Governments all across the world, including US and India, are all out to do everything they can (and more) to save growth. Between US and India, the difference just being that the US Fed Reserve Chairman and their Finance Secretary has to officially justify and testify what they are upto. Back home in India, we get to know about what has already been done. No questions asked. More like, no one to ask.
If we are unhappy about what is being done, we sell stocks and bonds. Quite simple. And so bonds have been bearing the brunt of these growth-saving-efforts. Government wants market to fund it another Rs.46,000crores over the next 6-8 weeks. Phew.. So much to absorb, literally. With this, the total amount of auctions has reached Rs.231,000crs (gross) for the current fiscal. Out of these, banks alone have bought Rs.164,000crs. Add the demand from insurance companies, primary dealers and mutual funds, fact is the supply might be short of the requirement!
Last few weeks, the yields have been surging, prices dropping. Does it hit my stop-loss as a bond buyer? Not really. I would look to add more. Underlying bullish trend still remains firm, the rally just being postponed for the time being.
Let's see why. Excessive supply of bonds is negative for the market in two ways. Firstly, the liquidity angle. Supply of bonds equals absorption of system liquidity. But only temporarily. Government is borrowing BECAUSE it wants to spend. So money has to flow back sooner rather than later. Also, if there is even a short term liquidity mismatch, RBI will step in swiftly to infuse money by buying more MSS bonds or cutting CRR or if need be, both.
Coming to the second impact, that of higher supply of bonds due to auctions. That is, demand being equal higher supply can be absorbed only by reducing prices. If you look beyond the obvious, the long and short of it is that MSS bonds are being replaced by Non-MSS bonds in the investors' portfolio. There is no NET increase in the stock of bonds available really. That is why buyers won't really feel the weight of auctions in these times.
To put numbers into this statement, the total amount of MSS bonds bought back during Oct. 2008 till date is Rs.65,040 crs. Total auctions during the same period was Rs.86,230 crores. Redemptions during the period was Rs.11,450crs. The net increase in outstanding bonds in the market, hence, is only Rs.9,740crs. During the same period, the net accretion to banking system's deposits was Rs.187,940crs. Incremental SLR demand on this comes to Rs.45,105crs. Now, compare 45,105 with 9,740 and you will know why the yields are so lower than what they were in October 2008. The demand side from other generic buyers apart from banks have not been considered in my calculations. (For basic readers of this blog, hope the math is not very confusing)
Point is, me thinks this situation will continue. Meaning, the pain of incremental supply is not really a lot. Look at the armory with the RBI. CRR is at 5%, can be cut to 3% without any hitch. That's about Rs.72,000crs of liquidity. Outstanding MSS is Rs.108,764crs. Add both, and there's a lot of money to be released if need be. Don't forget, we are already sitting on a surplus liquidity of Rs.43,000crs approx.
Now, if interest rates still have to come down by 150-200bps over the next few months (my views expressed in earlier posts still hold good), yields can only go one way - DOWN. And so, I'll look to buy more gilts through my favorite ICICI Pru Gilt Fund.
Showing posts with label Gilts. Show all posts
Showing posts with label Gilts. Show all posts
February 11, 2009
January 13, 2009
An entry point for getting into bonds
Last few months have been extremely conducive for traders, including day traders and jobbers. Not just in equities, but even in currencies and commodities. With the introduction of currency futures in September 2008, punting in that space have become fairly convenient too. However as a retail trader, bonds are still inaccesible to me for direct trading. Ironically, my best trading views and most of my high conviction ideas are in that space. Anyways, trading in equity derivatives and currencies have been fun and excitingly profitable. I am not a commodities person. As of now!
