Brighter Days Ahead

The quirky movement that the Indian equity indices have witnessed in the past few trading sessions has left the investor fraternity quite baffled. The sentiments in the markets have changed suddenly from optimism to caution. A lot has happened or rather changed in the recent past which has directly impacted the investor psyche about the markets. 

While on the domestic front the RBI surprised many on the street by increasing the repo rate by 25 basis points, on the global canvas it was increase in the pace of QE Taper by the US Fed which surprised the investors. Add to that the disappointing macroeconomic numbers from China as well as US for the month of January, the scenario changed drastically in short span of time. 

With the increase in pace of QE taper as Ben Bernanke cut the bond buying by USD 10 billion consecutive time (after reducing it by USD 10 billion) to take it to USD 65 billion per month.  Since then there has been consistent worries of FIIs flowing out of the riskier emerging markets and taking a flight back to safety. And impact of the same is being seen in the form of equity indices globally witnessing a slide. 

With such a sudden change in the global as well as domestic scenario, the investors here are in two minds. First is whether to look at the positive side as the developed economies are improving and it would eventually lead to a better scenario going ahead, or look at the outflow of FII funds which has been playing a pivotal role in keeping the markets at higher levels. In short, for the investors, it is a tricky call right now; because investors do not know whether this is a dip that needs to be bought as this is the first time the market is coming down to test the 200 day moving average (DMA) in recent past. Just to put it in a perspective, the 200 DMA usually does not break that easily. Here we have a situation where the indices hit those levels, but you do not violate that very meaningfully and it turns out to be a bit of a buying opportunity. But some time it closes below the important levels and only moves southwards. So the important question arises that, is it a long-term buying opportunity or we still have more to endure? This is one question is hindering the minds of investors. 

We are of the opinion that, there is no single Yes or No kind of answer for this question. There are quite a lot of factors that we need to consider on global as well as domestic front. On the domestic front there are quite a few positives like improvement in CAD, some solace on the fiscal deficit issue and finally the expected stability on the political front. On the global front also the improvement in the developed markets is the biggest positive. However whether these factors really help the Indian markets to new highs needs to be seen. Going ahead with the story we have presented few of the important factors which are likely to decide the course of markets going ahead. 

Global Markets and FII Inflows – what to expect? 

A lot of focus recently has been on the FII outflows from emerging markets and India has not been an exception. However we are of the opinion that, it is a very narrow view and is like focusing more on the symptom rather than focusing at the exact cause for this kind of sudden outflow. It is true that the additional tapering by Fed is a major factor which will impact in the short term. However we feel it is not the only factor which has led to these outflows. This can be seen from the fact that, after long time questions are being raised on whether emerging markets are as robust as the investors thought it earlier was. The questions stand justified as PMI numbers in China have contracted in the preceding month. After the series of events like credit squeeze and slowing GDP growth would surely make its impact on the global markets. Historically it is been proven that when you get such a powerful increase in debt, it always leads to some sort of trouble, either a financial crisis or a major economic slowdown. Here there are many voices that are indicating that the slowdown in China is good for the Indian markets as the Developed markets are witnessing growth, the incremental pie of exports would be from India. However, China is one of the biggest exporters in the world and still is one of the fastest growing economies. Hence as mentioned earlier slowdown in China would create some ripples in global markets and even Indian markets would not be spared.
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As for the developed markets, there are clear signs of improvement in macroeconomic scenario.  And that is the reason why the US has gone ahead with a Taper. It was anyway expected, but what surprised everyone was the pace and timing. In one of our earlier stories “Caution – Enter At Your Own Risk”, we had categorically stated that, timing of the QE Taper holds the key. And the way US Fed has cut the bond buying on two successive occasions, it is no wonder that the FIIs have been on a selling spree in the past few trading sessions. 

Most important question here is, whether this FII selling would continue? We feel, though it may continue in the short term, in Medium to long term the FII would come back to Indian markets. The simple factors behind the same are that we would get a political stability, in next one quarter, GDP growth would start picking up pace and eventually the financial performance of India Inc would start its upward journey. Further the biggest positive aspect for the Indian markets is that the Indian market provides the length as well as breadth for institutional investors as it has good sector spread and chunk of companies that have deep volumes for institutional players. So it is impossible to create another India. Hence we still stand by our call we had taken in our cover story of FIIs to lighten the Indian markets. Here Pankaj Pande adds, “While it is difficult to predict FII inflows, we believe India remains the favourite investment destination for global institutional investors. This is evident from the fact that India has received the highest FII inflow in the last 10 years among emerging markets at $132 billion, far higher than the second highest inflow of $84 billion in Taiwan”. Even Nilesh Sathe says, “It depends on fundamentals of Indian equity going forward. But among the emerging markets, India will be a favoured destination for FIIs. They will always invest where the return is likely to be better. The likely hood of stable Government will trigger higher FIIs inflows”. Dinesh Thakkar also agrees and adds, “Since our external sector risks have subsided to a material extent and domestic fundamentals such as growth, inflation as well as corporate earnings are now on an improving trajectory. I believe that our markets would continue to attract FII investments”.

