Equity & Debt Strategy

Mid Aug – Sept’ 2017

Equity Market Update &

Equity MF Strategy

Confidential | 3

17,000

17,400

17,800

18,200

18,600

19,000

9,400

9,500

9,600

9,700

9,800

9,900

10,000

10,100

10,200

30-Jun-17 06-Jul-17 12-Jul-17 18-Jul-17 24-Jul-17 30-Jul-17

NIFTY Index Nsemcap index

Strong Earning of HDFC

Bank and Reliance

CPI falls to 1.54%

Cess on Cigarettes hiked

-2,243

10,023

3,965 3,764

-2,080-5,122

-2,587 -3,432

11,4089,425 9,165 8,255

-10,000

-5,000

0

5,000

10,000

15,000

Apr 17 May 17 Jun 17 Jul 17

FII DII MF

10.6%

8.2%7.4%

6.2% 5.9%4.4%

-1.4%

-3.8%-5.0%

0.0%

5.0%

10.0%

15.0%

Energy Bank Realty Infra IT Auto Pharma FMCG

Both Large and Mid Cap index did well in July Both FII and MFs continue to be net buyers

In July, NSE Energy index was up 10.6% while FMCG led

by ITC was down 3.8%

Source: Bloomberg, AMFI, KIE As of 31st July 2017 YoY% unless specified * Equity + ELSS + 65% of Balanced

cr

Monthly Inflows to Equity MF* continue to be strong

Rs. cr

12,078

14,06715,720

13,012

0

4,000

8,000

12,000

16,000

20,000

Mar 17 Apr 17 May 17 Jun 17

Nifty was up 6% in July post good results by HDFC Bank and Reliance

Confidential | 4

1.8 1.7

1.51.4

0.0

0.4

0.8

1.2

1.6

2.0

Mar 17 Apr 17 May 17 Jun 17

US macro disappointing, ECB policy key event to watch out for

US inflation has fallen below the Fed Target of 2% making

it difficult for the Fed to follow rate hike path

Europe GDP growth strong at 2.1%, could lead to ECB

tightening monetary policy

US Dollar index at lowest level since Trump election on

Euro strength and disappointing US macros

Source: Bloomberg

China Manufacturing PMI still stable while Government is

trying to control property prices and leverage

Source: Bloomberg YoY% unless specified

2.10

0.00

0.50

1.00

1.50

2.00

2.50

Sep13

Dec13

Mar14

Jun14

Sep14

Dec14

Mar15

Jun15

Sep15

Dec15

Mar16

Jun16

Sep16

Dec16

Mar17

Jun17

92.86

87.00

90.00

93.00

96.00

99.00

102.00

31-Mar-17 30-Apr-17 31-May-17 30-Jun-17 31-Jul-17

51.10

46.00

47.00

48.00

49.00

50.00

51.00

52.00

53.00

Feb 16 Apr 16 Jun 16 Aug 16 Oct 16 Dec 16 Feb 17 Apr 17 Jun 17

%%

Confidential | 5

Government has accelerated expenditure, Infra and Agri to benefit

115.7

37.7

92.4

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

Mar 17 Apr 17 May 17

0.3

7.3

11.9

4.0

10.0

14.7

8.6

-11.2-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Mar 17 Apr 17 May 17 Jun 17