Whilst I am incapable of trading in bonds directly due to logistical issues including big lot sizes, I can translate my views into money through open-ended gilt schemes. I have been bullish on bonds since September 2008. We have already seen a super-rally in bonds. The benchmark 10-year yield has eased from 9.50%+ levels to sub-5.25% levels over the last 3-4 months. Despite that, there is still some juice left in bonds, more so on a relative basis vis-a-vis equities. The 10-year yield is currently trading close to 5.70% level. The market witnessed a huge bout of correction and profit-booking during the first few trading sessions of 2009 till yesterday. The primary trigger for the sell-off was the Rs.50,000 crores fresh borrowing announced by the government for the last three months of the current fiscal. That, and the fact that we had rallied a lot (and pre-maturely perhaps), resulted in a correction of a good 90bps over the last one week. 1% change in yield of 10-year government bond is equivalent to approximately 7.10% change in the bond price.
Where do we stand now? Let us look at the negatives first. Firstly, higher supply is pain for bonds. Secondly, the generic demand in the form of SLR might be moderating with lower deposit growth. Bank deposits are growing at 21% for few fortnights now, lower than the 25%+ that we have seen last year.
Among the positives:
The biggest driver will be falling inflation. With fuel prices expected to be cut again in a couple of weeks, we could see inflation falling more starkly. At a time when the policy makers are trying to revive growth, real interest rates cannot be higher than 2%-3%. Year-on-year price change will soon be negative. So, we will see the overnight Reverse Repo rates and CRR cut by at least 75bps-100bps pretty soon. Liquidity remaning in the positive regime and call rates at sub-4%, 10-year yield cannot stay at these levels for very long. The 10-year over call rate spread should be at a high of 50bps-75bps at the peak of the markets. So if call rates do trade at 3.5%, 10-year yield can surely see the sub-4.50% levels.
Corporate results and industrial/manufacturing growth has few more quarters before showing signs of strength.
Net net, there exists not many reasons to keep yields high. At current levels, one could buy bonds and expect atleast 10% returns in a time-frame of 4-6 months, conservatively. That's 20% per annum! Not bad at all.
About my portfolio: I have invested in the ICICI Pru Gilt Fund - Investment Plan. With an average maturity of 16.66 years, modified duration of 9.15 years and backed by a decent corpus of 716crs (as on 31st Dec. 2008 - sourced from their fact sheet), it is perhaps the best bet for the above-mentioned view.
Happy investing!
Whilst I am incapable of trading in bonds directly due to logistical issues including big lot sizes, I can translate my views into money through open-ended gilt schemes. I have been bullish on bonds since September 2008. We have already seen a super-rally in bonds. The benchmark 10-year yield has eased from 9.50%+ levels to sub-5.25% levels over the last 3-4 months. Despite that, there is still some juice left in bonds, more so on a relative basis vis-a-vis equities. The 10-year yield is currently trading close to 5.70% level. The market witnessed a huge bout of correction and profit-booking during the first few trading sessions of 2009 till yesterday. The primary trigger for the sell-off was the Rs.50,000 crores fresh borrowing announced by the government for the last three months of the current fiscal. That, and the fact that we had rallied a lot (and pre-maturely perhaps), resulted in a correction of a good 90bps over the last one week. 1% change in yield of 10-year government bond is equivalent to approximately 7.10% change in the bond price.
Where do we stand now? Let us look at the negatives first. Firstly, higher supply is pain for bonds. Secondly, the generic demand in the form of SLR might be moderating with lower deposit growth. Bank deposits are growing at 21% for few fortnights now, lower than the 25%+ that we have seen last year.
Among the positives:
The biggest driver will be falling inflation. With fuel prices expected to be cut again in a couple of weeks, we could see inflation falling more starkly. At a time when the policy makers are trying to revive growth, real interest rates cannot be higher than 2%-3%. Year-on-year price change will soon be negative. So, we will see the overnight Reverse Repo rates and CRR cut by at least 75bps-100bps pretty soon. Liquidity remaning in the positive regime and call rates at sub-4%, 10-year yield cannot stay at these levels for very long. The 10-year over call rate spread should be at a high of 50bps-75bps at the peak of the markets. So if call rates do trade at 3.5%, 10-year yield can surely see the sub-4.50% levels.
