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.