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Global volatility to drive markets in the near term

07 Oct 2022 0 COMMENT

Global volatility

  • Globally, the epic centre of the recent sharp fall in equity markets including India is the global bond market. During the week, U.S. 10-year bond yield crossed 4.0% mark for the first time in 12 years reacting to previous week’s rate hike and hawkish commentary by U.S. Federal Reserve. Rising expectations of higher terminal rate in U.S. from less than 4.0% to 4.5-4.75% in last one week has led to current further sell-off in bonds.
  • U.S. 10-year yield had risen sharply from 3.5% at the start of the week but saw some moderation in the later part of the week towards 3.85% as BOE announced emergency measures to buy Government bonds. Yields have now moved up by around 1.5% in last 2 months from 2.5% in first week of August 2022 to 4.0% this week.
  • Bond buying measures by few other central bankers/Governments similar to BOE may not be ruled out as implications of sharp rise in yields are grave ranging from general investment losses to systematic risk for select sectors (Insurance companies) to higher cost of funds leading to business unsustainable etc.

Indian Markets

  • Indian equity benchmarks corrected for third week in a row amid global volatility and currency depreciation
  • Nifty corrected 7.5% over past ten sessions rendering prices to extreme oversold conditions and in the process tested its key 200-day EMA (16850)
  • In the upcoming truncated week, we expect Nifty to witness technical pull back from oversold readings with key support placed at 16500 levels. Use dips to buy amid volatility for target of 17300
  • India VIX has corrected 2% for the week, despite Nifty correcting 3.5% during the week indicating that market participants are not expecting major turmoil in the near term
  • Seasonality: Historically, September has been a volatile month. However, over past two decades, Q4 returns for Nifty has been positive (average 11% and minimum 5%) on 70% of the times. The history favours buying dips from hereon
  • Relative outperformance: Indian equities continued to relatively outperform global peers while pricing in many negatives. While most global equity benchmarks have tested June lows, Nifty is 10% away from June lows
  • Sectorally, Consumption and BFSI are expected to lead recovery while Auto, capital goods and select Pharma stocks provide re-entry opportunity post recent decline
  • In large caps, Indusind Bank, Bank of Baroda, Reliance, Bajaj Finance, Titan, Britannia, TCS, Sun Pharma, Maruti Suzuki are preferred
  • In midcaps, ABFRL, Lemontree, Schneider Electric, Mazgaon Dock shipbuilders, Gabriel, Granules, Havells, KPIT Technologies 
  • Nifty has started the October series with 6 month high open interest at inception. Weak global cues have triggered fresh shorts in Index futures and we believe any short covering trend should be expected only if Nifty sustains above 17200.
  • Among heavyweights, Kotak Bank and Reliance along with stocks from the realty space have seen aggressive short accumulation. A short covering move can be expected if these stocks sustains above their call bases at the same time, despite continued under performance Technology stocks hasn’t seen any gradual build up of short positions.
  • The out performance of India vs global peers faltered further last week and FIIs have aggressively sold Indian equities. During the week itself, FIIs have liquidated equities worth | 16,000 crores. Despite the buying of more than | 13000 crores by domestic institutions, Nifty lost more than 2% as FIIs selling was more concentrated towards index heavyweights. With recent selling, FIIs have turned net sellers in Indian equities for the month as well.

 

RBI Policy, Indian bond markets are also outperforming global bond markets

  1. Rate hike by RBI by 50bps was on expected lines and even the borrowing calendar was largely as per market expectations.
  2. Inflation estimate for FY23E maintained at 6.7% with decline in commodity prices and good monsoon cooling off inflation, though imported inflation pressure amplified by appreciating dollar remains a risk.
  3. Revival in demand has been consistent among agriculture, industry and services sector, however, geopolitical tension and mounting fear of recession pose a risk to exports. Overall, GDP growth is revised downwards from 7.2% to 7% in FY23E.
  4. Focus remains on withdrawal of accommodative stance and calibrated monetary policy action to tame inflationary pressure
  5. India’s foreign exchange reserve at US$ 537.5 billion as on September 23, 2022. About 67% of the decline in reserves during the current financial year is due to valuation changes arising from an appreciating US dollar and higher US bond yields. Incidentally, there was an accretion of US$ 4.6 billion to the foreign exchange reserves on balance of payments (BOP) basis during Q1FY23.

