Review of 2012 market outlook
At start of the year, we termed our investment strategy for 2012 as “borrow and invest” given the signs of optimism despite mixed signals both from domestic and external sectors. Let us now take stock of the first three weeks of the year. NIFTY has outperformed other asset classes with 10.35% rally (from 4588 to 5064) at an alarming annualised rate of 190%. Gold has rallied by 6.71% (from 1564 to 1669) at an annualised rate of 122%. 10Y benchmark bond 8.79% 2021 has posted gain of 3.41% (from 101.00 to 104.44) at an annualised rate of 62%. On the currency front, USD Index has posted gain of 2.84% (rally from 79.52 to 81.78) at annualised rate of 52% while rupee outperformed the USD Index by posting gains of 6.15% (rally from 53.34 to 50.06) at an annualised rate of 112%. So, the start of the year has been good despite high cost of borrowing due to tight liquidity conditions. What next? There are signs of improvement in external sector into the short term while medium to long term outlook continue to remain unclear. Despite downgrade handed over to most of Euro zone countries, aggressive liquidity support from ECB/IMF has provided good relief to the financial system. It is good to keep the financial system stable while Euro zone Governments address monetary and fiscal side issues to get the Euro zone economy back on track. There is now time for Euro zone countries to sort out fiscal issues to prevent the worst. On the domestic front, inflation has eased as per expectations and shift of monetary stance from anti-inflation to pro-growth is just round the corner. This will be bullish for domestic stock market; bond market and rupee. While the issues related to high inflation and low growth is diluted, more focus need to be given to worries relating to fiscal deficit and trade/current account gap. Gold will continue to shine till positive signals emerge from the Euro zone and will retain its safe-haven status as alternate to US Dollar. Over all, the strategy remains unchanged but it is important to stay tuned to turnaround signals for maximising returns. Strategic investors have to acquire skills of “wind surfing” and “fishing”. You need to get into the correct wave and exit at the right time; else would get swallowed into the water. More importantly, need to have patience to wait for the big fish. Stay tuned for entry and exit signals. The investment strategy of “cash is king” for 2011 proved good in making small returns for the time value but more importantly principal remained safe and believe year 2012 will provide decent returns on own and borrowed funds.
What is RBI’s stance on 24th January?
This is one of few occasions when there is no consensus in expectations. It is a divided house. While economists prefer pause mode, market participants look for relief from tight liquidity and high cost of liquidity. As mentioned in earlier reports, the downtrend in inflation is established for March 2012 headline inflation print below 7%. There has been positive developments in favour of inflation driven by strong rupee and downtrend in commodity prices. There are signs of improvement in investor appetite to address supply side concerns. However concerns from fiscal deficit and demand side pressures stay valid. The only strong factor in favour of pause mode is the elevated core inflation and it is important to watch the trend in core inflation into the next 3-6 months. On the other hand, market is short of liquidity by over 3% of NDTL and overnight call money rate is trading at the higher end of extended corridor between Repo rate and MSF rate (8.5-9.5%). RBI’s release of liquidity through OMO bond purchases has not yielded desired results. It has only helped the Government to cut its borrowing cost. But for OMO, 10Y yield would have been above 9% by now. This has resulted in pushing the tenor spread into discount with negative spread on 1X10Y bond yields; thus the need to push overnight rate into 8% while maintaining stability in 10Y yield around 8.20%. This stance is considered “win-win” case for all stake holders of the system. The current market conditions are clearly anti-inflation and anti-growth; delivery of CRR and rate cuts is unlikely to generate headwinds to downtrend in core inflation. It would at best dilute the headwinds to growth momentum to get the system back into neutral-growth mode while retaining anti-inflation impact. RBI’s monetary action now (with 50 bps cut on CRR and Repo rate) could at best drive the call money rate from current level of 9.25-9.5% into 8.50-8.75% with reduced draw down from LAF counter from over Rs.1.5 Trillion to below Rs.1 Trillion. The shift into this market conditions post RBI action cannot be considered as shift of stance from anti inflation to pro growth; instead can be viewed as course corrective actions to shift the market conditions from anti-growth to neutral growth. Having guided the 10Y bond yield from 9% to below 8.20% through OMO operations, RBI can afford to reduce its excessive OMO purchases and allow the investors to absorb bond supplies. While I tend to agree with economists on the need to pause till release of pressure on core inflation; there is also need to release pressure on liquidity and its cost as we move into financial year end and more importantly when rupee (and commodity price) worries are clearly out of the way. The expectation therefore is for RBI to deliver 0.5% CRR cut and 0.25-0.5% rate cut. It is a contrarian view at this stage and it is fair to expect RBI to address serious concerns of other stake holders of the market; having done enough to address cost of Government borrowing.
