Markets at life time High

Indian Equity Strategy: Market at life time High

Indian equity markets made fresh life time highs on the back of improving domestic macros, supporting global equity and expected governance improvement in India after next general elections. Sensex crossed the level of 21,200 after a gap of almost six years. FII have been looking at Indian equities again with a lot of enthusiasm with more than 2.5 billion dollars invested in the month of October.

Global markets have turned supportive of equity. In their recent meeting, US Federal Reserve has expressed concern about the quality of macroeconomic recovery in US and has decided to maintain the current pace of bond buying program. This dovish stance from the Federal Reserve will help sustain upwards bias in Emerging market equities, currencies and bonds. The revival in global risk appetite has resulted in fresh FII inflows into emerging market equities with India turning out to be a big beneficiary. India has been one of the top performing equity markets since the middle of September when Federal Reserve first announced the postponement of tapering program.

Rise in Global Equities since 18^th September, 2013

The tough measures to ensure financial discipline in the peripheral eurozone area in the last few years have began to show results. European economies have seen rebound in growth with Spain recently coming out of recession. We expect this macroeconomic recovery in the Euro area to get stronger in the next few quarters.

RBI carried out the review of Indian monetary policy last week. As expected, it carried out a 25bps increase in repo rate along with a 25 bps cut in MSF. The corridor between repo and MSF has been restored to 100 basis points. The liquidity provided through term repos of 7-day and 14-day tenor has been increased from 0.25% of net demand and time liabilities (NDTL) of the banking system to 0.5% further easing short term liquidity. With these latest steps, the extraordinary measures taken by RBI in September to defend the rupee have been largely reversed. The trade data also reflects significant reduction in CAD and we believe that the worst is behind us on that front.

GDP growth in the last two quarters has remained below 5%. Capital formation growth in the country has further with no sign of pick-up as yet. The forecast for FY14 GDP growth has been cut from 5.5% to 5% by RBI  We believe that growth in the next two quarters will improve due to strengthening export growth and expected pick-up in agriculture. Also, revival of large stalled projects cleared by the Cabinet Committee on Investment will give a boost to capital formation activity. The worst seems to be behind us from a growth perspective and we believe we will see a multi-year revival of the growth and earnings cycle in next few quarters.

The political activity in the country is going to get more and more interesting as we approach the General elections scheduled in May. The recent opinion polls indicate support building up for Gujarat Chief Minister Narendra Modi led National Democratic Alliance (NDA). There have been several concerns about governance and populist schemes in the last few years and markets are getting excited about prospects of a better government emerging from the next election. We would expect a bigger rally building up going into the election.

While Sensex has made fresh life time highs, the performance of various sectors have been quite divergent. Pharma, IT and Auto have been best performers in the last six years, while Banking, Oil & Gas, Capital Goods and Metals have been worst performers. We expect this trend to start to reverse going forward. With the normalization of Repo MSF corridor, we believe RBI might pause in the immediate future. With monetary policy risk out of the way, we have turned positive on interest rate sensitive sectors like banks and automobiles. We expect export oriented sectors like IT to continue to benefit from the significant rupee depreciation seen this year. Telecom is another sector which might deliver strong earnings due to return of pricing power & reduction in competitive intensity.

We maintain our year-end Sensex target of 22,400. A good monsoon, strong export sector, continued monetary stimulus in US & a stable Euro area are significant positives for equity markets. With domestic macro-economic data also on the mend, we are aggressive buyers of Indian equity.

Indian Economy: Murphy’s Law at Work

Murphy’s law states that "Anything that can go wrong, will go wrong". This seems especially true in the context of Indian economy and Indian equity markets in the last one year. Last year this time, India was grappling with an imminent sovereign downgrade with an uncontrolled fiscal deficit, policy paralysis of the highest order with no economic reforms for eight long years and a weakening rupee. With Mr. Chidambaram coming back to the finance ministry, measures were announced to tackle the fiscal situation. We saw government spending being curtailed, FDI allowed in several sectors like Retail & Aviation and a more benign monetary policy.  Several policy measures were undertaken to cap fiscal deficit. The fuel price deregulation announce in January is probably the most significant reform measure in the last five years and will have significant positive long term impact on the economy. This combined with severe expenditure curtailment lead to a better than expected fiscal deficit number for FY13. With RBI easing monetary policy, it was expected that GDP growth will revive, although slowly, from the 5% levels of last year. And just when things seemed to be looking up, we had an 8% fall in rupee value through the month of May and June which changes the overall macro picture.

India is not alone in the currency carnage which was triggered, party, by US Federal Reserve’s comments on tapering on Quantitative easing. However, India is most vulnerable due to the high deficit levels on both fiscal and current account. RBI has been forced to intervene and carry out monetary tightening to defend the rupee. These monetary policy measures are going to slow down economic activity further and a recovery is now pushed back into 2014. We are now expecting a GDP growth of around 5% for the fiscal. Equity markets have reacted with banking and auto stocks taking a big hit. However, the broader market has been resilient with BSE Sensex with 5% of its all time high. We believe that all possible negatives which could happen have played out. One can add a fractured electoral outcome as another potential negative. However, no one is expecting very decisive mandate from elections next year so expectations are already low. There is not much that can go wrong from here. We have GDP growth, currency, Current account deficit, all at a decadal low. Things can only look up. Growth should get a boost once these temporary measures by RBI are withdrawn. We see more actions on the import side which will also help stabilize the rupee.

It’s difficult to see the sunshine when dark clouds gather. A good monsoon, commodity price correction, a strong macroeconomic recovery in US & a stable Euro area are significant positives for equity markets this year. We expect things to incrementally get better from here.