Equities A Long-Term Commitment

K Sandeep Nayak
ED & CEO
Centrum Broking

GROWTH IN SIGHT

• India is likely to see a gradual improvement in GDP growth in the second half of the current fiscal year, driven by a good monsoon and a revival in consumption demand from our rural economy.

A SUITABLE MIX

• In building an equity portfolio, one needs to have a suitable mix of large-caps and mid-caps. The allocation to large-caps should be consistent with one’s liquidity requirements.

India is likely to see a gradual improvement in GDP growth in the second half of the current fiscal year, driven by a good monsoon and a revival in consumption demand from our rural economy. This, coupled with an improvement in the global growth outlook led by China’s recovery and US stability, has led to our equity markets witnessing a rally. Both benchmark indices, Nifty and Sensex, are within striking distance of new all-time highs.

The current rally is skewed in favour of quality large-cap stocks, but the broader market is still down. In the last one year (ended October 18, 2013), the Nifty has gained about 10 per cent, while the Nifty Mid-Cap index is down 10 per cent and the Nifty Small-Cap Index is down almost 15 per cent. The risk-reward, therefore, is still in favour of investing in good quality mid-cap stocks. The real challenge is to identify quality mid-caps to invest in. This is easier said than done, and the market punishment for failure here is very severe.

About six-eight weeks ago, a sense of gloom prevailed with the analyst community, which was worried that the INR would touch 75/USD very soon. Thankfully, things have changed and the INR has moved back to the level of 61/USD. The RBI’s decision to offer a fixed-rate swap for banks bringing NRI deposits for three years and over and other reforms have boosted the rupee.

The trade deficit numbers made for a happy surprise in September and the earlier measures to restrict gold imports also seem to be paying off. Exports rose 11.2 per cent in September, while imports fell 18.1 per cent. This compressed the trade deficit to USD 6.8 billion, the lowest since March 2011. The trade deficit for earlier months had been USD 10 billion plus, causing us worries of a large Current Account Deficit (CAD) for 2013-14. The government’s current estimate of containing the CAD for FY14 within USD 70 billion (four per cent of the GDP) will keep the rupee in check, and the currency should settle between 59-62.

The MSF rates have been cut by 125 basis points in the last one month. For all practical purposes, the repo rate turned out to be an academic one. A cap of 0.5 per cent of the Net Demand and Time Liabilities (NDTL) for each bank was fixed by the RBI on borrowing from the repo window. The short-term rates are now determined by the MSF rate, and the latter is down to nine per cent from the earlier 10.25. Expect the gap between MSF and repo which is currently 150 basis points to narrow down by March 2014 to 50 basis points. This should be perceived by markets as an easing of rates. Having said that, one will need to keep a close watch on inflation numbers, both WPI and CPI, closely to determine how soon we move towards a lower interest rate.

The triggers for the market going forward will be:

1. WPI and CPI numbers for each month- these numbers are to be closely watched to determine the trajectory of interest rates. Any improvement in these numbers will lead to an expectation of easing in rates and will lead to market rallies.
2. Better GDP growth numbers in H2FY14. A gradual improvement in GDP numbers due to a successful monsoon and a revival in rural demand should lend a further boost to our markets.
3. State election results of the five states going to polls in December – the results will give an indication of the next formation at the Centre and is likely to be a defining event for market though it would still be early days to draw any conclusions for the next Central Government.
4. The US Fed’s commentary on US economic data and the deferred timelines for any tapering.

These events are likely to cause market gyrations and increased volatility in case of outcomes perceived negative to our markets.

We have always preferred to adopt a bottom-up stock picking approach, with a long-term investment horizon. We are patient investors in the old private sector bank space, and our top pick there is Karur Vysya Bank, which is amongst the best managed old, private sector banks. We are not positive on the real estate sector in general, but are upbeat on DLF in the long term given its strategy of exiting non-core businesses and reducing debt. We are also bullish on MNC companies such as Clariant Chemicals and BASF, which have great businesses, are available at reasonable valuations and also offer reasonable dividend yields. The banking sector is under close watch and asset quality concerns, if overdone, could afford reasonable price points to enter the sector to play on the recovery of the GDP.

Any retail investor has to work out his/her financial goals with a financial advisor/wealth manager. Understanding one’s risk appetite and loss tolerance limits is the key to work out any plan. One needs to systematically go about an asset allocation plan, deciding between debt and equity. Once this is agreed upon, go about identifying the instruments to invest in. A well-managed mutual fund with a good track record is one route to execute your financial plan. Another way to execute the equity strategy is direct investment in the markets, which should be done only if one has adequate time to work with one’s advisor and review progress continuously. If time is a constraint or one does not have the temperament to handle equities directly, it makes sense to stick to the mutual fund route.

In building an equity portfolio, one needs to have a suitable mix of large-caps and mid-caps. The allocation to large-caps should be consistent with one’s liquidity requirements. In company selection, one needs to avoid companies laden with debt, those having no dividend track record or companies whose promoter holdings are pledged. Invest in companies which have a proven management with good corporate governance track record. Equity investment is a long-term activity and having a horizon of three-five years is a must.