Year End Musings

Second worst year since 1980 for Sensex

• 2nd worst performing country in Asia Pacific EM’s
• Pain is self-inflicted; Correction more due to India Specific Issues
• Concerns about the mid-term direction this country is taking
o Increasing subsidies, zero reform
• Trend growth rate coming down, could settle at 6.5-7%
o Inflation expected at 7% leading to nominal growth of 13-14%
• A new normal in rupee, to sustain above 50
• The 3 ‘I’s : interest rates, inflation and infra
o Of the three, two will turn positive in 2012. Infra will take time
• Globally, things not as bad as perceived in August
o In US, there is no double-dip
o In Europe, Endgame will require ECB coming into play; that has started

Back where it all started??

here's an interesting chart in today's mint

It shows how the the fiscal and current account deficit in the economy has reached the same level as in 1991. Prme Minister Manmohan Singh gets a lot of credit for supposedly getting the country back from the brink. However, his performance during the last eight years leaves a lot to be desired. There has been fiscal and economic mismangement of teh highest degree in the last three years. The cuurent handling of rupee depreciation is the lastest example of that. Although the first UPA term was equally bad, the slip didn't show up due to trickle down effect of NDA regimes earlier reforms and a resileint global economy.

the gains of 2003-2008 have been completely squandered with populist schemes and poor energy planning. As things take a turn for te worse in global economy, a very tough challenge lies ahead. Not sure if Mr Singh is upto it......

Here Comes Monti

The new Italian prime Minsiter has been chosen. Mario Monti, is an ex european Commisioner who has been a big proponent of the idea of EU. He has been all along a big beliver of the monetary Union and is expected to do everything to keep Italy within the Eurozone. He will announce his cabinet today evening. The Italian bond yields have come off a little as the new govenment takes shape. I believe that if Monti announces a credible roadrap to reform Italian Finances, Risk assets accross the world would rally sharply in the short term. Lets see what Monti has up his sleeve.........

Euro Conundrum

The last of October saw a sharp rally in risky assets across the world on the back of the three –pronged agreement reached by European Union political leadership to stem the contagion from the soverign-debt crisis: A voluntary 50% hair cut for private investors in Greek debt which would help reduce soverign debt in greece, Recapitalizing seventy European banks to the extent of 108 billion dollars and increasing the size of European Union Financial Stabilty Fund (EFSF) to 1.4 trillion dollars which would provide support to other peripheral Euro area countries.. All the three measures combined with further fiscal austerity measures were supposed to stem the contagion in European markets.

With renewed uncertainity about governments in Greece an dItaly, bond yields have spiked up further. It is our view that for Euro area to sustain, sooner or later, European governments will have to move towards some kind of fiscal union to prevent a full-blown crisis. A move in the opposite direction could have huge economic and political costs.
Third quarter GDP data in US came in at 2.5%, above consensus expectations which eased concerns about US economy moving towards a double-dip. The dollar Index fell 5% resulting in sharp bounces in equity, commodities and crude oil. In this month’s US Fed meeting, the markets will look for any indication of further quantitative easing although Fed Chairman continues to mention that Fed has several tools available at their disposal to spur growth and they will use it as and when required. US consumer demand has been holding up so far and the Thanksgiving holiday buying will give a good indicator of how that demand will move from here onwards.
RBI hiked repo rates by 25bps on 25th October. The tone of the policy statement by the Governor has changed from hawkish to dovish with growth continuing to remain under pressure. The governor talked about ‘De-sesonalized quarter-on-quarter headline and core inflation measures showing moderation’. According to RBI, inflation will start falling in December and will moderate to about 7% by March 2012. The Governor also said that ‘likelihood of a rate action in December mid-quarter policy review is relatively low’. RBI has cut the FY12 growth forecast from 8% to 7.6%. RBI has effectively hiked rates by 525 bps in last sixteen months and this could result in demand destruction leading to price moderation. Our own sense is that considering the significant slowdown in growth expectation, Rbi will definitely pause if not end the rate tightening cycle now.
FII’s put in 2500cr of fresh money into Indian equity markets which resulted in markets rallying almost 7%.The rupee after depreciating almost 13% to 50 levels has bounced slightly and stabilized around 49 mark. We believe this provides a very exciting entry opportunity in equity markets for dollar investors. The second quarter earnings have come in on expected lines. The earning season has been led by private sector banks, FMCG and automobiles. ITC and HUL came in with excellent results and both are trading at life time highs. We continue to remain positive on FMCG names as consumption demand remains quite strong. PSU banks continue to face pressure on the asset quality with power books coming under great pressure. Also, Infra companies continue to face pressure due to high interest rates and lack of new orders.