Government Formation – What’s next…..If BJP doesn’t make it to the required number

Apart from FIIs one factor that has been to the core of Indian equity markets remaining at higher levels is the expectation of NDA forming a government at the centre when the elections happen in the month of May 2014. It is a known fact that policy paralysis played a significant role in India Inc losing its sheen. Hence the change of government is obviously a necessary change required for the smooth flow of new macro policies that would help India pick up its GDP growth. 

If we consider current sentiments, it clearly shows that NDA would form a government. Even India Inc voices similar thoughts along with most of the investor fraternity who feel the BJP government would be beneficial for the markets. Here Thakkar says “Markets are pinning hopes on a strong show by the BJP-led government in the general elections owing to their pro-development and reform agenda. In case that happens over the coming six months, then I believe that market momentum would strengthen benefiting stocks in cyclical sectors”.

Though everyone is quite confident of the BJP forming a government, there are few doubts being raised now as Aam Aadmi Party (AAP) has emerged on the horizon and many other parties are also planning to form a third front. So what happens if the BJP government does not manage make it to the required number? Here we are of the opinion that, though the opinion poll is suggesting that the BJP would come to Power, everyone knows how the 2004 and 2009 pre poll estimates went haywire. Though we do mean that BJP won’t make it to power, our idea is to see beyond. 

Here we are of the opinion that, whoever forms the government at the centre the policy paralysis would not occur going ahead. Hence BJP or No BJP, the scenario on the domestic front would surely improve. But the elected government would have to prove its efforts and efficiency in first 100 days of its formation. At present it seems that BJP which has proved its mettle in the past and has the right policies to drive the sentiments ahead. However, let any party form the government, there will be no stopping for the India growth story. The growth rate would pickup, capital formation would happen and the capital gearing would help India Inc put in a better performance. Dipen Shah also agrees that, “As of now we are not making any assumption of what the outcome will be. What we are trying to say is that whatever be the outcome, it should be a clear mandate in favour of a particular coalition, be it either UPA or NDA. If that happens, it will be positive for the market”.
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Corporate Results: December Quarter yet to show any positivity 

One major deciding factor for markets is the corporate financial performance. The past few quarters have been quite disappointing with the EPS growth witnessing a sort of decline. There were certain factors indicating towards the betterment in the December 2013 quarter (See Figure: Sensex EPS Movement). However the performance has not been any encouraging for the December quarter. Apart from few sectoral surprises in IT and Pharma (Which are export oriented sectors) there does not seem to be any improvement. Agrees Pankaj Pande, “Corporate results have been on expected lines with no major positive surprises. Defensive sectors continue to do well while capital intensive sectors are still facing growth challenges suggesting that the recovery signals are not yet strong enough”. Manufacturing has been a drag and even the financials have been witnessing a pressure on the non performing assets front. Hence the noticeable factor is only the export oriented sector that has managed to provide positive news with the help from depreciating INR. As for the revival we have to wait for at least another two quarters for any significant improvement. The margins are still under pressure and it is the volume growth which is helping the companies to witness growth. As regards to the improvement, as the GDP growth starts picking up better capacity utilisation will directly add to the bottomline. But it would take another two quarters to witness any improvement. 

Domestic Macro Data – Some Revival

If we consider the macro data, there has been a lot of improvement on the factors that were considered as problems for the Indian markets. First and the foremost has been the improvement in CAD which has been brought down to below USD 50 billion. Earlier it was expected to be more than USD 90 billion. Strong policies of government and RBI taken in terms of gold import curbs and foreign currency window really came to the rescue. Apart from that we expect some amount of betterment on fiscal Deficit Front as Government (though by twisting the terms for divestment) has managed to raise Rs 40000 crore from divestment. And the telecom auctions have started on the positive note with the Government mopping up Rs 13000 crore on the first day itself. Though the ministry has not provided any target as to how much it expects from 2G auction, it has really been a positive development and would help it control fiscal deficit to expected limits. 

The only worry remains is the inflation, which has remained above the tolerance levels of RBI. As a result Dr. Rajan has gone ahead with a 25 basis points hike in repo rates, which came as a surprise to many on the street.  However when we dig deep into the policy action, it seems that the move has been right. First of all, his efforts have helped to the fall in the INR against the USD. If we take a look at the movement of different currencies against the USD, it shows that INR has been one of the best performing currencies. On this front Dinesh Thakkar of Angle Broking says, “Although the rupee has come under pressure (depreciation of about 1% in January 2014) it hasn’t weakened as much as currencies of some other emerging markets such as South Africa, Russia and Turkey which depreciated by about 5-6% during January 2014”. He further adds “This can be attributed to improvement in our trade balance on the back of positive export performance as growth in advanced economies recovers and also compression of non oil imports reflecting weak domestic demand. In light of these positives, the INR is likely to be more resilience as compared to the scenario in May 2013”.

