This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in
US economy is recovering fast and probably faster than most of the analysts had expected a few months back. Earlier these analysts had a view that though the US economy is recovering, the recovery would be fragile till the time the employment situation improves. The US Bureau of Labor Statistics on friday released the Non-Farm Payroll numbers and the numbers were extremely good. After adding 195,000 jobs in May, this number got released at 195,000 again for June. So, is the US economic growth back on track and if yes, why is it bad for the emerging markets including India?
The immediate effect of this strong uptick in the US jobs growth is that the US Dollar has further strengthened and US bond yields have risen substantially in an anticipation of a further strengthening of US growth in the near future. The 10-year US treasury bond yield jumped 9.42% on friday itself, from 2.50% to 2.74%. This is a very steep rise in a single day. If we look at the yield movement since May 1, 2013, it has risen from 1.62% to 2.74%, a rapid jump of 68% in just over two months.
1-Year Chart of US 10-year Govt. Treasury Bond Yield
Source: Bloomberg.com
Earlier in June, the US Federal Reserve announced its intention to start tapering quantitative easing (QE) and thereby cut back on its unprecedented asset purchases. This mere announcement of a possible gradual withdrawal of quantitative easing sent all the major international financial markets into a tizzy, as it made the institutional investors sell their holdings quite heavily in almost all the markets, especially in emerging markets like India, massively increase their cash holdings and rethink their investment strategies and asset allocation region-wise.
Foreign Institutional Investors (FIIs), who had pumped in a huge amount of money into the Indian markets till May 2013 this year, pulled out heavily from the Indian debt markets and equity markets in June, to the tune of $5.68 billion and $1.85 billion respectively. This huge pullout by FIIs, good prospects of US economic growth, strengthening of USD, no relief from the bad GDP growth numbers & deficit numbers here in India etc., all have resulted in a steep fall in the value of Indian rupee and hardening of bond yields.
After hitting a low of 7.09% immediately after its auction in May, the 10-year 7.16% benchmark govt. bond yield has risen quite swiftly to 7.49% by friday. With the US non-farm payroll numbers announced on friday, the yield is expected to rise further here in monday’s trading. Similarly, the rupee is expected to cross 61 level mark against the US dollar on monday.
With the yields moving higher and the rupee getting weaker, the case for the RBI to cut interest rates has got very weak. So much weak that some of the analysts have started issuing reports predicting the inflation to take a U-turn once again and the RBI to raise its policy rates to stem the rupee fall and contain prices of imported goods. It is again going to put a lot of pressure on some of the struggling debt-heavy manufacturing companies.
So, at a time when Indian economy badly requires foreign money inflows to bridge their current account deficit and to strengthen the falling Indian currency, there is a big threat that the FIIs are thinking otherwise. FIIs are ready to move their money back to the US debt and equity markets at the slightest of signs of US growth getting stronger and Indian growth not moving out of the mire.
So, what should the Indian investors do in the current situation? – I think the declining trend in India’s economic fundamentals should take a U-turn very soon, probably in the next few days or few weeks. Indian govt bond yields, which had fallen down quite sharply in May, have risen with a similar intensity in June and should top out sometime this week from a short-term perspective. The investors, who are sitting on the sidelines to invest in the gilt funds or income funds to make money due to interest rate fall, should put a certain percentage of their investible surplus into these funds sometime this week itself.
Though not easily visible, some of the Indian economic fundamentals have also started improving. As the US growth returning back to some normal levels is a good news for the global economies including Indian economy in the long-term, I expect the equity markets also to do well from medium-term to long-term perspective. The investors are advised to go stock specific and do a thorough research before committing their hard-earned money to any of the stocks. Probably I am sounding too optimistic on the Indian markets than the actual picture at the ground level, but only the investors, who invest in markets in advance before they actually make a turnaround, make good money in these markets.
Shiv thanks a lot for your lengthy explanation. You are right.You, as a certified professional planner express your opinion.And these opinions are just not wild guesses but based on sound thinking.It is our good fortune that we have the benefit of such opinions free of charge.I have been telling Manshu this a lot of times.One Mint has taught us a lot.
