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Market Review WEEK ENDED OCTOBER 29, 2010 International Global equity markets exhibited divergent trends amidst mixed economic and earnings newsflow. The MSCI AC World index was almost unchanged during the week as declines in Japan and UK offset gains in the US & Latin America. For the month as a whole the index was up 3.53% and China was the top gainer with doubledigit returns. Global economic reports indicate slowdown in the pace of growth in industry and broad economy, across many countries. All eyes are now on the US with speculation about the quantum of easing to be announced by the Federal Reserve and mid-term elections. Global treasury yields rose on expectations the asset purchases will fuel inflation. Rise in precious metals helped commodities post strong gains – the Reuters Jefferies CRB was up 1.16% for the week and 4.82% for the month.The US dollar index eased further against a basket of currencies. • Asia-Pacific: Regional markets trended lower led by declines in Japan and Hong Kong. Japanese economic data was lacklustre – consumer prices continued to dip and industrial production fell. However, exports remained on an upward trend due in part to demand from Asian economies. Bank of Japan said it will buy back ¥5000 worth of bonds, including corporate debt with lower credit ratings than it previously purchased. South Korea GDP grew by 0.7%qoq on the back of robust expansion in private consumption and construction. However, slowdown in exports led the pace of growth to decelerate from 1.4% seen last quarter. Taiwan reported slowdown in industrial production, partly due to impact from typhoon. Bank Indonesia and Bank of Korea are reportedly evaluating options for regulating capital inflows that have caused sharp rise in domestic currencies against the dollar. • Europe: Mining stocks dragged UK markets lower by over 1% while Germany posted marginal declines as relatively better economic data helped sentiment. Eurozone economic data was mixed – unemployment rate inched higher to 10.1% from 10% and inflation rate accelerated to 1.9%. Industrial orders for August were higher than expectations. German Gfk consumer confidence index was unchanged over last month levels. Swedish central bank hiked rates by 25 bps to 1% and said it is likely to remain on hold in the near future. Russia left refinancing rates unchanged at 7.75%. Sovereign debt issues in EU periphery came under pressure due to developments in Ireland and Greece. UK economic growth came in ahead of market expectations - GDP rose by 0.8% in the third quarter helped by increased construction activity. On the M&A front, LVMH bought 17.1% stake in Hermes International for about $2 bln. • Americas: US indices closed the week on a mixed note. Tech stocks firmed up on the back of good earnings reports from majors such as Microsoft. US GDP growth accelerated to 2%qoq primarily on the back of positive contributions from personal consumption. Consumer confidence index improved slightly, demand for commercial aircraft pushed up durable goods orders index and new home sales bounced back from lows. Goldman Sachs sold $1.3 bln of 50-year bonds. Canada’s GDP growth bounced back in August (up 0.3% mom) after the July decline. Elsewhere in the region, Brazil announced it had discovered oil in a deep-water field known as Libra, which could yield up to 15 billion barrels. Weekly change (%) Weekly change (%) MSCI AC World Index -0.04 Xetra DAX -0.07 FTSE Eurotop 100 -0.12 CAC 40 -0.91 MSCI AC Asia Pacific -0.42 FTSE 100 -1.15 Dow Jones -0.13 Hang Seng -1.79 Nasdaq 1.13 Nikkei -2.38 S&P 500 0.02 KOSPI -0.76 Equity Markets - India Indian equities slid lower this week on global cues and mixed corporate earnings reports. This led frontline indices to close in the negative territory for the month as a whole, underperforming global counterparts. Mid and small cap stocks underperformed large cap stocks this week, narrowing their outperformance for the month as a whole. During the week consumer durables and auto stocks emerged top gainers while real estate and power indices posted large declines. FII flows into equity markets were to the tune of $310.4 mln in the first four trading days of the week. Data indicates inflows for the month were close to $5.3 bln in October and aggregate $24.6 bln for the calendar year to date. Net FII inflow Source: SEBI, CEIC, CLSA Asia-Pacific Markets The recent surge in FII inflows (into equity as well as debt markets) can help ease concerns on the BoP front and policymakers appear comfortable with the current trend in flows. Markets will closely watch moves from central banks in India and the US closely next week for further direction. • Macro/ Policy: The six core infrastructure industries index growth moderated further in September to 2.5%yoy compared with a 4.3%yoy growth last month. Drop in production of petro-products and coal weighed on overall performance. In contrast, crude petroleum and finished steel sectors