Sudip Bandyopadhyay’s Blog

MARKETS LACK POSITIVE TRIGGERS

Lawrence Summers, the former US Treasury Secretary commented last week that once again Europe’s effort to contain its crisis have fallen short.  Global debate on austerity vs. growth is finally showing signs of conclusion with clear indication that austerity in the face of depression has only made the depression worse.  Unfortunately, inspite of the end of this debate in favour of growth, there seems to be little prospect of near term course correction either in Europe or in US.  Complete conviction on Keynesian Doctrine is absent and half baked measures for liquidity enhancement are not yielding necessary results.

April was ugly for the International Markets.  The UK officially slipped into a double-dip recession.  US data showed weaker growth than hoped for and an apparent stalling in the improvement of the jobs picture.  The eurozone crisis deepened as Standard & Poor’s downgraded Spain’s debt.  Yet stock markets survived relatively unscathed.  The residual liquidity still available in the global markets ensured that markets held on inspite of negative news flows.  However, it’s more than clear that the anemic growth seen in the past few months is now a thing of the past.

Asian markets including China have also seen significant deceleration, leading to concerns regarding overall world economic health.  All these economic headwinds do not augur well for the Indian capital markets.  During the first three months of the current calendar year, Indian capital markets remained buoyant on the back of continuous buying by FIIs.  The trend got reversed in April.  Apart from the global headwinds, domestic factors also contributed to this reversal. Deteriorating fiscal position including increasing capital and current account deficits have rung warning bell for Indian capital markets.  Depreciating rupee coupled with complete policy paralysis at the government level, has frustrated the foreign investors.  Though fundamentally not very significant, retrospective changes in taxation rules have also worsened sentiments.

All of the above negative macro factors on top of worsening corporate performances, on account of shrinking demand, high inflation and high interest cost of funds have led to deteriorating fundamentals in the market.  It is extremely unlikely that the fundamentals will improve in the short term.  It is also unlikely that the global economic crisis will get over in the next three to six months.  Under the circumstances, the overall capital market outlook for India in the next six months is unfortunately bearish.  Expected good monsoon and fresh liquidity injection in global markets will only arrest further downslide of the index.  Positive triggers for facilitating a breakout from current levels are sadly missing.

However, there will continue to remain pockets of out-performance and select sectors like FMCG and Pharmaceutical will out-perform the markets.  Valuation will continue to be clobbered by growth.  Picking stocks that look cheap relative to their own fundamentals will not work in the short to medium term.  Growth investing, involving looking for companies whose profits are growing even if they are expensive, will provide better returns.

Domestic equity market has been extremely volatile over the last few weeks and it is expected to remain so in the near future.  While the basic tenet of the ‘India Growth Story’ remains intact, doubts are being expressed all around regarding the pace and the effectiveness cum efficiency with which economic reforms and fiscal matters are being handled by the government, in India.  Global economic situation and increasing oil price has been adding fuel to the fire of volatility.

During the next few months, domestic capital market triggers will come from the following :-

1. Progress, performance and distribution of monsoon rains

2. Domestic inflation

3. Cost of funds

4. Q4 FY12 and Q1 FY13 corporate results

While the current expectations around the monsoon are positive, concerns remain regarding inflation and consequently interest rates.  Corporate performance can get significantly impacted if interest rates do not come down over the next few months.  While the RBI has recently carried out 50 basis points cut in interest rate to bring back economy on the path of growth, further reduction interest rate is warranted.

The global trigger effecting capital markets will primarily be the following :

1. Global liquidity situation and consequent appetite for “risk on” trade

2. Economic situation in Spain and Italy particularly with respect to refinancing their debt

3. Progress of US economic recovery

While concerns remain regarding Spain and Italy and even the pace of US economic recovery, global liquidity situation is expected to remain extremely favourable.  This will ensure flow of FII investments into India leading to buoyancy in Indian capital markets.

Retail investors have been absent from domestic capital markets for sometime and even now level of retail interest is very low.  Volatility and index fluctuation will continue but scope for significant capital appreciation continues to remain in Indian capital markets.  The strategy needs to be sector specific and stock specific.  Blindly buying the index or sectors will not yield the desired results.  The investor needs to carefully analyse and pick up appropriately priced stocks for capital appreciation.

Amongst sectors both Pharmaceutical and FMCG present attractive opportunities on a stock specific basis.  Bigger pharma companies involved in drug discoveries, seeking approval for marketing drugs in US and Europe are subject to significant price volatility due to uncertainty around their business model.  However, companies focused on domestic markets or involved in contract manufacturing are largely immune to this volatility.  Considering the significant cost advantage and available skill sets of domestic manpower, midcap Indian pharma companies are attractive manufacturing and R&D partners for global pharma majors.  M&A opportunity in this sector is also significant. Domestic pharma companies focused on CRM have siginificant upside potential even at current level.  Companies like Divis Laboratories, IPCA Laboratories etc. present attractive opportunities.  Select FMCG stocks also may offer capital appreciation even from current levels.

Keeping in mind the recent interest rate reduction by RBI, few interest sensitive sectors like Banking and Automobiles provide opportunities on a stock specific basis. In the automobile space both Maruti and Tata Motors look attractive at current valuation.  While Tata Motors hve significantly appreciated over the last few months, Maruti may move up significantly from current levels.  Recent launch of their SUV should enable them garner market share in the hitherto untapped segment which constitute around 15% of the total automobile sales.  Apart from this, the production blockage suffered by the company during the last fiscal are not expected to recur during the current year.  This will ensure normal volume growth in the existing product basket apart from incremental share gain in the SUV segment.

In the banking space, select private sector banks like ICICI look attractive.  The asset quality and NIMs are excellent.  With RBI reducing interest rates both NIM and asset quality are expected to further improve.

As a sector though Fertilizer has been under-performing, investors can look at GSFC at current levels considering the strong fundamentals.  While the policy environment is yet to improve, input constraints suffered have by and large been addressed.  Significant cash reserves and low valuation make this company extremely attractive at current valuations.