Now going ahead we are expecting the inflation to contract. Good agri. growth would bring the food prices down (a major Reason behind the higher inflation), providing some leeway to RBI to consider growth as a focus area.  Apart from that the RBI chief has categorically mentioned that, there is no further possibility of tightening going ahead.  All in all the worst seems to be priced in at current level and only way remains is improvement. 
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Our Technical View On Markets

In the year 2013 we had the Nifty moving up from 5900 to 6400 levels. The nifty moved up by 500 points in the year and on an average nifty moved 33 points a month or a single tick up in a day. This rally of 500 points was driven by a few sectors and largely driven by a few stocks. IT, Pharma and FMCG were the strong pillar for the index. In last five-six years the index has oscillated in a range and structurally has formed a multiple top around levels of 6350-6400. If we look in to history, markets after registering a fresh high tends to correct and in first leg nifty made high of 6357 in early 2008 and post that registering high it corrected up to levels of 2252. In second leg nifty made a high of 6338.5 in late 2010 and saw correction up to 4628 levels and in the recent leg nifty registered high of 6415 in late 2013 and now entered into sideway and correction phase, if we notice structurally nifty is forming higher bottom. Nifty needs to hold levels of 5500-5600 on weekly closing basis as its strong support indicated by long term upward rising trend line and as long as nifty continues to hold this level it the long term trend would be positive. In third leg there are probabilities where nifty might correct up to levels of 5500-5600 as hinted by momentum oscillators RSI, which is indicating a negative divergence on the index and hasn’t moved past the 2010 highs.  Once this third leg of correction is over and support is taken around trend line support (5500-5600) it’s likely to resumes it journey upwards with improved force. If that happens then we could see a triple top break out from the range of 6360-6400 region which could take nifty to higher levels of 6600-6900 in the months to come.  In short term nifty would be volatile, sideways and long term looks optimistic.

Valuations Are Not Expensive, But not Un-demanding also

Though it is a scenario where sentiments are playing important role than the valuations, we though have to look at the valuations also. If we take a consensus view the valuations of the market are at around 14.50x. Our view is, though the markets are not expensive, they are not un-demanding also. So, to that extent, they are somewhere in between and our call is that, if the valuations has to move up from the current levels, we will need more clarity on the growth and inflation-interest rate perspective. As of now we feel Indian domestic markets are seeing that there are uncertainties based on growth. Further when we speak to management at present, we do not get any confidence that things are improving at least domestically on the investment side. Hence unless and until the election is over, we feel the valuations would not permit the markets to move upwards. 

However there are other views also. Like Dinesh Thakkar Says, “The Sensex is presently trading at 14x its one-year forward P/E ratio lower than its average over the past 5 years as well as 15 years. Also, valuations for the broader market look attractive. Growth has largely bottomed out and I believe that non-farm GDP growth could potentially come in above 6% in FY2015. We attribute a 16x multiple to our Sensex EPS and arrive at a target of 24,600 for the Sensex over the next 12 months”.   

Even Dipen Shah agrees “The Sensex seems to be attractively valued at about 12.8x FY15E earnings, vs. a long term average of around 14x on year forward. After two subdued years with negligible growth, Sensex earnings are expected to grow at 17–18 per cent in FY14 and FY15 primarily due to the low base effect and earnings upgrades in select stocks”.

Nilesh Sathe adds “The market is trading at around historic average P/E of 17.5x and trades very close to all time high. Therefore, it is reasonable to assume the market to touch new high in this year itself. We can expect a level of NIFTY at 6600 to 6900 within one year from now”.

Way Is Northward- But Volatility To persist

Considering all the above factors, it clearly seems that there is good amount of uncertainty in the markets. The global as well as domestic factors are currently indicating towards the volatility in the Indian markets. And this volatility would be good for the traders as they can ride the momentum on either side. However for the retail traders, the volatility would be a big worry. Hence remaining on the sidelines would be the right option. Yes, it is true that the timing the markets is not possible. So the best option would to go with Systematic Investment Plan (SIP) where you invest a fixed amount at regular interval. 

As for the answer will the markets touch a new high? We feel the markets are bound to Move northwards, however not before the elections. Till then the volatility will persist as FII outflow would continue keeping the investors on their toes. But be it a BJP Government or a Non BJP government, the fundamentals would improve taking the markets to new trajectory. But patience is the key and SIP is the way for the investors.