Impact on yields

  1. 50 bps rate hike, in-line with expectation, have led 10 year Gsec remaining flattish at ~7.3-7.35%. Indian bond yields have also seen some pressure with 10-Year bond yield moving up from 7.1% (second week of September) to 7.35% currently.
  2. Economic stability, steady currency and healthy growth opportunity on relative basis could spur inflows in bonds which augurs well for stability in domestic yields in the current scenario. Inclusion of Indian bonds in global index will act as another catalyst for increased inflow in bonds

Overall, just like equities, Indian bond markets have also outperformed global bond markets in terms of stemming the sell-off.

Impact on banks

  1. With 10 year Gsec at 7.3% and banks MTM at 7.5%, expect some reversal of treasury losses reported in Q1FY23. The same to lead to a sequential surge in earnings of PSU banks
  2. In the wake of increasing competitive intensity on deposits, utilization of excess CRR and SLR for lending to safeguard any negative pressure on margins
  3. In-spite of hike of ~190 bps in repo rate, credit demand from retail segment remains buoyant and is expected to remain strong in ongoing festive season. Higher inflation to keep credit demand for working capital abated while capex demand is witnessing gradual uptick
  4. NBFC are expected to witness continuous traction in credit demand, though margins could remain under pressure due to elevated cost of borrowing

 

Monsoon

 

  • Monsoon activity for the country as a whole has remained in the above normal zone post robust rainfall in July 2022 with cumulative rainfall till date placed at 107% of LPA i.e. 7% above the normal range.
  • India is well poised to surpass the revised IMD forecast of rainfall in Monsoon 2022 to be at 103% of LPA.
  • Sowing activity has been near normal with acreages down 1.2% YoY on aggregate basis while is down 5.5% YoY in the case of Rice due to muted rainfall in the eastern belt.
  • Water reservoir levels are healthy pan India with present reading at 108% of last year levels & 113% of last 10 year average levels. Positive for the upcoming Rabi Crop

 

Expected Auto Nos

  • We expect PV space to report healthy volume prints i.e. high single digit M-o-M volume growth for September 2022 amid new launches in the SUV domain and upcoming festive season. Key outperformance in this space is expected from Mahindra & Mahindra (on the back of commencement new Scorpio deliveries) and Maruti Suzuki.
  • 2-W space could witness mix trend wherein commuter segment is expected to report steady performance with positive reading is expected from the premium segment involving the likes of Eicher Motors.
  • While CV space and tractors could witness a M-o-M decline due to seasonality.
  • On the Exports front, volumes could be subdued given the macro uncertainty as well as currency volatility. So, Bajaj Auto and TVS Motors could report muted volume prints for September 2022.

 

We remain positive on the auto space given the expectation of double digit volume growth in the near term coupled with benign commodity price outlook leading to healthy margin recovery. Our Top bets are largely domestic oriented businesses with healthy growth prospects namely Maruti Suzuki (target: ₹ 10,000), M&M (target: ₹ 1,590), Eicher Motors (target: ₹ 4,170) and Ashok Leyland (target: ₹ 180) in the OEM space.

 

Pharma stocks resilient driven by India Formulations theme and CRAMs

  • Expect Pharma to provide stability on back of stable growth prospects and reasonable valuations.
  • ~12% correction in Nifty Pharma over the last one year has already factored in US generics specific pain and transitory margins pressure on account of RM inflation, higher logistics and supply related challenges.
  • Our stability argument for Pharma is mainly based on stable India branded formulation outlook which is poised to maintain 11-13% growth trajectory for the next few years with higher chronic diseases incidents, minimum capital investment and improving MR productivity. – Preferred picks- Torrent, Ajanta, Sun, Abbott.
  • We expect support and earnings comfort on CRAMs which continues to remain as mainstream Pharma theme on visibility capex driven by ‘’China-plus One’’ theme which is reflecting from incremental order wins and client additions. We expect ~15% revenue growth between FY22-24E in the CRAMs space. Preferred picks- Divi’s Labs, Laurus lab.
  • Similarly, the US generics space, which still remains competitive, is shrinking in the overall revenues and we expect optical recalibration and shift towards specialty and complex generics which are more remunerative- Preferred picks- Sun, Cipla, DRL
  • Our observation suggests that during FY19-FY23E, while the US contribution to the overall I Direct Pharma universe has gone down from 32% to 29%, that of India branded has gone up from 29% to 34%. This has reflected in EBITDA margin expansion from 20% to 22%.

