The Indian stock markets were among the best performing in the world in 2012 with a complete roller coaster ride. Beginning the year with a lot of pessimism, pre-budget expectations attracted lots of flows and a market rally, which eventually fizzled out due to onerous issues like GAAR and poor fiscal discipline. The economy started dwindling, with GDP growth slowing down to 5.1%, current account deficit (CAD) rising to in the high 3% region, rupee touching all time low, inflation refusing to come down. The government almost appeared to have paralyses and country rating downgrades was becoming imminent threat. With the changes in the government and its resolve to get the growth back, market hopes have surfaced again of an economic revival. This has again led to a market rally and fund flows.
The year has been one the best performing for the Indian market with approximately 30% return and also one of the best years in terms of FII flows ($20 bn). One the biggest reasons for such large flows and sudden change in the sentiment is the structural story of India. Most other emerging markets (EM) are struggling with many structural problems, China has a problem of growth and political transition, Brazil and Russia are largely commodity driven economies. Developed markets are dealing with their own problems. India is the only market of this size, other than Indonesia, which has a structural story in place. Hence, India was one of the largest beneficiary of EM allocation in 2012.
With the change of guard at the finance ministry, things began to stabilise. Over the last few months, government has initiated a slew of politically difficult measures both to turn around the business and market sentiments as well as helping the real economy. These included a hike in fuel prices to contain fiscal slippages, liberalising capital account to improve the BoP situation, making progress on SEB debt restructuring and coal prices pooling, moving to hike the FDI limit in multi-brand retail and very recently introducing direct cash transfers for government welfare schemes as well as passing of the Banking Bill in the Lok Sabha.
This approach of the government, which seems to have decided to get the economy back on track before federal election, sets the tone for 2013. Global environment appears to be by and large stable with an easy monetary policy stance. Key drivers of the markets next year would be local factors and initiative taken by government to begin the investment cycle, to restore the confidence back in economy, to control fiscal deficit and some of the structural reforms.
While markets have cheered the initial overtures of the government, the continuation of its performance will clearly depend on what the government is able to do on issues like GST reforms, power sector, inflation and FDI flows.
Admittedly there are still several lingering issues in sectors like power, mining etc that will continue to be a drag on the economy. But contrary to a lot of predictions, we believe that the last budget before the general elections would not be a populist one, but one firmly fixated on boosting growth. The ruling party seems to have realised that good economics is also good politics. This was evident from the Congress leaderships unstinting support during the struggle to get the retail bill passed in Parliament.
With the Reserve Bank set to cut interest rates next year, directionally it should help to improve corporate bottom line and hopefully have impact on the investment cycle. Interest rate coming down with policy clarity could be a killer combination for boosting investment, the former is almost certain but not the latter. We need to see what happens there.
On the corporate earnings side, the pace of downgrades has slowed substantially and valuations are not rich, especially in view of the fact that Indias relative growth prospects are still attractive. These factors will be supportive of capital flows in the coming year. We foresee continued flows from hedge funds as the government reforms come on track and the economic outlook improves.
However, the large current account deficit is a very big threat to India. Any reversal of flows for either global or local reasons can put serious stress on Indias forex reserves. We currently have reserves to pay our import bills only for six months. This is precarious and a very bad risk looming on us.
Markets currently are set to perform well atleast in the first part of the year. The key will be to see how the government reacts as we come closer to the general elections. It is quite possible that towards the end of the year, populism could re-surface. Till then we should enjoy the mini-bull market.
The author is president & co-headWholesale Capital Markets, Edelweiss Financial Services Ltd
Ride the changing tides
Renewed investor confidence has led equity markets to gain a steady momentum in the last couple of months. The Sensex has reached a high of over 19,600 in 2012, which is just about 8% short of its record high. Despite weak macroeconomic indicators, the Sensex has clocked about 23% gains year-to-date. So going ahead, with sentiments progressively improving in the economy and amongst foreign investors, I believe the markets are likely to touch an all-time high in the next six-nine months.
The outlook for global as well as domestic growth in 2013 is gradually improving. Global liquidity flows are expected to remain robust since central banks, particularly in advanced economies, are committed to liquidity infusion to revive growth in their economies. With greater liquidity in the financial system, global investors appetite for high-yielding risky assets has improved and in this context Indian equities are better placed to benefit than its emerging market peers.
Already the Indian equity markets have outperformed, with more than 13% gains since September 2012 compared to 9% gains witnessed in the broader emerging markets. FIIs have also pumped in more than $20 billion in the equity markets in 2012 and with further reform measures on the anvil robust capital inflows in the economy are expected to continue well into 2013.
The renewed push to reform measures by the government has boosted market sentiments. The reform momentum is likely to continue in the coming months right up to the budget session, with a wide slate of legislation like land acquisition, GST, DTC, etc. coming up for consideration or implementation. With credible progress on fiscal consolidation and peaking out of inflation, the RBI is likely to get some elbow room to ease rates and that should augur favourably for stocks in cyclical sectors. What is more pertinent at this juncture though is not only the reduction in policy rates but also giving a heads-up to the investment cycle and alleviating supply constraints, and here the role of the Cabinet Committee on Investment would be important. Also, the government needs to provide stimulus measures for the export sectors as decline in exports is another reason why the overall GDP growth rate has come down.
Broadly, there are opportunities in both defensives as well as interest sensitives. In the defensive space I have a preference for growth at a reasonable value, and in cyclicals I prefer those with a healthy margin of safety. Amongst defensives, the IT sector looks the best and pharma to some extent. Within IT, I prefer a top-down approach where the large caps are likely to do better. I believe the IT sector can record at least 8-10% dollar growth, and expecting about 4-5% currency depreciation, overall IT companies should be able to deliver at least 14-15% earnings growth, which is quite decent.
Although pharma stocks are expensive at 17-18 PE, they are expected to continue delivering 18-20% growth. FMCG stocks are a tad expensive, but a 25-27 PE valuation is justified for these stocks, so a 5-10% correction can make them a decent buy.
In cyclicals, Im overall bullish on interest sensitive sectors. In the banking space, private sector banks have been a favourite. Also, I expect interest rates on retail loans to be lower by about 100 basis points, so that is one positive catalyst on the near-term horizon, especially for four-wheeler automobile companies. Quality stocks in the cap good space remain a decent bet, though one may need a longer investment horizon for this space.
Overall, in terms of earnings downgrades the worst is over and things will get better going ahead. Valuations are close to their long-term average but given the current scenario, there are still a lot of quality stocks for investors with a reasonable time horizon.
Ultimately investors should remember that successful investing is not about identifying and following the trend but identifying when a change in the trend is about to happen. Markets have not done well for almost four-five years, because no one had expected that from a 9% GDP growth we would decelerate to just about 5-5.5% and the markets had to go through this painful process of recalibrating expectations downwards. But, going forward, with a 6-6.5% GDP growth and corresponding 14-15% earnings growth, our markets should give consistent returns in line with earnings growth. Indian markets look headed for a positive future outlook and I believe it is a great time to start investing for retail investors.
The author is chairman & managing director, Angel Broking