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A softer than expected payroll data in the 1st week of August set the stage for significant asset market correction and pull back in sovereign yields globally. Market positioning also started to price in possibility of a 50-bps rate cut in September by the FOMC. The correction in asset prices was accentuated by potential unwinding of Yen carry trades. Over the course of the month, incremental data on a broader level in the US painted a relatively more sober assessment with data that validates a scenario of a softer landing. The FOMC chair during the much-anticipated Jackson Hole seminar also seemed to validate a reduction in policy rates in the September FOMC meeting. Asset markets broadly remained positive over the month with pullbacks post the correction in the early half.

Chart 1: Indian assets remain unaffected

EQUITY

Indian equities continued their up move in August to close the month at fresh highs. The month had started with a violent sell off in global markets due to a confluence of macro factors. On one hand, economic data from the US has started to weaken reigniting recession fears. While this comes at a time when the Fed Chair has already hinted at rate cuts, monetary easing will help the economy only with a lag. There has been a considerable drop in the US 10-year bond yields consequently, to nearly 3.8% now versus levels of 4.7% earlier this year. On the other hand, and in sharp contrast, Bank of Japan raised interest rates to 0.25% taking markets by surprise and marking an end to an era of zero interest rates. BoJ tightening at a time when Fed is nearing cuts led to a significant appreciation in the Yen against the Dollar towards 145 now versus 160+ levels from a couple of months ago.

This spooked markets on a potential reversal of the Yen carry trade. While the calm of the past couple of weeks has allowed equities to claw back their losses, dust has not settled yet as JPY continues to hold on to recent gains while US 10-year yields hold on to recent declines. Indian markets recovered too with the Nifty and the Sensex rising 1.1% and 0.8% respectively, while Nifty Midcap 150 and Nifty Small cap 250 indices rose 0.3% and 1.2% respectively during the month. While at the headline index level, equities continue to do well, there appears to be a change in the underlying market complexion. For one, breadth has started to decline, as evinced in a declining proportion of BSE500 stocks outperforming the index. As a style, Quality has started to do well with the top quintiles on quality outperforming the bottom quintiles in August. Sectorally too, Defensive sectors such as Consumer, Tech and Healthcare have started to outperform cyclical sectors such as Capital Goods, Real Estate and PSUs.

There, therefore, appears to be a defensive shift underway in the equity markets. This has been our base view for some time now. The global macro uncertainties appear to be coming at a time when Indian equity valuations have been expensive. Also, our proprietary equity sentiment measure stays elevated suggesting heightened complacency. Finally, while we stay constructive on earnings in the medium term, the near-term trajectory has been decelerating as commodity price tailwinds abate and revenue growth stays anemic. This mix we believe is ideal for a reduction in the thus-far-unabated speculative action in equity markets. We remain of the view that increasingly the market will become more discerning and move back towards companies which have strong business models, long-term earnings growth visibility and sustainable cashflows.

Chart 2: Market breadth has been narrowing in the recent upmove

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