenue forecasts.

ECB cut its refinancing rate by 25 bps to 0.5% since inflation fell to a 3 year low of 1.2% in Apr’13 and

unemployment rose to a fresh record of 12.1% in Mar’13.

Manufacturing activity in the EU region contracted for the 21st consecutive month in Apr’13 (PMI stood at

46.9 in Apr’13 vs. 46.5 in Mar’13). Euro GDP could fall 0.1 % in Q1CY13 (6th straight quarterly decline).

France and Spain were allowed to extend their Fiscal Deficit target for 2 more years. Many are seeing

this step as an end to the austerity measure in Euro zone.

Japan household spending rose by 5.2% yoy in real terms in Mar’13, the highest growth rate since

Feb’04. “Abenomics” is having some impact on sentiment in Japan.

China’s HSBC Service PMI came in at 51.1 in Apr’13 as compared to 54.3 in Mar’13. Manufacturing PMI

of China was also disappointing (50.5 for Apr’13 Vs. 51.6 for Mar’13)

India Macros: CAD

We estimate FY14E CAD/GDP of 4.1% with

crude at USD 105/bbl and gold price at USD

1450/oz (FY13E CAD/GDP: 5.1%).

To ease debt inflows the Government has

removed sub limits for FIIs. There is space of

~USD 8 bn in GSecs and ~USD 25 bn in

corporate bonds.

Government has decided to cut withholding tax

on interest payments to foreigners on Govt. &

corporate debt from 20% to 5% for a two year

period (w.e.f 1st Jun’13). Positive for Debt

market.

India Macros: IIP

IIP grew by 2.5% in Mar’13 as compared to 0.6% in Feb’13 (3rd consecutive month of positive

growth).

Capital Goods grew at a healthy pace of 6.9% in Mar’13 after showing growth of 9.5% in Feb’13.

Consumer Durables contracted by 4.5% in Mar’13 after contracting by 2.4% in Feb’13.

Industrial production growth in FY13 was at 1% against 2.9% in FY12.

Cycle of Industrial production is likely to have bottomed out.

However, conditions still not conducive for a sharp uptick in IIP for FY14E.

India : Institutional flows

YTD FII inflows into India have been USD 12.2 bn. Pace

of monthly flows has slowed down in Apr & May’13.

YTD, DIIs and Local MFs put together have sold stocks

worth USD 9.3 bn.

FII ownership of Indian equities is at an all time high.

Japan has seen the maximum FII flows of ~USD 65 bn

in this calendar year (YTD).

India: Key Findings on economic front

Everyone is expecting global economic growth will improve in the second half of CY13. A shift to

tighter global policy still seems some time away. Outlook for 2014 looks better than 2013.

Domestically, all macro parameters seem to have bottomed out but real improvement on the ground

is still very slow. Recovery process could be slow and painful (U rather than V shaped).

Expect manufacturing activity to revive slowly due to low base, monetary easing, favourable govt.

policies and depreciated rupee. April PMI seems to contradict the IIP growth seen in Mar’13.

FY14E GDP growth likely to be sub 6%, which will be better than FY13E of 5% but lower the desired

and optimum level of 7%. Capex cycle is still showing no signs of revival.

Inflation averaged ~7.3% in FY13, which is likely to be ~6% in FY14. Moderate commodity prices

should keep core inflation under check. H1-FY14E inflation to remain lower than H2-FY14E.

Recent buyback of shares by HUL’s parent (i.e.USD 5.4 bn) and the Jet-Etihad deal bodes well for

India’s Capital Account and raises hope of revival in FDI.

Current Account Deficit could go down to ~4% in FY14E from >5% in FY13E mainly on account of

lower gold and oil import bill. This could help address India’s macro risks related to the Rupee.

India: Key Findings on market front

This year’s rally in the US markets and other regions is mainly led by defensives and dividend

oriented stocks and less by high beta cyclical sectors as was the case in previous rallies.

After 2008, this is the first year to see huge net inflows into equity ETFs and mutual funds worldwide.

Flows are tilting more towards developed markets (i.e. US and Japan) than EMs.

The large monthly QE of ~USD 74 bn by the Bank of Japan and recent 25 bps rate cut by ECB point

towards cheap liquidity continuing to flow into the global system.

PE expansion has accounted for 40-50% of the global rally since the Oct’11 lows. Valuations in some

regions is running ahead of fundamentals and is sensitive to liquidity flows.