Corporate results and industrial/manufacturing growth has few more quarters before showing signs of strength.
Net net, there exists not many reasons to keep yields high. At current levels, one could buy bonds and expect atleast 10% returns in a time-frame of 4-6 months, conservatively. That's 20% per annum! Not bad at all.
About my portfolio: I have invested in the ICICI Pru Gilt Fund - Investment Plan. With an average maturity of 16.66 years, modified duration of 9.15 years and backed by a decent corpus of 716crs (as on 31st Dec. 2008 - sourced from their fact sheet), it is perhaps the best bet for the above-mentioned view.
Happy investing!
January 02, 2009
Stimulus package: Version 2
Barely a couple of days after I wrote that I see more rate cuts coming from the RBI, we get 100bps cut each in Reverse Repo and Repo rate, coupled with a 50bps cut in Cash Reserve Ratio. These rates stand at 4%, 5.5% and 5% respectively.
The government, from its side, has announced a number of measures as a part of its second and more importantly, last package for this fiscal. You can read the details here. With national elections expected to be held during May/June 2009, I do not expect any more fiscal measures effectively before the end of June 2009. Plus, if there is a change in government, the new team will take few more months to take any concrete actions. My fear is, by that time the damage in the economy would have been done.
Barring few specific measures like cuts in excise duties, nothing else in the fiscal package looks likely to impact the economy positively enough. With the demand side of the equation almost in a standstill in key sectors, a lot of these measures merely gives the producer class some breathing space before the inevitable happens. And that is cut in production and prices leading to cut in shops and reduction in worforce. We have already seen this in few sectors. More will come our way this year.
The fiscal package includes some shockers. Increasing the FII limit for investments in corporate bonds! Are we kidding? Considering what the spreads have been for Indian corporate papers in Euro markets, I find it improbable that they will absorb similar issuances in Indian soil. Similarly, raising the ECB interest ceiling for select integrated township developers also seems a blunt measure.
Am I, as a consumer, going to spend more based on this fiscal package? No. And that is the problem.
I am glad that the monetary measures have come again. The rate cuts I expected have come a little earlier than my sense of timing. That leads me to believe that we have to see more. At least 50bps more on all the three key rates before the end of this fiscal. Of course, considering what already has been seen, further 50bps is just nominal. But it makes a lot of difference for bond yields. 10-year yield falling below 5% on Monday is a given. 4.50% is the next level I would be watching, but not quite soon. Higher spending means higher borrowing. The supply side for bonds will temper the rally to some extent. Yet, do not expect anything to prevent 4.50% to be traded over the next few weeks.
What next? Expect a series of rate cuts by banks. Deposit rates first, followed by lending rates. They would hope that the consumers will return to borrow soon. I have my doubts. When your job is in danger, you don't think of adding a liability (for an asset) to your personal balance sheet, do you?. Sentiment is the key here too, like in markets. It takes a lot to convince a terror victim that the world is a very safe place!
The government, from its side, has announced a number of measures as a part of its second and more importantly, last package for this fiscal. You can read the details here. With national elections expected to be held during May/June 2009, I do not expect any more fiscal measures effectively before the end of June 2009. Plus, if there is a change in government, the new team will take few more months to take any concrete actions. My fear is, by that time the damage in the economy would have been done.
Barring few specific measures like cuts in excise duties, nothing else in the fiscal package looks likely to impact the economy positively enough. With the demand side of the equation almost in a standstill in key sectors, a lot of these measures merely gives the producer class some breathing space before the inevitable happens. And that is cut in production and prices leading to cut in shops and reduction in worforce. We have already seen this in few sectors. More will come our way this year.
The fiscal package includes some shockers. Increasing the FII limit for investments in corporate bonds! Are we kidding? Considering what the spreads have been for Indian corporate papers in Euro markets, I find it improbable that they will absorb similar issuances in Indian soil. Similarly, raising the ECB interest ceiling for select integrated township developers also seems a blunt measure.
Am I, as a consumer, going to spend more based on this fiscal package? No. And that is the problem.