 

No signs of recovery in Chinese property sector, rising interest rates coupled with sharp uptick in dollar index sour sentiment for base metal prices…

Over the last few months, no signs of recovery in Chinese property sector, rising interest rates globally coupled with a sharp uptick in dollar index has led to softening trend in global base metal prices. Growth concerns in China have weighed on metal prices, in general. A private gauge measuring China's factory activity fell deeper into contraction in September. The China Caixin manufacturing purchasing managers index dropped to 48.1 in September from 49.5 in August, according to data released by Caixin Media Co. and S&P Global.

Base metal prices have been muted over the last one month, Over the last one-month zinc prices on the LME have witnessed a fall of ~ 17% and is currently hovering at ~ US$ 2957/tonne. Similarly, over the last one month Aluminium prices on the LME have witnessed a fall of ~9% in the last one month and is currently hovering at ~US$ 2185/tonne. Also, Copper prices on the LME have witnessed a fall of 3% in the last one month and is currently hovering at ~US$ 7647/tonne.

LME takes first step towards possible Russian Metal ban....

LME is launching a discussion paper that marks the first step towards potential ban on new supplies of Russian Metal. Going forward, any move by LME to block Russian supplier could have significant impact on global metal market as Russia is major producer of Aluminium, Nickel and Copper.  Nickel in Russia is mainly produced by Nornickel and accounts for ~7% of global nickel mine production. Rusal, the world's largest aluminium producer outside China accounts for ~6% of global Aluminium supplies. Russia also accounts for ~3.5% of global refined copper supplies.

Gas Pricing

  • From Oct 1 onwards, Domestic (APM) gas prices are expected to rise sharply to US$ 9/mmbtu (from US$ 6.1/mmbtu earlier), while to US$ 12/mmbtu from difficult fields (from US$ 9.92/mmbtu)
  • The price rise comes at a time, where crude oil prices are falling steeply and hence, it would create a dilemma for downstream gas companies (such as MGL, IGL). IGL and MGL currently utilise pooled gas comprising of APM (90%) and Spot Gas (10%).
  • IGL, last week, had also announced that it will not pass any cost increase to end users in the near term by lowering the internal operating expenses and maximise volumes and hence, the current cost rise would hit its margins
  • Upward revision in gas prices would be beneficial for companies such as ONGC and Reliance as their realisation would increase. 
  • For mid-stream companues like GAIL, increase in gas prices would impact their petchem volumes but improve the lpg segment volumes. Regasification volumes of Petronet LNG too would decline (due to higher spot gas prices)

Hidden Gems

Havells India

CMP: | 1320        TP: |1650            

  1. Havells India has transformed from being industrial product driven business to one of the best players in the FMEG space with market share ranging between 6%-20% across consumer appliances category
  2. In the FMEG category, company has reported one of the best revenue growth of 63% in Q1FY23 led by strong sales of cooling products. Even on a three-year basis, Havells’ revenue has grown at a CAGR of 16%, ahead of its peers’ revenue CAGR in the range of 7-12%.
  3. We believe the company will see pick-up in demand from Q2FY23 onwards supported by festive demand and cooling raw material prices.
  4. We believe, there will be a sharp recovery in Havells’ EBITDA margin (by ~500 bps) over its Q1FY23 level on the back of cooling raw material prices and Llyod’s improved operating leverage
  5. Havells is constantly working on improving its market share across its product segments through new product launches and increasing penetration in tier II and tier III cities.     
  6. We have upgraded our rating on Havells India to BUY with a revised target price | 1650 factoring in Lloyd’s improved performance and its strong balance sheet
 

Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a SEBI registered with SEBI as a Research Analyst vide registration no. INH000000990. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The non-broking products / services like Research, etc. are not exchange traded products / services and all disputes with respect to such activities would not have access to Exchange investor redressal or Arbitration mechanism.