2W Sales Passenger Vehicle Sales

Government has frontloaded its capex leading to

substantially higher expenditure

2 Wheeler sales were less impacted by GST reflecting

strong rural demand

Source: Nomura, KIE, CS, DB YoY% unless specified

Higher expenditure focussed on Agri, food procurement

of Rabi crops substantially increased to support farmers

42,351

15,162

85,925

25,133

0

20,000

40,000

60,000

80,000

100,000

Ministry of Consumer, Food and PublicDistribution

Ministry of Chemicals and Fertilizers

Apr-May 2017 Apr-May 2018

Both FII and MF have been increasing their exposure in

mid-small cap stocks

35.00%

40.00%

45.00%

50.00%

55.00%

60.00%

Mar-16 Jun-16 Sep-16 Dec-16 Mar-17

FII MF

% of Portfolio in non Top 30 stocksRs. cr

%

Confidential | 6

Rest of the economy still struggling

82% of the stocks are trading above their 200 Day daily

moving average

Source: KIE, CS, Morgan Stanley YoY% unless specified

Low inventory levels across sectors could be a new

normal post GST which will hurt manufacturing this year

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

0

10

20

30

40

50

30-Apr-17 31-May-17 07-Jun-17 14-Jun-17 21-Jun-17 28-Jun-17 07-Jul-17

Days of inventory - Pharma

27.2

17.9

8.3

4.4

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Mar 17 Apr 17 May 17 Jun 17

Exports Growth has started to slow down due to INR

strength

Manufacturing PMI hits 8 year low on GST disruption, new

orders also contracted

52.5 52.551.6

50.9

47.9

53.6 53.8 52.6

51.3

46.2

42.0

44.0

46.0

48.0

50.0

52.0

54.0

56.0

Mar 17 Apr 17 May 17 Jun 17 Jul 17

India PMI - Manufacturing PMI New Orders

Confidential | 7

Earnings and Valuation –Liquidity and Hope of strong Earnings growth in FY17-18 has led to slightly expensive valuations

Nifty at 18.2x Bloomberg one year forward earnings

estimate, Mid Caps at premium vs historic level

MSCI India P/E Premium over MSCI EM is still close to

long term average

Nifty Q12018 EPS is expected to fall by 5%, Pharma has

disappointed while Energy has done well

Banking and Automobile sector to lead Earnings growth in

coming next 2 Fiscal Years

Source: Bloomberg, KIE Estimates Outperformed if PAT>1.05x Expected, Underperformed if PAT<0.95 of expectedYoY% unless specified, ^ CY17-18

12

8

12

18

Outperformed Underperformed As Expected Not Released

12M Forward

PE

41%

34%

36%

38%

40%

42%

44%

46%

Mar 17 Apr 17 May 17 Jun 17 Jul 17

0

10

20

30

40

50

0

5

10

15

20

25

30

35

40

45

Automobiles Banking Consumers Energy Pharma Techology Nifty 50 Nifty 50 (ex-energy)

Earnings Growth FY19E P/2019E

% x

18.219.6

15.1 15.3

0.0

5.0

10.0

15.0

20.0

25.0

Large Cap Mid Cap

Current 12M Forward PE 5 Year Average

7.7%

1.3%

5 Year Average

Confidential | 8

Key Triggers – GST Implementation and Monsoon

• Global Economic data : World economy improving. Expectation of fiscal stimulus from Republican Government

• Lower Domestic Interest rates: Many Banks have cut their MCLR sharply which should help in reviving credit demand

• Resolution of NPA: Effective addressal by government of NPA issue in Indian Banks

Positive Triggers

• US Policies: Revival of Trump/Reflation trade could lead to EM outflows again

• Earnings: Consensus expected earnings growth for domestic equities is high at around 20%, any downgrade would make the valuations more expensive

• GST implementation: Demand revival getting delayed post GST

• Geo-Political Risk: Political uncertainty in UK, Germany, Netherland

• Monetary Policy: Faster than expected monetary tightening in Europe and US

Risks

Confidential | 9

India Equities: Valuations & Strategy – Maintain Neutral Stance

At current levels of approx. 9711 (11th August, 2017), Nifty is trading at a 1 year forward PE of 19.1X. Also the ratio of potential upside to downside is biased towards downside at current valuations.

Risk-Reward Scenario based on earnings growth & valuations:

New Deployments:

Equities continue to rally to life time highs on theback of foreign and domestic liquidity. RuralConsumption and Government spending hasstarted to show signs of uptick, although mostdomestic indicators are struggling due to dualimpact of Demonetization and now GST. Post RBI’s25bps rate cut in the August policy, we see furtherpolicy action dependent on the inflation trajectory.

Mutual Funds: As domestic liquidity continues todrive markets, we advise new investments inMutual Funds to be deployed 25% in lumpsumand subsequent in tranches via SIPs/STPs

On a risk-reward basis we continue to maintain Neutral stance

• Recommended allocation within equity mutual funds is as under:

• 100% Large Cap allocation (Prefer Large Caps due to relatively Favorable Valuations)

• This allocation to Large caps can also be taken through Opportunistic Funds which currently have a bias towards Large cap

• For investors who want equity exposure but have low appetite for volatility, they can take equity exposure through

Balanced Funds. Balanced funds have 20% to 30% allocated to Debt which provides cushion to the portfolio return during

market volatility.

