A Favourable Long-Term Bet

Ambareesh Baliga
COO
Way2Wealth

Though there are concerns such as policy inaction, retrograde steps, high interest rates, high oil prices, a weak rupee and waves of instability from the western markets, mainly the EU, the long-term outlook for the Indian economy is still optimistic, says Ambareesh Baliga.

DRIVING THE MARKETS

• A meaningful re-rating of the Indian markets will have to be preceded either by confidence in the implementation of key reforms or a turnaround in the earnings downgrades cycle.

FIIs IN INDIA

• India is better placed among the emerging markets, and hence, should be able to attract a larger share of the flows.

The year 2011 was dismal for the Indian stock markets. The current valuations at 13x are close to the historical averages (10-year average of 14.6x). Though the rate tightening cycle is behind us, poor visibility on the implementation of key reforms continues to remain an overhang.

The monetary cycle is expected to ease soon. However, a meaningful re-rating of the Indian markets will have to be preceded either by confidence in the implementation of key reforms or a turnaround in the earnings downgrades cycle. Policy inaction, retrograde steps, high interest rates, high oil prices, a weak rupee and waves of instability from the western markets, mainly the EU, are some of the lingering concerns. India is better placed among the emerging markets, and hence, should be able to attract a larger share of the flows.

The new earnings season has begun with cautious optimism, with increased possibility of the bottoming out of the earnings downgrade cycle. The growth rates (in single digits) are expected to remain in tandem with the earlier quarter’s performance. However, there will only be a modest earnings revision post the results, as the key factors, viz. interest rates and a revival in the operating environment, are yet to play out. The Banks, Consumer Goods and Auto sectors would be in the limelight.

With crude oil prices continuing to maintain higher levels, the risk of inflation continues to remain high. With an inevitable increase in petro prices, the inflation trajectory looks dim. The RBI has adopted an extremely hawkish stance on the repo rates, and will take cues from inflation data behavior in FY13. We don’t see aggressive repo rate cuts in H1 FY13. However, inflation is expected to come down gradually as a higher base takes effect, and this could lead to a rate cut of 75-100 basis points in H2 FY13.

Given the concerns surrounding the economic outlook and the impact of the high oil prices, the rupee is likely to remain weak in H1 FY13. The slowing economic growth in India and a widening current account deficit are also exerting pressure on the rupee. The RBI has been intervening intermittently to shore up the rupee, but this is not turning out to be of much help. As long as the rupee doesn’t cross the Rs 52.50 mark, the economy will not feel the currency heat.

There is still a fair amount of uncertainty surrounding the GAAR issue. Clarity on the same will provide much-needed relief, as the FIIs are skeptical on the issue of tax before they invest further. The movement of the crude oil prices will be another key factor to be watched. A series of domestic events, including the corporate results, are likely to keep the market volatility high. The political equations have already been discounted, and we don’t expect any changes on that front.

After a stellar rally of nearly seven per cent in the January-March 2012 period, which incidentally, was the Dow’s best first quarter in its history, the weak unemployment data has stoked fears that the US economic recovery may not be strong enough. The markets will be closely watching the Q1 gross domestic product results. Last month, China lowered its GDP growth target to 7.5 per cent, intensifying concerns that the world's second-largest economy is slowing faster than expected.

The Nifty is currently at a crucial juncture, close to the 200 DMA. A drop below this level will result in another downward phase, which could take the markets to levels closer to 5000 or a tad below that. One should look at investing in that fall, as the longer-term outlook for our economy is still optimistic.