After I offered my comments I did a little bit of digging.I wanted to know whether there was any correlation between the NAV,s of Gilt Mutual Funds and the RBI rates.For this purpose I chose just one fund viz L&T Gilt Investment Growth option.Why I chose this fund is because it is a top fund in the category of Gilt mutual funds..In the recent past,in respect of Bank rates , things started to happen fast from 17-3-2011.RBI started to hike rates from 6.75% on a regular basis from this day and the top rate reached 8.50 on 25-10-2011 in a span of just 8 months. The fall in rates started from17-4-2012 and to day it is 7.25%.During all the 8 months when there was a repeated dose of hike in the interest rates, the NAV was more or less a steady increase from Rs22.51 to Rs 22.94.Though the interest rates increased rapidly,instead of a fall, the NAV,s showed a marginal increase.Can you please explain why?
From 17-4-2012 the Interest rates started to fall from 8% to 7.25%.The NAV which was Rs 23.91 on 17-4-2012 is to day Rs 28.17.Wild increase indeed.I know the sample selected is not significant,yet do you think the NAV was up only due to the fall in the interest rates. If it was so,why earlier the rapid hikes in the interest rates did not trouble at all the NAV?
Hi Mr. Ramamurthy,
I’ll do a post on the same explaining the reason(s), on or before this weekend.
Mr Ramamurthy, Since April 2012, the increase you mentioned in Giltfund is 17.8%. Which also includes interest coupon reinvested (assume the fund was invested in g-sec with yields of 8.5%), so interest return over 15 months is 10.7%, remaining 7.1% is capital gains, which is not a wild increase. Theoritically, price impact = % change in yield * duration of bond. Assume bond fund average duration is 10 years, so your interest rates fell by 0.75% (as per you), therefore price impact = 0.75%*10= 7.5%, which is inline with 7%.
Now back to instance where the rates were hiked from 6.75% to 8.50%, as per this formula, he should have made a net loss, I agree. But one possible reason he dint make loss is because he managed the bond duration well, he reduced the duration of bond, by taking right call on interest rates. Which is believeable, since it is the best Gilt fund among all. If you take the performance of the median or the lowe rung Gilt fund, Im sure, it would have had capital loss.
To me shiv’s post sounds very positive. And, as per him, anybody who will invest now will make good money.
On the Same day I received a post, which points out caution.
http://www.quantspartner.com/Dollar_vs_INR.aspx#
Please help me to reconcile between two post.
Read Below.
Indian Equity Market and INR/USD, not in Sync with each other
A typical relationship was established between Sensex and INR/USD since FY06, accordingly :
1.When Sensex use to be around 19,000, corresponding INR/USD rate use to be around 42-45. So, we should see the possibility of INR appreciating to that level in order to justify the current Sensex which is around 19000 ???
However, even the most Optimist person would think again about such appreciation, but such possibility cannot be ruled out completely.
2.And, If that relationship is not completely broken, then theoretically, Sensex should be at a level around 10,000.
It sounds, most Pessimistic, but that is what the chart tells us.
Both the above scenario, emerge out as conclusions when one analyses the below chart.
Chart: Relationship in Sensex and INR/USD over Medium term.
Other Observations:
1.In 2008, when market fell by 60%, during the same time INR/USD depreciated by 32%.
2.Thereafter, till Nov-10, market gained by 150+% at the same time rupee appreciated by 14+%.
3.Since Nov-10, the INR/USD has depreciated by 37% however market has fallen by just 11%.
4.If one just concentrates on the graph, and believes “other things being constant”, he may conclude that index should be at a level much below the level reached in March-09.
Background:
Over the past few months, stock market participants are very nervous due to strong depreciation in INR/USD. As the rupee depreciates, worries over costly imports, Current Account Deficit (CAD), questions about the future economic growth arises. Some have opinion that India will no longer remain to be one of fastest growing economies of the world, and people everywhere opine that India will return back to “Hindu rate of growth”, implying a low growth economy.
All the nervousness gets reflected with the sharp fall in benchmark indices. But our market bounces back each time after a sharp fall to present a view that all these are not real worries, and thus the volatility persists.
Our 4QFY13 Result analysis, titled “Problem at Bottom of Pyramid” shows that currently Indian economy is actually in a dire state.