With interest rates peaking out and inflation also expected to start coming down in next few months, we expect that the coming months should see improvement in equity market sentiment. We advise investors to stay invested and build a longer term equity portfolio.

Last week the Indian equity markets closed up by 0.75%. Reliance AGM discussed how the company will be debt-free by the end of this fiscal. The focus will be increasingly on retail business. Our view on Reliance remains cautious and we expect annual returns in the range of 10%-15%.

The Q4 GDP growth came in at 7.8%. A slowdown was observed in the manufacturing output. The farm output growth was a positive surprise which was up 7.5% on y-o-y basis which is the highest in the last several quarters. . IIP data for the month of April would be out this week. The consensus viewremains that the IIP data has bottomed out in February at 3.6% and from now onwards we will see a bounce back. We expect industrial growth to average 7.5% for FY12

In US the unemployment rate increased from 9% to 9.1% which was a negative. The factory output and the payroll data also were also disappointing. This added to the fears of a pullback in the US economy’s recovery.

In Europe, the EU and IMF have finished the financial analysis of the Greek economy and they are expected to come out with a new bail out package by 30 June 2011.

On the overall equity view, we continue to expect a robust 15-20% returns for next few years. The markets are trading at a very reasonable valuation of 14 times FY12 earnings. Despite the expectation of an economic slowdown, the economy is still expected to grow at 7.5-8% for FY12. We expect corporate earnings to grow at 17-18% for next year. There are short term concerns like inflation &interest rates but a large part of that is already discounted by the market. We look forward to quarter 1 earnings for FY12 starting in July to give more clarity on full Fy12 earnings. The monsoon session of Parliament, also starting in July, could see some reform measures being announced

May 5, 2011

April turned out to be a lacklustre month for markets with nifty being down 1.4%. FII investments continued in April with a total amount of 7000 crore invested in addition to the 7,000 cr invested in last week of March. There has been a net inflow of around 5000 crores by FIIs so far in this calendar year.

RBI announced the annual policy for FY12on 3^rd May. Policy actions undertaken are as follows:

· Repo Rate increased by 50 bps to 7.25%

· Reverse repo to be now a derived value fixed at 100bps discount to Repo. The new rate is 6.25%

· MSF, a new programme for banks to borrow overnight from RBI, with the rate fixed at 100bps premium to repo rate (8.25%).

· Savings Rate increased by 50 bps from 3.5% to 4%.

· Provisioning requirement for certain non-standard assets increased.

All the measures combined could lead to margin compression for the banking space. The savings rate hike would lead to a 12-13bps pressure in banks margins. So far, demand for both industrial and consumer credit has held on quite well. However, if demand softens, banks may not be able to fully pass through interest rate hike to clients resulting in further margin pressures. Also, higher interest rates might lead to NPL creation. There could be some pressure on Capital Goods space as cost of capital increases and the order inflow activity slows down. Home loans would become expensive.

The tone of the policy was clearly hawkish. RBI stressed on managing inflationary expectations as its number one priority. It expects the high crude oil and commodity prices to sustain at these levels and even gain going forward. RBI has forecasted the Fy12 growth at 8%. There could be downside risks to that if infrastructure and manufacturing activity slows down further. RBI also expressed concern about the ongoing fiscal consolidation with the budgeted crude oil and fertilizer subsidies being clearly insufficient. This might lead to enhanced government borrowing programme in H2 FY12 putting further upward pressure on bond yields.

