Hybrid Outlook

Indian markets continued their upward recovery in the month of August driven by optimism across counters. The rally in Indian equities is in stark contrast to the rest of the world plagued by pessimism on account of inflation and recessionary fears. For the month S&P BSE Sensex & NIFTY 50 ended with gains of 3.5% each. NIFTY Midcap 100 & NIFTY Smallcap 100 ended the month up 6.2% & 4.9% respectively. FPI’s continued to be large buyers this month with a net inflow of Rs 56,521 Cr across asset classes.

Key Market Events
• US Fed Remains ‘Hawkish’ targeting sticky inflation
Statements from ‘Jackson hole’ indicated inflation targeting in the US would affect growth prospects in the medium term. Overarching focus of the monetary policy aims to bring “price stability and get inflation within 2% target even though it will entail sustained periods of below trend growth, softening labor market and pain for households and businesses”. He also hinted at another ‘unusually large’ increase in Fed fund rate in the coming FOMC meeting in September.

• India becomes 5th largest economy in GDP terms; Q1 GDP below estimates
India retained the tag of the fastest growing large economy with a Q1 GDP print of 13.5% on the back of low base effects. The prints indicate domestic demand remains healthy, supported by private consumption growth. Weaker than expected manufacturing growth & high cost commodity driven weakness in the external sector affected the overall GDP print. Oil below US$100 and the sharp fall in industrial metals imply this weakness are likely to strengthen the next series of GDP prints.

• INR – Strong against most trading members
INR has remained relatively stable successfully navigating pressures against the US Dollar. On a YTD basis, INR has depreciated 7% vs. USD but has appreciated 5.6% vs. EUR.

• INR Bond Inclusion – Clamor Grows
JP Morgan Global Indices has been collecting feedback from global investors in the past two months. There are two key takeaways: 1) The index team now has more incentive to include India on the back of Russia's exclusion; and 2) Most GBI-EM investors either support or don’t object to the inclusion. Given the large size of the domestic bond market, an inclusion would be a sizable change to EM indices implying inflows of ~US$30 billion over the next 18 months

• Oil continues its downward descent; Commodities key to inflation cool off
Despite ongoing geopolitical turmoil, weak growth prospects have dampened commodity prices. Brent Crude ended at $96.49/bl for the first time since Jan 2022. Commodity prices have exasperated inflation across the world. Peaking commodity prices bode well for the inflation problem.

Market View

Equity Markets

GDP prints indicate domestic demand remains healthy, supported by private consumption growth. The weakness was primarily in the external sector and can be attributed to higher commodity prices (Faster import growth on account of higher cost of commodities imported). Slower than expected manufacturing sector growth also affected the overall GDP print. Oil below US$100 and the sharp fall in industrial metals imply this weakness will turn to strength in the next series of GDP prints.

Inflation remains a key risk to equity markets. While the RBI has successfully managed domestic inflation through monetary policy thus far, roaring inflation across the developed world continues to remain worrisome. Despite hawkish policies, inflation across developed markets continues to remain at record levels. Extreme effects of inflation and hawkish monetary policy can potentially ravage demand economics in these countries, resulting in knock on effects to countries like India.

Our portfolios represent our conviction of the ongoing domestic demand ‘revival’ story. While we remain cautious of external headwinds, strong discretionary demand evident from high frequency indicators and stable government policies give us confidence that our portfolios are likely to weather the ongoing challenges. Markets have already digested several macro-economic negatives. Going forward, we believe, oil inflation and currency will be key metrics to decide the trend for the Indian economy. While we keep a caution eye out for short term headwinds, we are now optimistic of an improving market trajectory.

Debt Markets
The worst is behind us! Policy makers have been grappling with the inflation challenge for the last 2 years. While the RBI has successfully managed domestic inflation through monetary policy thus far, roaring inflation across the developed world continues to remain worrisome. Despite hawkish policies, inflation across developed markets continues to remain at record levels. Markets today have priced in much of this pessimism and hence we believe that the worst is behind us.

Domestic macro continues to remain strong. This is evident through high frequency indicators like credit growth, GST collections, credit card spends, UPI payments etc. Stable currency and return of FPI flows have also cushioned the economy. For bond markets this can be seen as a positive. The 10 Year G-Sec has new returned to levels last seen in early April (~7.20%) retracing much of the pessimism that was priced in. Our call to migrate portfolios to relatively longer tenor assets, over the last few months, has played out well so far.

Incrementally, we believe inflation has peaked at least locally. Falling oil prices, food prices and even metal prices are likely to give comfort to the RBI that the inflation cycle is nearing an end. While we do not anticipate the end of the rate hike cycle just yet, market yields are unlikely to rise materially from here. Markets have priced terminal rates close to 6.25% - 6.50% levels which implies markets pricing in policy rate increases of up to 100 bps from current levels.

For investors with a medium term investment horizon, we believe the time has come to incrementally add duration to bond portfolios. This however does not imply approaching the extreme long end of the yield curves as inherent volatility could be a factor in the near term. The impending inclusion into global bond indices could result in long term flows into government bonds which may result in capital gain opportunities for investors.

The current yield curve presents material opportunities for investors in the 4-year segment. This category also offers significant margin of safety given the steepness of the curve. For investors with medium term investment horizon (3 Years+), incremental allocations to duration may offer significant risk reward opportunities. Spreads between G-Sec/AAA & SDL/AAA have seen some widening over the last month which could make a case for allocations into high quality corporate credit strategies. Lower rated credits with up to 18-month maturity profiles can also be considered as ideal ‘carry’ solutions in the current environment.