Indian market has firmed up on the back of improved macro data points and global rally. FIIs have

invested >USD 12 bn in Indian markets but Sensex is up just 2.6% as compared to its median of

CY13.

FII ownership in Indian equities has touched 8 year high (i.e.>21% in BSE 500 cos.) whereas share of

promoter shareholding is at a 8 year low.

Two key things have come forward in the last two months. 1) Post DMK exit, India could face early

elections & 2) Earnings growth for FY14 could see downgrade due to lowering of FY13 base.

The sharp correction in Mid and Small Caps in Mar’13 qtr has removed the froth from the markets.

There is no large position built-up from the domestic side.

Macro environment remains challenging, hence it is ideal to remain cautious & defensive.

India: Key risks

The biggest risk to Indian markets is the political uncertainty. Post the exit of TMC late last year and

now DMK, the UPA is a very weak coalition. It has just 236 seats Vs. required 271 seats

The government is solely dependent on outside support from opportunistic regional parties, SP &

BSP, both of which have a very poor history in terms of withdrawing support at the lost moment.

Post Karnataka state elections there are four large state elections due in Nov’13 (i.e. Rajasthan,

Madhya Pradesh, Chhattisgarh & Delhi).

Political uncertainty could hurt business and investor confidence, which in turn could impact capital

flows, which are a must for containing the Current Account Deficit and rupee depreciation.

End of Quantitative Easing by leading central banks could impact easy flows into emerging markets.

India being one of the major beneficiaries in emerging markets could get impacted.

Europe is still struggling to recover and will remain in the contraction zone in CY13. If Eurozone

concerns resurface then that could lead to global uncertainty.

Falling interest rates will be a key contributor to FY14 earnings growth. Any long pause in future rate

cuts by RBI will lead to disappointment in earnings growth and impact valuations.

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Equity MF Strategy

Strategy

Based on the last assessment in Apr’13 our Sensex range stands at 17,000 to 21,000. Risk

reward ratio has turned negative (potential upside of 5% & potential downside of ~15%). Rate cuts

not getting passed on to end users. Some disappointment in FY14 earnings due to this.

Broader market participation is missing. Concentration is only in select Nifty & semi-large cap

stocks. Last 10% rise in Nifty is not supported by delivery based buying (mainly F&O driven rally)

Going forward, we recommend to go slow on lumpsum investments till Sensex witnesses 8% - 10%

correction from current levels of 20200.

Prefer investing in a Systematic manner in equities.

We recommend to allocate 70% of total equity MF portfolio in large cap funds, and 30% in mid cap

funds.

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Recommended Funds

Source: MFI Explorer

Performances of schemes less than 1-year are absolute, and above 1-year are CAGR. Performances of schemes are as on Apr 30, 2013, while Corpus of scheme is as on Apr 30, 2013.

Schemes Corpus (in

Crs) Fund Manager

1 Year (% Returns)

3 Years (% Returns)

Large Cap Funds

Birla Sun Life Frontline Equity Fund 3,020 Mahesh Patil 20.05 6.40

ICICI Prudential Focused Bluechip Equity Fund 4,193 Manish Gunwani 13.94 8.59

SBI Magnum Equity Fund 1,040 Rama Iyer Srinivasan 12.63 5.91

UTI Equity Fund 2,293 Anoop Bhaskar 13.82 8.16

Mid Cap Funds

ICICI Prudential Discovery Fund 2,571 Mrinal Singh 11.66 6.89

IDFC Sterling Equity Fund 1,360 Kenneth Andrade 7.59 5.97

Kotak Midcap Fund 258 Pankaj Tibrewal 9.37 4.50

SBI Emerging Businesses Fund 1,234 Rama Iyer Srinivasan 18.07 14.18

Indices

CNX Nifty Index 13.00 3.96

CNX Midcap Index 4.65 -1.01

Yield Curve – current scenario

G Sec Curve

Corporate Bond Curve

Corporate Bond curve currently flat, expected to gradually steepen going forward

AAA Corp Bond Spread (10 Year vs 1 Year CD)

The above graph tracks the movement of 1 year CD yields versus 10 year corporate bond yields since 2009.

