We looked at the three episodes in 2012, 2013, and 2014 where the rupee was depreciating. The Nifty50 and large-caps managed reasonably well, exiting each episode with a less than 10 percent loss or small gains
While GDP of 8.2 percent will grab headlines, it’s a rearview number. What’s more important in our view is that the rupee has made a clear break out to an all-time low versus the dollar and is one of the worse performing currencies this year.
The follow-up questions are 1) How have equities performed during periods of a depreciating rupee, and 2) what sectors outperformed and underperformed during these periods?
Mid and smallcaps look particularly vulnerable in depreciating currency scenarios:
We looked at the three episodes in 2012, 2013, and 2014 where the rupee was depreciating. The Nifty50 and largecaps managed reasonably well, exiting each episode with a less than 10 percent loss or small gains.
Midcaps had significant and painful sell-offs in 2011 and 2013, but attractive gains in 2014. While definitive statements can’t be made because each cycle is different, clearly this suggests caution with respect to mid and small-cap exposure until currency depreciation stabilizes.
Sectoral Preferences clearly favour IT, FMCG, Pharma and Reliance Industries (Energy):
IT and Pharma clearly benefit from a depreciating rupee. FMCG benefits due to the inelasticity of demand for fast moving goods, and the ability of most FMCG companies to pass on price rises.
Year-to-date (YTD), these are in fact the sectors that are outperforming, along with energy. With respect to energy’s surprising outperformance, one needs look no further than Reliance’s 60 percent weight in the index.
We were early proponents of structural benefits from reforms coming through at a lag. The thesis seems to be playing out. We’ve also been bullish on equities for a few months now, after being bearish late last year into early this year.
With a 1,000-point rally in the Nifty50, it’s a good time to reassess where things stand.
Global and macro concerns are worth monitoring, in particular, the depreciating currency and the potential for a rise in crude. EM outflows, Fed balance sheet contraction, Fed rate hikes remain headwinds.
Demand for crude remains strong, alongside production declines in Iran and Venezuela, and Permean basin woes on water and infrastructure, as well as late cycle global commodity dynamics.
Weak currency policy a concern:
Recent data suggests the RBI stayed on the sidelines, while the rupee depreciated suggests that a strategy of maintaining export competitiveness vis-a-vis other emerging markets could impact domestic growth prospects.
Not only does a weaker currency decimate FI returns, it creates a vicious cycle of further selling and dissuades FIs from investing in India, while importing inflation. A double whammy of crude and currency can be a worrisome combination.
Already, however, we are witnessing the highest ever diesel prices. Financial debt has recently risen in domestic consumer balance sheets, and the potential to further weaken domestic disposable income remains.
Should crude rise or the currency weaken further, consumer disposable income will get impacted by rising EMIs, fuel prices, inflation and rate hikes.
Good earnings this quarter have already raised expectations for the current quarter and beyond. The key to all this may be whether strong domestic flows are structural in nature or taper off at some point.
As long as domestic flows remain strong, it’s entirely possible that we get through the currency weakness and crude risks. However, should crude or the currency worsen further, the RBI will likely be forced to raise rates later this year.Disclaimer: The author is Chief Investment Officer, Sanctum Wealth Management. The views and investment tips expressed by investment experts on Moneycontrol are their own, and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.