Currency market
USD/INR is attracting good selling interest (from exporters) on spot move into 50.45-50.60 (3M/April 2012 dollars at 51.60-51.75) while spot rupee gains into 50.15-50.00 holds firm on month end dollar demand and importers’ interest to buy January 2012 dollars; thus providing two-way sideways trading mode within 50.00-50.50. The market dynamics have turned clearly in favour of rupee driven by good FII/NRI flows and high FX premium. RBI is also seen on the USD sell side giving great comfort to rupee bulls. The risk is from month-end dollar demand and RBI’s shift of stance from USD sell to USD buy mode which could drive the rupee down into 50.65-51.00. USD Index has held well above 80.00 but cannot rule out extended weakness into 79.50 before reversal; thus setting up a possible test/break of 50 into 49.85. For the week, it would be tight consolidation within 50.10-50.45 with overshoot limited to 49.85-50.60. The strategy to sell April 2012 dollars at 51.60-51.75 and buy January 2012 dollars at 50.10-49.95 stays valid. The short term expectation is for consolidation at 49-52; hence the suggestion to sell April 2012 dollars below 52.00 and refrain from buying beyond January 2012. Most stake holders expected RBI to prevent extended rupee gains below 51 to protect export competitiveness and allow rupee to trade around fair value in REER terms. It is possible that the intention may be to knock out NDF trades; long dollar positions in the domestic market will hurt profitability of domestic companies. For other companies who have incurred huge mark-to-market provisions on export contracts, there will be write-back of provision into P&L account. If this assumption is correct, RBI may not be worried on extended rupee gains into 49.00-48.50 to complete 100% reversal of rupee fall from 48.60 to 54.30. Over all, despite emergence of positive signals for rupee; there is no clarity on the way forward. It is prudent to stay with caution when signals are mixed and complex.
EUR/USD lost steam ahead of 1.3000 (high of 1.2986) for close of week at 1.2930; thus trading end-to-end of set “inner ring” of 1.2650-1.3000 (low of 1.2625). The financial support from IMF into Euro zone has provided relief for EUR/USD to halt extended weakness into 1.2500-1.2350 and has set the immediate focus at higher end of set short term range of 1.2350-1.3150. For now, would watch immediate support at 1.2875-1.2825 to hold for move into 1.3075-1.3150 before reversal; any further extension is expected to falter below 1.3250. Over all, we watch consolidation at 1.2825-1.3075 and stay neutral on directional break-out which could then trigger move into 1.2625 or 1.3250; thus trading end-to-end of the inner range with stop/reverse strategy on break is considered good at this stage. The fear of BOJ intervention on EUR/JPY below 100 has provided support to USD/JPY to trigger decent rally from 76.50 to 77.35. Over all, the pair is boxed at 76.50-77.25 for close of week at 76.90. There is no momentum to extend gains into 77.75-78.00 without BOJ entry and would be safe to sell at 77.25-77.75 with tight stop above 78 for pull back into 76.50-75.50. The preference for sharp rally from above 75.50 into 79-80 stays valid. We do not expect BOJ entry till 75.50 comes into threat; hence market will trend into 76.50 and possibility of stops trigger below there to guide swift move into 75.50. It is also important to track EUR/JPY around 100; move below 100 will provide support to USD/JPY while move above 100 will drive the pair lower into 76.50.