Source: EPS Estimates by KIE

Nifty @ 9711 Fwd PE(X)Fwd EPS Estimate

Estimate Target

Nifty Level% Upside / Downside

1 Year Upside 18 588 Q4-FY19 10,584 8.99%

Downside 16 508 Q1-FY19 8,128 -16.30%

Debt Market Update &

Debt MF Strategy

Confidential | 11

Indicators

Policy Action

• RBI cuts Repo rate by 25 bps in August policy

• Further rate cuts will depend on inflation trajectory

• One member pushed for 50 bps cut

Inflation

• CPI came at all time low of 1.54% in June 2017

• RBI expects CPI to be little over 4% by March 2018

• We expect CPI to remain below 2% in July 2017

10 Year G-Sec Benchmark Yield

• 10 Yr yield likely to remain in range

• 6.35% – 6.55% range likely in near future

Liquidity

• Liquidity surplus still at Rs. 2.9 trn

• RBI will do one more Rs. 10,000 cr of OMO sale

• RBI is timing OMOs gradually

INR

• Appreciated to 63.7

• Likely to remain in a range

Key Risks

• US policies; Fed hikes; Global monetary tightening

• Impact of 7CPC HRA allowance implementation on CPI

• State and PSU implementation of 7CPC

• Farm loan waivers can impact fiscal deficit by 1% to 1.3% of GDP

G-Sec Supply

• The gross G-Sec supply to be Rs. 5.8 trn

• SDL issuance of Rs. ~4 trn+ expected; QFY18

issuance expected to be Rs. ~1.2 trn

Debt Market: Key Variables

Confidential | 12Source: Bloomberg

As of 3rd Aug 2017

RBI cuts repo rate by 25 bps - Expects inflation to bounce back in H2

1.54%

3.72%

Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Inflation at a all time low, core inflation also below 4%

CPI

Core Inflation

2,811

0

1,000

2,000

3,000

4,000

01 03 05 07 09 11 13 15 17 19 21 23 25 27 29 31

Am

ou

nt

in R

s. B

n

Liquidity remains high as RBI going slow with OMO Sales

43

6.43

6.00

0

10

20

30

40

50

60

70

80

6.00

6.50

7.00

7.50

8.00

Spre

ad (

bp

s)

% Y

ield

Benchmark yield didn’t move much as 25bps was mostly factored in by the market

Spread 10 Year G Sec Repo Rate

* Avg Spread over Repo in Falling rate regime – 61 bpsAverage Spread over Repo in Rising rate regime – 71 bps

-16

-11

-15 -15-16 -17

-8

6.43

-20

-15

-10

-5

0

5.60

6.00

6.40

6.80

7.20

1Y 2Y 3Y 4Y 5Y 8Y 10Y

Sp

read

(b

ps

)

% Y

ield

Bonds rallied on inflation data and strong FII buying

Change Current G-Sec Yield 1M earlier G-Sec Yield

Confidential | 13

FII flows continue to be robust on back of strong macros

63.71

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

Jul 17 Aug17

60.00

64.00

68.00

72.00

INR has appreciated to 63.7 level

Source: Bloomberg

As of 31st July 2017

2,894

Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

US

D M

illi

on

FIls continue to pour money in debt

52.72

Nov 16 Dec 16 Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17

30

35

40

45

50

55

60

65

70

Crude bounces back above 50 level

Brent

$/bbl

99.3%

99.8%

Aug16

Sep16

Oct16

Nov16

Dec16

Jan17

Feb17

Mar17

Apr17

May17

Jun17

Jul 17

60.0%

70.0%

80.0%

90.0%

100.0%FII Debt Utilization has increased substantially and

is almost 100%

Government Corporate

Confidential | 14

India Fixed Income: Strategy

Substantial part of the portfolio should to be played through a mix of high rated and credit accrual strategies. Exit from duration funds only for investors who have completed 3 years and can deploy with another 3 years view.

Investment Focus:

Passive Accrual-Oriented Debt funds

High quality portfolios (~100% AAA / Sovereign) Portfolio is run on a passive accrual basis i.e buying a bond and holding it till maturity thereby earning from the accruing of

interest Higher predictability of return, lower volatility & lower interest rate risk

High Yield Credit-Oriented Funds

Low volatility on account of maturity of portfolio between 3 – 5 years, attractive and stable accrual yields Experienced teams to carefully evaluate and tightly monitor high yielding debt instruments

Short Term Bond Funds

Actively managed to run a low avg. maturity of 2-3 years, attractive risk-reward Lower volatility and interest rate risk than Dynamic Bond Funds, better suited from a risk-adjusted basis in volatile markets

Continue to recommend ultra short term relative to liquid funds (up to 3 Months)For short term parking of funds for a minimum of 6 months, Arbitrage funds preferred over ultra short term funds on back of better tax adjusted returns

Source : AMCs, other Financial websites

Confidential | 15

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