We are eagerly waiting for your short comments, you can mail us at quants.partner@yahoo.com, quants.partner@gmail.com, quants.partner@hotmail.com
About Us:
QuantsPartner.com is a website which aims to help investor and analyst by providing Excel Financial models and a 2 minute scanner of a company in PDF .
The scanner is a 6 page “chartical report”, where you will get a quick overview of the company as a whole. Once an analyst has fair idea about the company’s financial health, and he wants to undertake a detailed analysis, and share it with other, he should look for “Financial Model” (an excel file) which has all the data in a standardized form for easy n smooth working. As you tinker with basic numbers, its impact on all other numbers & ratio can be seen.
Look at Sensex in dollar terms i.e. through the eyes of the FII, as he is the one who drives the market. For him, even at same 19,000, the sensex has lost 43% due to currency (INR 42 to 60).
A very good point,ankurm which we could have totally missed.
Sengukai : So according to you the improvement in the US economy is only artificial and not real.Do you expect when sanity returns the money taken back by FII,s will return to India?
Manshu and ankurm
Please see shiv,s advice in the penultimate para of his post.He is of the opnion:
1.Indian economy will improve soon
2.Indian Govt Bond yields which had risen will fall soon
3.Yields will gradually decrease resulting in hike in Bond Price
4.So invest in Gilt and Income Funds.
For all this to happen RBI has to reduce the interest rates.The general opinion is RBI will not do this in view of heavy current account deficit and high depreciation of Re vis a vis US dollar.
I dont think Shiv,s optimism is shared by many.Dont you think the best way open is to wait and see. My only problem is what happens to large number of investors who put lot of money recently in Income/Gilt funds anticipating drop in interest rates.What should they do? Stay with the current investment or to shift it to liquid funds?
Mr ramamurthy, if you are asking Gilt funds vs liquid funds, both are for very different purpose. Depends on your time horizon. If you need safety and only need to invest for short duration, go for liquid fund. If you want to invest for longer term horizon, you should go for gsec funds. Anyways even if you gain 4-5 bps capital gains from Gilt funds, wheres the point taking the risk, if you want the money back in the short term.
Mr ankurm,I know the supposed difference between Liquid and Gilt/Income Funds.
I have with me the performance of top funds in each category.(Escorts Liquid/SBI Income/L&T Gilt) .In case of 1 month return Escorts is marginally up as compared with the other two.In case of all other periods like 3 months,1 year,3 years the other two are vastly superior.I cant put it in tabular form in this post.The data has been collected from Valueresearchonline.I am sorry,but the data I have does not support your argument that for shorter terms go in for Liquid funds.
Mr ramamurty, we can always do lookingback analysis and conclude x is better than y. The fact is that liquid funds invest in short term instruments, maturing in < 3months, hence they are good for short term fund parking, plus due to minimal duration, interest rate risk is minimal, there is no MTM. Bond funds due to long duration (5-10 years ++), have highest interest rate sensitivity, which can mean a good thing when interest rates are falling, they benefit. But there is MTM risk
Mr Ramamurthy, bond yields and bond prices have inverse relationship. Bond yields and interest rates move in same direction, as bond yield is nothing but IRR you will get if you will hold bond till maturity. Therefore, you should not invest in bond funds when yields are expected to rise, as the price of bonds will fall. When yields are rising, you should be invested in short term money market funds as their rates get reset higher due to their short term maturity.
Now whether, Indian yields and interests are expected to go up or not, I leave it for the experts to give their opinions.
Thanks for that repsonse Ankur – I was in the middle of posting that when I saw yours pop up and I was going to write the same explanation.
Does that make sense sir, and I hope that clears up your confusion. Please leave a comment or email me if you have a follow up question.
Welcome Manshu
Excuse me.Your expert opinions to a lay man like me sounds contradictory.About 3 months back you guys said RBI is likely to drop interest rates resulting in Bond yields going up .So you asked us to invest in Income and Gilt funds.We followed and invested in Income/Gilt/Dynamic Bond Funds.
Now suddenly you say RBI may NOT reduce interest rates(they may in all likelyhood raise the rate) and the yields will go up .I cant understand this. I thought interest rates and Bond yields had inverse relationship.So when the interest rates will NOT be dropped how will the yields go up.Now also you advise us to invest in Income/Gilt Funds.
I fully understand that things can go wrong.I am not blaming you for the unexpected rise in the US economy.