The lower panel tracks the spread between the 2 yields (10 year minus 1 year). Current Spread of 14 bps is

lower than historical spread of 75 bps

Spread is expected to revert to mean as RBI cuts rate further and liquidity position improves

RBI Credit Policy – 3rd May 2013

Repo rate cut by 25 bps to 7.25%; CRR unchanged at 4%

RBI estimates GDP growth in FY2014 at 5.7% and inflation range-bound around 5.5% with

conditional pick-up in both metrics likely in 2HFY14.

This is in line with our estimates (as also the trajectories) of 5.7% for GDP growth and average

inflation of 5.5%.

Money supply growth projected at 13%, deposit growth at 14% and non-food credit growth at 15%

The RBI has clearly mentioned that “by far the biggest risk to the economy stems from the CAD”

which is significantly higher than the sustainable level of 2.5% of GDP.

Liquidity issues will likely be addressed through a mix of CRR cuts and OMOs, leaning more

towards OMOs in the near term.

Inflation

Headline WPI inflation falls to 4.89% in April from 5.96% in March

Core WPI inflation came in at 2.7% in April, lower than 3.4% in March, along with some comfort

from the currency side.

Given that the RBI would want to condition the “evolution” of inflation to ~5% by March 2014, it is

still not time for it to turn more aggressive with monetary easing.

We still think the RBI will remain cautious in its communication to the market and restrict itself to a

25 bps repo-rate cut on June 17.

10 Year G sec yield heads south

10 year G-sec yield has fallen sharply from 7.70% to 7.40% in recent times due to

- Lower than expected WPI inflation data

- RBI reiterating that it will continue to actively manage liquidity through various instruments, including OMO

- Rate cut expectations

Source: Reliance AMC

Debt Market Outlook & Strategy

With the recent sharp rally in long term bond yields, as on 15th May 2013:

10 year AAA-rated Corporate Bonds are trading at 8.20%-8.40% p.a.

10 year AAA-rated PSU Bonds are trading at approx. 7.85% - 7.95%p.a.

10 year State Development Loans (SDLs) are trading at approx. 7.88%-7.95% (annualized)

10 year G-sec yield is currently at 7.40% as on 15th May 2103

We continue to see room for a further 50 bps repo rate cut in FY2014 with the next 25 bps on 17th Jun’13

In summary, we expect the next 6 months to be favorable for duration oriented strategies

Strategy

Duration funds continue to provide attractive opportunity on back of potential easing in long-term bond yields on account of rate-cuts by RBI.

Thus, we recommend to have a bias towards long duration bond funds.

24 – 36 months FMP’s should be considered on account of prevailing high yields.

Debt Recommendations

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Category Schemes Recommended Risk Profile Investment Horizon Upto 3-Months

Liquid / Ultra Short Term Funds

DWS Ultra Short Term Fund - Institutional Plan Low Kotak Floater - Long Term Low Tata Floater Fund Low UTI Treasury Advantage Fund - Institutional Plan Low

Investment Horizon of at least 6-Months and up to 1-year

Short Term Income Funds

Kotak Bond - Short Term Low to Medium ICICI Prudential Short Term Plan Low to Medium DWS Short Maturity Fund - Regular Plan Low to Medium

Arbitrage Funds Kotak Equity Arbitrage Fund Medium IDFC Arbitrage Fund Medium

Investment Horizon of 1-Year & Above

Fixed Maturity Plans (FMPs) 1-Year Low to Medium Short Term Income Funds Templeton India Short Term Income Plan - Retail Low to Medium Dynamic Bond Funds SBI Dynamic Bond Fund Medium

Income Funds

Birla Sun Life Income Plus Fund Medium IDFC SSIF – Investment Plan - Regular Plan Medium Kotak Bond - Plan A Medium SBI Magnum Income Fund Medium

Investment Horizon of 2- to 3-Years and above

Fixed Maturity Plans (FMPs) 2-Years, 3-Years FMPs Low to Medium Dynamic Bond Funds SBI Dynamic Bond Fund Medium

Income Funds

Birla Sun Life Income Plus Fund Medium IDFC SSIF – Investment Plan - Regular Plan Medium Kotak Bond - Plan A Medium SBI Magnum Income Fund Medium ICICI Prudential Income Opportunities Fund Low to Medium

Investment Horizon of more than 5 Years (Long-Term)

Income Funds ICICI Prudential Income Opportunities Fund Low to Medium

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Disclaimers

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