Indian markets struggle in February but GDP figures prove positive.

Summary

• After a strong start to the year, Indian asset markets came back to earth with a bump in February. Mainline indices declined nearly 5% (local return), reversing gains of a similar magnitude in January. Mid/small cap stocks marginally underperformed larger caps. The IT sector performed best with financials, particularly banks, leading the declines. The Fund marginally outperformed partially recouping Januarys underperformance.
  
  
• The month ended with a host of macro data. GDP expanded 7.2% between October-December, the fastest in 5 quarters and better than expectations of 7%. The government also estimates GDP will grow 6.6% in the year to March 2018, again slightly better than estimated.
  
  
• The Nifty registered earnings growth of 13% at the finish of third quarter results, with revenue growth the strongest since 2014. Public sector banks however posted poor results due to ongoing non-performing loan (NPL) issues, a trend worsened by the revelation of a large fraud at the third largest public sector bank (Punjab National Bank).

Fund activity

The Fund had another quiet month of activity. We added to some existing positions (Interglobe Aviation and Axis Bank) and reduced our holdings of Gateway Distriparks.

We have been periodically topping up our position in Interglobe since our original purchase in November last year. The Fund has had a position in Axis Bank since launch, but we decided to top up now as we had reduced the unit size shortly after the demonetisation event in late 2016. Axis has been outperforming since late last year but more recently came under pressure from worries over the issue of NPLs afflicting most Indian banks. We think Axis is well positioned to emerge as one of the winners in the financial sector and therefore were happy to add into weakness.

We have also owned Gateway Distriparks for many years, as it is a company that is a leader in Indian logistics. After performing extremely well initially, the stock has been underperforming more recently primarily due to wider macro issues. While we are hopeful that a macro recovery will ultimately play into the strengths of the company, we are aware that new competitors are causing pricing pressures. We have therefore decided to reduce our position size, while we await further clarity.     

Following the end of the third quarter earnings results, the earnings growth of the companies in the fund underperformed the Nifty results in aggregate. On the whole the companies in the Fund reported a good set of numbers, but some exceptional charges hurt a few of our stocks. The better news is that in aggregate using consensus numbers, the Fund’s stocks are expected to post over 55% Earnings Per Share (EPS) growth for the financial year ending 31 March 2019 versus 22% for the Nifty.

Outlook

While the global economy is in the early stages of a cyclical upturn, at a headline level India’s macro outlook has somewhat worsened at the margin. Concerns have centred on rising inflation and its impact on central bank policy, whose commentary has become noticeably more hawkish. In addition the fiscal deficit has increased and the trade balance deteriorated. All these factors combined have pushed up government bond yields (also influenced by global trends) and hence India’s cost of capital.

We wouldn’t panic just yet. The fact is that India’s economy is recovering from the twin shocks of demonetisation and Goods and Services Tax (GST) implementation and is showing further growth momentum in the latest data, evident from most high frequency indicators being positive and the recovery in credit growth. Obviously the latest GDP prints also back up better growth momentum.

It would be remiss of us not to comment on potentially one of India’s biggest bank frauds. Punjab National Bank (PNB) has reported a near US$2bn fraud involving some prominent jewellers. While there is plenty more detail to emerge, it highlights the need for India’s state owned banks to be run on much more commercial lines, with adequate risk management systems. It also will play into the anti-corruption trend that has been a vote winner for the Prime Minister since his election in 2014.