Patience Will Pay

Arun Gopalan
VP – Research & Investments
Systematix Shares

This year, we saw a clear division between the performance of traditional emerging markets (EMs) such as the BRICS countries and the frontier EMs, such as Pakistan, Nigeria, etc. The traditional EMs delivered muted returns, with Brazil down 13 per cent, Shanghai up 11 per cent and India in between, up six per cent, whereas most frontier markets have delivered more than 50 per cent in the past one year. But these markets are no threat to India. We see the country evenly placed as far the EMs are considered, and it will continue to attract FII investment.

On the report card of India Inc., it can be said that the overall expectations from the earnings season were quite muted and the Q2FY2014 results were quite in line with those expectations. But certain sectors surprised us positively. Automobiles was one of those, where we saw Tata Motors deliver good results on the back of strong numbers from JLR. Pharma was the other sector in positives, with Sun Pharma doing well but outshined by Lupin. IT too fared well, with TCS leading the pack. But the biggest surprise came from certain PSU banks, which reported some extraordinary numbers.

What we noticed was that the domestic business of most companies underperformed. We saw foreign subsidiaries outperform their Indian parent companies, which was evident in Tata Steel and Tata Motors. The toplines of most companies remained under pressure, but the margins saw significant uptick in certain segments due to better cost management. Interest costs continued to squeeze out margins below the line. Going forward, we envisage the muted trend continuing in H2FY2014 and also see the interest costs biting deeper.

Inflation continues to be enemy number one for the RBI Governor, though he has acknowledged the importance of growth by pausing the series of rate hikes. However, he has sounded out a clear warning that inflation continues to be worrisome. The main culprit is food inflation, especially vegetable prices, which were sky high in October. With the prospects of a good rabi crop, we may see food inflation ease a little. Any adverse move in the inflation numbers and the RBI might be forced to raise the repo rate by another 25 basis points in January 2014. In Q3FY2014, we see there is a high probability of a 25 basis points rate hike, but not beyond that. We also believe that the rate easing cycle may begin as early as Q1FY2015 if inflation sustains at a comfortable level.

Quite clearly, the Indian markets are going to be affected by a number of events in CY2014, the most obvious of which is the general elections. A stable (but seemingly elusive) government at the centre will be biggest boost the Indian bourses could ask for in 2014. A weak government or hung Parliament might the crack the Nifty down to the previous supports of 5750 and below. The global trigger for the markets would come from the US taper, which of course, may not tangibly affect us. We are not expecting any dramatic earnings surprises in the next quarter. The other big internal trigger would come from the rate cut cycle, which we believe will begin in Q1 or Q2 of the next fiscal.

We hold that a stock-specific approach makes better sense in the current scenario. But overall, we believe that IT and Pharma stocks will do well. We are also bullish on the Capital Goods and PSU Banks space. From a deep valuation perspective, we like some stocks in the Infrastructure space. Telecom is also a space we would watch. Select Automobiles stocks too may prove to be a good bet.

We would advise retail investors to remain invested in the equity markets and perhaps increase their allocation to equities, keeping a two-three year perspective in mind. Choose a suitable option from our Conservative, Moderate and Aggressive portfolios and stay invested. The current fluidity and uncertainty is not a permanent phenomenon, and equities will continue to be a strong asset class.