OK, charts and reasons why or why or not ,is a very good acedamic excercise.But I would prefer less of that and more of what the retailer should do?Please come down to earth and offer practical advise to the retail investor.I know I am asking for FREE advice.If you want to charge a fee for the advice please say so.
In a nutshell do you want to us to invest in Bond Funds when the yields are RISING or FALLING?
Hi Mr. Ramamurthy,
Investors should invest in Gilt or Income funds whenever the interest rates are expected to start falling, this was a likely scenario 3 months back and also at present. Whatever has happened in between was very swift and totally unexpected. Nobody had expected the US federal reserve to announce its plans to taper off QE. Nobody had expected the rupee and bond prices to fall with such a speed. Still, whatever we write here is just our opinion and nobody is under any obligation to follow what we write here.
We are not selling anything here on this blog. We are just giving information on financial products & services, in simplest possible language and expressing what we think. It is up to the readers whether they agree with our thoughts or not. I do give paid advice to my clients, but my opinions/views remain the same as they are expressed here, its just that paid clients get advice according to their personal circumstances, their individual/family portfolios, asset allocation and risk appetite. You are also most welcome to become my client and in that case also, my advice will remain unbiased and similar to what I write here. The decisions would be quick, balanced and as per the changing market conditions and still, I might go wrong on many of the occasions, amid many right decisions.
People follow what they read in newspapers, magazines or websites, but mostly after the events get materialised. A couple of months back, I mentioned the same thing to Mr. Arun Batra. Please check this link: http://www.onemint.com/2013/05/17/understanding-inflation-indexed-bonds/
This is what I said – “It was easy for the investors 5-7 months back to predict interest rates falling & bonds rallying, how many investors switched their money into long-term gilt funds or income funds? Now, when they have already rallied, people will start enquiring about it once the newspapers/websites have stories about their returns all over the places.”
Whatever I’ve written above in the 2nd last para, I do stand by that – “Indian govt bond yields, which had fallen down quite sharply in May, have risen with a similar intensity in June and should top out sometime this week from a short-term perspective. The investors, who are sitting on the sidelines to invest in the gilt funds or income funds to make money due to interest rate fall, should put a certain percentage of their investible surplus into these funds sometime this week itself.”
Two notable things here are – one, “short-term perspective” and the other, “a certain percentage”. I’m not 100% sure what is going to happen 3-6 months down the line and not even advising to put your 100% money in Gilt/Income funds at this point in time. Investors should do that as per their risk appetite. Higher the risk, higher is the potential return.
I myself admit that I’m sounding quite optimistic here – “Probably I am sounding too optimistic on the Indian markets than the actual picture at the ground level, but only the investors, who invest in markets in advance before they actually make a turnaround, make good money in these markets.” – and probably I turn out to be grossly wrong in 6-12 months from now. But, focus on the line of the article and that is the key.
You have this misconception – “I thought interest rates and Bond yields had inverse relationship.” It is not right. Interest rates/bond yields have inverse relationship with bond prices.
In a nutshell, I wanted to say that Investors should invest in Gilt or Income funds whenever the interest rates/bond yields are expected to start falling. I expect the bond yields, which had fallen swiftly & then risen quite sharply in the recent past, to top out sometime this week and then start falling from a short-term perspective. The investors should invest in Bond Funds when they also expect the same.
If US economy is recovering, why should US Govt bond prices fall ? (i.e. yields rise)? Is it solely because Fed would stop buying govt bonds to end QE?
In general, for an economy in recovery stage, wouldnt you expect yields to fall, as demand for sovereign bonds increases?
unless you mean, people pull money out of debt and invest in equities
Hi Ankur,
As an economy improves, people get better employment opportunities, their purchasing power improves, the market prices of goods they buy go up, inflation goes up and hence the central bank gets ready to increase the interest rate to contain too much liquidity in the system. That is why the bond yields also go up.
A large portion of the improvement in the US Economy is due to the extremely loose monetary policy. The market suspects the legitimacy of the sustenance of this improvement in the absence of QE. Hence, the fall in prices and rise in bond yields.
Nevertheless, its also a matter of supply and demand. Almost 70% of the bonds are currently being absorbed by the Fed creating artificial demand. The market is simply reacting before-hand in anticipation of what is yet to come.