The strong interest rate play on rupee liquidity squeeze (higher call money rate at 9.25-9.50% and system short of cash by over Rs.1.5 Trillion) is providing stability for higher FX premium with 3M above 8.5% and 12M above 6%. Given the MM rate of over 10% across 1-12M, it is logical for 12M to stay above 6% but sustainability of 3M premium over 8.5% is surprise despite exporters’ supplies. PCFC book at L+3.5% gives an attractive 3M rupee yield of over 12% if funded through Buy/Sell swaps; let us continue with this strategy with no worry on mark-to-market. Reversal in 12M premium will be shallow till ease in money market rates; 1Y Bank deposit rate at over 10% against sub 6% FX premium provides attractive dollar return of over 4% for those who have access to foreign currency funds. We have now seen two extremes – dollar liquidity squeeze pushing 12M premium below 2% and rupee liquidity squeeze pushing 12M premium above 6% and it is matter of time before normalcy is restored by RBI to get it back into ideal range of 4.5-5.5%; hence the suggestion to traders to stay “received” on Jan/Dec at 5.85-6.0% (271-278). There is no need to put a range now as we watch excessive extension beyond 8.5% in 3M and 6% in 12M difficult to sustain for sharp reversal soon. On the other hand, exchange rate play is neutral till USD/INR spot trades within 49.85-50.60.
Bond/OIS market
10Y bond extended its gains into 8.10% (low of 8.12% from high of 8.24%) but could not sustain for close of week at 8.18%; thus trading end-to-end of set 8.10-8.25% range. The expectation now is for consolidation at 8.10-8.20% with overshoot limited to 8.0-8.25%. It is important for RBI to deliver CRR and rate cut to maintain near term price stability around 8.15%. While the majority expect RBI to leave things unchanged, bond yields have priced-in rate cut action. It is possible that RBI will restrict OMO on rally into 8.0% and get back to OMO on weakness into 8.25%. Strategy is to play end-to-end of this range by buying weakness into 8.20-8.25% and selling on gains into 8.05-8.0%. The risk is for extended weakness into 8.25-8.35% on RBI’s pause mode but 8.0% will remain safe even on 50 bps rate cut on fear of RBI reducing its OMO purchases to arrest excessive gains to cut the discount on 1X10 tenor.
The tight liquidity and high short term money market rates pushed OIS rates into the set receive zone of 8.05-8.10% in 1Y (high of 8.08%) and 7.25-7.35% in 5Y (high of 7.32%) before close at 8.08% and 7.28% respectively. There is no change in strategy of staying received at 8.05-8.10% in 1Y and 7.25-7.35% in 5Y for reversal back into 7.85% and 7.10% respectively. It would need RBI’s rate action to drive the rates further down into the set pay zone of 7.75-7.65% in 1Y and 7.0-6.90% in 5Y. The bond spread between 10Y bond yield and 5Y OIS rate is steady around 90 bps. This should arrest 10Y bond weakness above 8.25% and 5Y OIS rate above 7.35%. The risk of extended rally into 7.40-7.50% is limited at this stage and if it does, it is considered good for strategic investors. Having said these, it is important for call money rate ease into Repo rate (from close to MSF rate) to get the downward momentum into 7.85-7.75% (1Y) and 7.10-7.0% (5Y)
Commodities market
Gold is firmly boxed within the set 1630-1670 range (low of 1631 and high of 1670); the bias is for marginal extension into 1690-1700 before sharp reversal into 1630 ahead of final pit stop at 1580-1550. NYMEX crude lost steam at the set sell zone of 102-103 (high of 102.06) before reversal into the lower end of set near term range of 98-103 (low of 97.91) for close of week at 98.39. Now, let us get our focus into 95-100 with bias for extension into 93.00-92.50. Hold on to “shorts” with trail stop above 100 for t/p at 95.50.
NIFTY
The intra-week rally from 4866 (close of 13th January) failed at 5064 but did not have any strength to trigger sharp reversal for decent close at 5048; thus posting a strong weekly gain of over 3.74%. The market looks bullish with good FII interest despite limited participation from domestic institutional investors. The next big move will be seen post monetary policy. The market has already priced in CRR and Rate cuts and disappointment on this count will be negative. It is safe to watch consolidation at 4950-5150 till policy is out of the way. RBI leaving CRR/Rates unchanged will trigger test/break of lower end into 4850 while shift into easing cycle will extend gains into 5350-5400. Over all, the near term range stands shifted to 4850-5350 with test/break either-way to attract. Strategic investors who bought one-third of appetite at 4550 can hold with trail stop below 4850 (and t/p at 5350) and to buy second lot at 4875. Fleet footed traders can stay long on weakness into 4925-4875 with stop below 4850 for 5150/5350.
Have a great week ahead...................Moses Harding
No comments:
Post a Comment