I am glad that the monetary measures have come again. The rate cuts I expected have come a little earlier than my sense of timing. That leads me to believe that we have to see more. At least 50bps more on all the three key rates before the end of this fiscal. Of course, considering what already has been seen, further 50bps is just nominal. But it makes a lot of difference for bond yields. 10-year yield falling below 5% on Monday is a given. 4.50% is the next level I would be watching, but not quite soon. Higher spending means higher borrowing. The supply side for bonds will temper the rally to some extent. Yet, do not expect anything to prevent 4.50% to be traded over the next few weeks.
What next? Expect a series of rate cuts by banks. Deposit rates first, followed by lending rates. They would hope that the consumers will return to borrow soon. I have my doubts. When your job is in danger, you don't think of adding a liability (for an asset) to your personal balance sheet, do you?. Sentiment is the key here too, like in markets. It takes a lot to convince a terror victim that the world is a very safe place!
December 31, 2008
What's in store for 2009?
2008 was a disastrous year for all asset classes, except bonds for the last few months of the year. Gold managed to do well too. Most of us in the market saw a different face of the markets relative to the last few years. Even the seasoned players have learnt a lesson or two from the events in the global markets. Risks got re-defined and 10% per annum seemed astronomical returns. The rate at which entities went belly-up was shocking. 50%-90% fall in stock prices were still digestable, but banks and financial powerhouses turning into hollow structures was the most shocking event of the year for me. Short-term US bills trading with negative yields was a revelation too!
One of the key drivers behind the mega-bull rally that the Indian markets witnessed during the period 2004 to 2007 was global liquidity. With global interest rates at significantly low levels, a glut of liquidity found its way into attractive avenues, including Indian equity markets owing to extremely robust economic shape of the country and sustained corporate earnings growth.
As we entered 2008, global interest rates had almost peaked with commodity and oil driven inflation being the primary reason pushing up rates. Also, the sub-prime crisis dried up otherwise liquid corporate bonds and MBS/ABS markets. Liquidity starved and risk averse investors resorted to 'flight to safety' by shifting their investors from equities to gold and US treasuries. The music had stopped! The selling pressure intensified with each episode of bankruptcy in the financial industry in US, UK and other major economies.
Within the domestic economy too, growth momentum clearly had started to slow down significantly. Indicators like IIP, GDP and credit growth had peaked in 2007 and investors started pricing in a slowdown in corporate earnings also. Resultantly, equity markets, with PEs at historically high levels, started to contract taking down the prices. Sentiment related factors also played its part as investors went from an extreme of greed to fear between the beginning and end of the year.
So what should we expect heading into 2009? Here are my thoughts:
1. Barring the first few months (till April/May 2009), volatility will die down significantly. One of the most important features that marked 2008 was high vols. 2009 will be a stark difference to 2008, at least in this respect.
2. Corporate earnings will shock us on the negative side. A large section of the market believes that most of the bad news is already in the price. I beg to differ. With interest rate cuts not yet passed on to the real system, the light at the end of the tunnel is still far-off. Q4CY08 to Q3CY09 will throw up results that will make Sensex at 9000-levels look rich.
3. Globally too, data releases and sentiment has a reasonably long way to keep falling before it picks up for the better. I do not expect the global investor community to consider India very seriously again before mid-2009. Fresh selling might halt soon, but buying might not resume soon.
4. Expect RBI to continue dropping interest rates even lower. From the current level of 5% for the benchmark Reverse Repo rate, I see room for atleast 100bps easing. With industrial production and exports looking to fall in the negative territory soon and inflation to fall into the sub-5% zone, RBI can focus completely on supporting the ailing growth. The interest rate differential between India and US in the growth cycle has been about 3%. I see no reason why it cannot be at similar levels in the slowdown phase. Growth in both the economies look to correct by about 4%-5%, which is not starkly different. So with US officially adopting Zero Interest Rate Policy (ZIRP), India's benchmark rate will possible settle at 3.5%-4% levels and that should happen before April 2009.
