Good time to build up a portfolio of quality stocks

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SummaryWe are cautiously optimistic on the equity markets ahead and believe that it is a good time to build a portfolio of quality stocks with a medium term perspective.

Real GDP growth of 5-6% and inflation of 5-7% should support early double-digit earnings growth for benchmark indices

We are cautiously optimistic on the equity markets ahead and believe that it is a good time to build a portfolio of quality stocks with a medium term perspective. The equity markets have suffered over various issues— domestic and global—in the past two years. But the negative spiral of multiple issues on the domestic front— namely sticky inflation, high-borrowing rates, policy and administrative inaction/logjam, fiscal deficit concerns, weak INR and an overall subdued investor and corporate sentiments—are showing early signs of unwinding and therefore our view has become “cautiously optimistic”.

In the last few weeks, the government markedly sprang into action with a slew of measures. These measures have helped change investor sentiment and the equity markets have responded with a 8% rally since early September. About $4.5 bn of FII inflows have come in and the INR has appreciated after a long gap and there are signs of revival in the corporate sentiment too—important for the capex cycle to start improving. We discuss many of the macro issues important for the markets below.

A key issue is, when will RBI resume the rate-cut cycle?

While it’s difficult to predict the extent of rate cuts over the short term, rate cuts will resume soon and should go down meaningfully over the next two years unless oil prices and other global commodities play spoilsport again and inflation proves stickier. Due to adequate liquidity, the borrowing rates have been coming down and wholesale lending rates are down 200bps from the peak and about 100 bps over the last six months. Plus more announcements by the government on fiscal consolidation and supply side policy measures should create elbowroom for RBI to restart rate cuts soon. Risk to the above is the government not staying the course and going back to “welfare economics” in a hurry.

Another big question is, when will GDP growth accelerate?

We think that for India’s GDP to accelerate significantly from current estimate of about 5-6%, the capex cycle needs to revive on a multi-year basis. For this to happen a lot more issues need to be resolved and the recent announcements are the early positive steps in that direction. We think that the government is aware that regulatory issues have contributed to the slowdown in the infrastructure space--projects have been stalled over land acquisition, environment clearances,

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