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Alpha Edge, April 2017 - Revival in. Markets ahead.

Another month. Another high. 2017 has been on a roll with equity indices hitting new highs on new hopes. The first quarter of 2017 had a few important events like UP elections and Fed policy stance indicators. With both of them favourable, markets cheered and ended the quarter with a ~12% net gain.

Globally, eyes were fixed on the Fed policy where markets expected one rate hike for now and an expectation for three more. As expected Fed raised the interest rates by 25 bps. However it gave a more dovish outlook, indicating two more hikes and it was deemed positive by the markets. What followed was a fall in the dollar index, with money flowing back into emerging markets like India. We are seeing global growth showing slow signs of revival but for a potential headwind in inflation. This has been inching up at a pace that is making economists uncomfortable. Going forward, if inflation is creeping higher but economic growth is not meaningfully accelerating, global markets may frown at the stagflation.

From a domestic stand point, we saw BJP winning the UP elections with a landslide mandate. This strengthens BJP’s stance in the 2019 general elections and signals to the opposition about the futility in baseless policy objections and its stalling tactics. The emphatic win bolstered everyone`s confidence on increasing political stability even though a full majority for NDA is another two years away. The strong certainty of a second term bodes well for a development focused government as it will give them more flexibility to undertake long term reforms. Another important event that occurred during the month was the passage of the GST bill in the Union cabinet. As per the finance minister, GST is on track to be implemented by July 1st. Even though the design of the multiple-rates GST is by no means ideal, it is still the most far-reaching reform since 1991. We believe that the design flaws can very well be ironed out as time passes. The impact of these reforms will become visible only in the medium to long-term. For now, the major piece that is missing in the economy is revival of Capex which is in turn dependant upon increase in capacity utilization and demand.

Calendar 2017 started on a strong note with the Sensex and the Nifty hitting all-time highs on the back of strong flows from both domestic and foreign institutional investors. Over the past few years we have seen a lot of macro-economic numbers improving along with the reforms undertaken by the government. What we are yet to see, is an increase in corporate earnings. What has driven the prices until now has been liquidity and investor optimism itself. This has resulted in valuations surpassing well above average levels to a point where the index is priced to perfection which leaves no room for error. Even though earnings revival is underway, the expectations of the intensity of revival is still high and that could result in short term volatility. Such volatility should be used to build medium to long term positions in equities. With inflation finding a floor, bond yields are unlikely to inspire debt fund investing. Especially with longer duration.

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