registered acceleration. With a view to check misuse of preferential share or warrant allotments by companies to promoters, SEBI has tightened the framework for preferential allotment of shares. As per the new rules, the promoter/ promoter group would be ineligible for preferential allotment in case it has previously subscribed but failed to exercise warrants last year or has sold shares in previous six months. SEBI also relaxed restrictions on the maximum application size for retail individual investors to Rs 2 lakh from Rs. 1 lakh across all public issues. Weekly change (%) BSE Sensex -0.66 CNX Nifty -0.80 S&P CNX 500 -0.91 CNX Midcap -0.95 BSE Smallcap -1.18 Debt Markets - India Indian treasury yields trended lower towards the close of week helped by RBI’s temporary liquidity measures and weak growth in the infrastructure index..The IPO-related strain on liquidity and seasonal tightness pushed up money market rates sharply. • Market movements: Yields on the 10-year benchmark bond eased by 1 bp while those on the 5-year paper increased 5 bps.Yields on 5-year corporate bonds were slightly up and consequently spreads over gilts reduced to 78 bps.Yield on the 1-year paper closed down 2 bps while those on the 30-year paper moved up 2 bps.As a result, the yield curve steepened and spreads between long and short end of the curve expanded to 161 bps. • Liquidity/borrowings: Call rates moved up to 12% during the week but RBI measures helped rates close down at around 6.5% levels. Demand for liquidity under the RBI’s LAF window averaged close to Rs. 97,000 crores as against Rs. 68,476 crores last week. Earlier in the week, RBI’s bond buyback programme met with limited success – investors offered bonds of face value Rs 3,173.79 crorse and bids were accepted for Rs 2,148.29 crores. RBI introduced additional liquidity support measures including a special second LAF for two days and a special repo auction (will allow banks to temporarily hold 1% lower SLR). • Forex: The rupee rebounded against the US dollar and closed the week up 0.4%. For the month as a whole, the rupee stood up 1.1% against the greenback. India’s forex reserves fell by $1.03 bln over last week levels and stood at $295.4 bln (as of Oct 22). • Macro: Latest data from RBI indicates credit growth has remained steady at 20% while deposit growth has picked up slightly to 15% (as of October 8). On the economic front, industrial and export data has softened in recent months and there are some signs of easing in headline inflation levels, but there hasn’t been a meaningful dip. Robust economic growth, growing income levels and global commodity prices are contributing to the pressure. RBI is scheduled to meet on Tuesday for the next review of its monetary policy and is likely to be shaped by the tight liquidity conditions, inflation levels and the strong capital flows.The latter are being led by the attractiveness of the India story and also increase in ECBs due to the widening interest rate differential.The central bank needs to balance between the inflationary impact of any sterilisation, import costs and India’s export competitiveness.The ongoing liquidity crunch could provide some room for sterilization and the expected second round of quantitative easing in the developed world needs to be taken into consideration as well. Hence, the monetary policy direction and guidance will provide an insight into RBI’s views on this multitude of factors. 29.10.2010 22.10.2010 Exchange rate (Rs./$) 44.43 44.59 Average repos (Rs. Cr) 97,021 68,476 1-yr gilt yield (%) 6.88 6.91 5-yr gilt yield (%) 7.84 7.79 10-yr gilt yield (%) 8.13 8.14 Source: Bloomberg, RBI, Reuters The information contained in this commentary is not a complete presentation of every material fact regarding any industry, security or the fund and is neither an offer for units nor an invitation to invest.This communication is meant for use by the recipient and not for circulation/reproduction without prior approval.The views expressed by the portfolio managers are based on current market conditions and information available to them and do not constitute investment advice. Risk Factors:All investments in mutual funds and securities are subject to market risks and the NAVs of the schemes may go up or down depending upon the factors and forces affecting the securities market.The past performance of the mutual funds managed by the Franklin Templeton Group and its affiliates is not necessarily indicative of future performance of the schemes. Please refer to the Scheme Information Document carefully before investing. Statutory Details: Franklin Templeton Mutual Fund in India has been set up as a trust by Templeton International Inc. (liability restricted to the seed corpus of Rs.1 lac) with Franklin Templeton Trustee Services Pvt. Ltd. as the trustee (Trustee under the Indian Trust Act 1882) and with Franklin Templeton Asset Management (India) Pvt. Ltd. as the Investment Manager. Copyright © 2010. Franklin Templeton Investments. All rights reserved