We would expect a GDP growth of 8% for this year which would be slightly lower than FY11. The reviving global economic growth augurs well for Indian IT and Metal companies. Also, we believe that consumption stays strong and with the expectation of a good monsoon, discretionary consumption should stay buoyant.

The earnings season is on and most of the companies have come out with inline results for Q4 FY11. While banks have generally delivered a good set of numbers, companies in Oil and gas and cement space have disappointed. Some pressure in margin is visible for engineering and construction companies due to increase in commodity prices and rising interest rates, but that should get compensated by the increase in earnings of Metal companies. We expect a steady earnings growth of 17-18% for Nifty as a whole for Q4 FY11.

While we remain concerned about rising interest rates & high crude oil prices in the short term, we continue to expect a robust earnings growth of 20% for FY12 which will drive equity market returns in the medium to long term. The market looks inexpensive and is trading at 14-15 times FY12 and 12 times FY13 earnings. After the recent correction in banking space, we believe valuations have become attractive. We prefer private sector banking names as they fare better on asset quality issues vis-à-vis their PSU peers. Also, sectors like Information Technology, Healthcare which are relatively lesser impacted by interest rate and inflation risks, should do well going forward.

The three 'I's: Inflation, Interest Rate and Infrastructure

March turned out to be a good month for Indian equity markets. In the first two months of CY11, Nifty ended on a negative note with an outflow of 9000 crores by FII. This changed in the month of March with a gain 9.4%. FIIs returned in the last Iek of March with almost 9000 cr invested in 7 days. The FII buying was seen across quality large cap names and a few mid-cap ideas.

On the macro economic front, consumer demand continues to hold up quite well across both rural and urban India. March witnessed strong auto sales numbers growth. All manufacturers’ sales surpassed expectations as retail demand continues to remain buoyant with two wheeler and four wheeler sales numbers Ill ahead of expectations.

The sector which has seen the most difficult times last year was infrastructure. There were various issues in terms of environmental clearances, lack of new orders, land acquisition and commodity prices. There seems to be some movement on the first two issues. Last month saw several coal mine development plans being cleared by the environment ministry. A few commodity green field projects also got clearances. There was a revival in order announcements by key infrastructure vendors like PGCIL which announced its largest ever Transmission & Distribution order of 5000 crores. NHAI is also expected to announce highway development orders to the tune of 2000 crores in this quarter. This momentum, if continued, will provide a much needed fillip to infrastructure development of the country and would be a big positive for the infrastructure stocks. Concerns related to commodity prices and interest rates have already been priced in by the market. The government also seems keen to press ahead with key reforms and introduced GST and Pension Reform bill in parliament.

Crude continues to be a cause of concern with Nymex crude touching 112$/barrel driven by continued unrest in Middle East and North Africa. Fighting continues in Libya with no side emerging as a clear winner. It would be prudent to assume that Libyan supplies would be disrupted for some time. Saudi Arabia has increased supplies to make up for that. HoIver, concerns remain on the unrest in Yemen and Bahrain spreading to Saudi Arabia which is the world’s largest crude producer.

Food price inflation in end-March again touched the double digit levels due to firm price trend seen in protein rich items like milk, cereals and fish. I now expect WPI inflation in april to cross 8%. I would expect inflation to stay at elevated levels led by firm food price trends and high commodity prices and average around 8% in Fy12. RBI is expected to announce its forecast for full year inflation in the May review. I would expect a further hike of 25bps when RBI next meets with a total hike of 50 to 100 bps for FY12. This view would change if there is any big spike in retail fuel prices led by continued upside to global crude prices.

Despite, the concerns about the three 'I's, the market seem resilient and are trading at reasonable valuations of around 16 times based on FY12 earnings. I believe that in Q4 FY11, I would witness steady earnings growth of 17-18% for Nifty companies. Similar to the scenario in Q3FY11, manufacturing sector might face some earnings disappointments due to high commodity prices and interest rates, but that should get compensated by the increase in earnings of Metal companies. I would continue to maintain a strict vigil on crude prices and inflationary expectations in the economy. I like sectors with earnings visibility, growth,superior capital efficiency of the businesses & good corporate governance and have maintained overIight position on Financials, Metals, Healthcare & Capital Goods.