What are the implications from an investment perpective, if the above holds true? Firstly, one can afford to stay away from equities for few more months. By that I mean you might not miss a mega rally by not investing now and investing after April 2009. I would want to put money into gilts. Gilts, not corporate bonds-linked income funds, mind you. I do not see any major value in corporate bonds irrespective of what the AAA and AA spread indicates. Gilts looks good to deliver an absolute 5%-8% returns over the next few months. Post that, money can move into equities. An aggressive investor could look to allocate 75% to gilts and 25% to equities. Within equities, banking, FMCG, pharma and capital goods segments are the sectors that looks good to me for the next couple of years.
Wish you and your loved ones a rocking New Year.
Happy investing.
One of the key drivers behind the mega-bull rally that the Indian markets witnessed during the period 2004 to 2007 was global liquidity. With global interest rates at significantly low levels, a glut of liquidity found its way into attractive avenues, including Indian equity markets owing to extremely robust economic shape of the country and sustained corporate earnings growth.
As we entered 2008, global interest rates had almost peaked with commodity and oil driven inflation being the primary reason pushing up rates. Also, the sub-prime crisis dried up otherwise liquid corporate bonds and MBS/ABS markets. Liquidity starved and risk averse investors resorted to 'flight to safety' by shifting their investors from equities to gold and US treasuries. The music had stopped! The selling pressure intensified with each episode of bankruptcy in the financial industry in US, UK and other major economies.
Within the domestic economy too, growth momentum clearly had started to slow down significantly. Indicators like IIP, GDP and credit growth had peaked in 2007 and investors started pricing in a slowdown in corporate earnings also. Resultantly, equity markets, with PEs at historically high levels, started to contract taking down the prices. Sentiment related factors also played its part as investors went from an extreme of greed to fear between the beginning and end of the year.
So what should we expect heading into 2009? Here are my thoughts:
1. Barring the first few months (till April/May 2009), volatility will die down significantly. One of the most important features that marked 2008 was high vols. 2009 will be a stark difference to 2008, at least in this respect.
2. Corporate earnings will shock us on the negative side. A large section of the market believes that most of the bad news is already in the price. I beg to differ. With interest rate cuts not yet passed on to the real system, the light at the end of the tunnel is still far-off. Q4CY08 to Q3CY09 will throw up results that will make Sensex at 9000-levels look rich.
3. Globally too, data releases and sentiment has a reasonably long way to keep falling before it picks up for the better. I do not expect the global investor community to consider India very seriously again before mid-2009. Fresh selling might halt soon, but buying might not resume soon.
4. Expect RBI to continue dropping interest rates even lower. From the current level of 5% for the benchmark Reverse Repo rate, I see room for atleast 100bps easing. With industrial production and exports looking to fall in the negative territory soon and inflation to fall into the sub-5% zone, RBI can focus completely on supporting the ailing growth. The interest rate differential between India and US in the growth cycle has been about 3%. I see no reason why it cannot be at similar levels in the slowdown phase. Growth in both the economies look to correct by about 4%-5%, which is not starkly different. So with US officially adopting Zero Interest Rate Policy (ZIRP), India's benchmark rate will possible settle at 3.5%-4% levels and that should happen before April 2009.
What are the implications from an investment perpective, if the above holds true? Firstly, one can afford to stay away from equities for few more months. By that I mean you might not miss a mega rally by not investing now and investing after April 2009. I would want to put money into gilts. Gilts, not corporate bonds-linked income funds, mind you. I do not see any major value in corporate bonds irrespective of what the AAA and AA spread indicates. Gilts looks good to deliver an absolute 5%-8% returns over the next few months. Post that, money can move into equities. An aggressive investor could look to allocate 75% to gilts and 25% to equities. Within equities, banking, FMCG, pharma and capital goods segments are the sectors that looks good to me for the next couple of years.
Wish you and your loved ones a rocking New Year.
Happy investing.
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