A New Beginning?

I have just come back from a Diwali break and had a good vacation. I did not miss much during my trip and most of the markets and stocks seem to be placed similarly as they were a couple of weeks back. The results season has progressed and in general has been quite decent given the low expectations that had got built up due to high inflationary pressures and poor economic data over the last three months.

One of the key facets of the results which have come out strongly is that consumers are still spending strongly even in an environment where inflation is near double digits. Consumer good companies have held or improved margins and reported strong nominal growth, although the volume growth has cooled down. Consumer Durables, especially that tend to get financed have seen some pressure and could see a further slowdown if interest rates remain high.

The complete inefficacy of RBI’s monetary tightening seems to have now been realized by the central bank and by making a statement towards no further tightening in the latest policy when reported inflation is still high and food inflation is at 9 month highs is a clear admission that the scope of inflation control does not lie in higher interest rates. Global commodities have cooled off over the last 3 months and a large number of commodities are now trading at or below levels of the same time last year. However the impact of this fall has got nullified in India to some extent due to the depreciation of the rupee. The INR is down by around 9.8% over the last one year and as per some studies a one percent appreciation/depreciation affects India’s WPI by around 0.3%. As such a 10% depreciation itself would contribute to a 3% increase in inflation. In other words if the INR had not depreciated the inflation would have been more near 7% than the current 9.7%.

The good part of the depreciation of the rupee has been that it has provided breathing space for the industry which has been reeling under high input and interest costs. The Chinese Yuan has appreciated by around 6% over the last one year and the INR has fallen by 10% thus providing an incremental competitive advantage of 16%, which is quite huge. Although skeptics have doubted the strong show by Indian exports over the last couple of years, one reason for the same is the improving competitiveness of Indian exporters in the global market place. With the Yuan set to appreciate further and with wage pressures being much greater in China than in India over the next 3-5 years Indian manufacturers across the board have a great opportunity to take away some market share from Chinese exporters. However policy support from the government in terms of ease of operations, better infrastructure and reduction in red tapisim will be required over the long run if Indiahas to leverage its demographic dividend.

The twin deficits of Current account and Fiscal deficit have raised concerns with regards to India over the last few months. On the fiscal side things are unlikely to improve in the near term as government spending is largely inflexible and revenues are coming down due to a slowing economy. The inability of the government to go ahead with the disinvestment programme has also created a revenue gap that needs to be covered with greater market borrowings. This has had an impact on government bond yields which have gone up by nearly 0.5% since the announcement of additional borrowings last month. In order to avoid crowding out there have been relaxations on foreign borrowings as well as norms of FII’s investing into both government debt and corporate bonds over the last two months. The relaxations should help bring in an additional USD 10 billion of funds into the country till March and reduce crowding out to some extent. On the current account side things seem to be much better with the trade deficit being at levels of USD 9 billion for the last two months. If the current run rate persists then the trade deficit can be controlled at 6% of GDP and the Current account deficit at 2.5%.

The global situation has seen pulls on both sides over the last one month. Whereas the news flow from Europe has been mixed i.e. sometimes positive and at other times negative the news flow as far as the US economy goes seems to be continuously improving albeit slowly. The data coming out of the US clearly indicates a low probability of double dip and a slow economic growth in the near term. Data on housing and on the jobs front has also showing incremental improvement.

Euro zone seems to be going through a phase of crisis of confidence where not only large money market and debt funds globally have sold out Euro zone sovereign debt, but even large Euro zone banks have cut down holdings in countries where there seems to be even a whiff of trouble. Recent results of European banks clearly show that most banks have been continuously writing off Greek debt and selling out Italian and Spanish debt. It is clear that ECB cannot absorb such huge amounts of selling. A leveraged EPSF with huge firepower is required to bring back some semblance of confidence. Given the fact that the Euro has held on pretty well it does not seem as if there is a huge outflow out of Euro zone as a whole. It is just a move towards safety. On an overall basis the negative news flow out of Europe seems to have peaked out now.

There are two aspects to the markets at this stage. The first is the downside risk, where it is clear to me that we seem to have made a very strong bottom at levels of 4700 for the Nifty which is unlikely to be breached anytime soon. Currently we are around 10% higher than those levels. There has been a significant time wise correction along with value correction in the markets. As investors have got frustrated most have got out of small & mid caps and most investors (who are left in the equity markets) are just concentrating on large caps. For confidence to come back it is necessary for markets to sustain at higher levels and as that happens we will again see money flow into the broader markets which seems to be very cheap relative to the large cap indices on an overall basis.

The second aspect is about the upside. My initial view was that we will see the markets retrace, at least 50% of its entire fall from last November levels. This leads to levels of around 5500 & 18300 for the Nifty and Sensex respectively. The pace of the subsequent up move will be dependant on the trajectory of inflation/interest rates as well policy initiatives from the government. Expectations for growth have come down substantially. When we started off this year the estimates were for an earnings growth of 20% for the current year and 25% for next year. Current estimates for next years growth have now come down to 16%, which seems to be fair in the context of lower input cost pressures going forward as well as our being at the peak of the interest rate cycle.

As such on an overall basis, it seems at this stage that most of the concerns are in the price. However any upside from an improving macro environment in 2012 is not being factored in at this stage. This gives me the confidence that 2012 will be a good year for he markets.

Astrologically speaking – I just could not resist writing this so here it goes. There is an extremely significant astrological phenomenon that takes place in the middle of November where the most powerful of planets i.e. Saturn moves into his strongest position as it moves into the sign of Libra. Libra is t
he sign where Saturn gets exalted and acts extremely positively. The discomfort that it felt during its last two transits in Leo and Virgo now will give way to a feeling of extreme comfort. The last time this phenomenon happened was in the period 1982-85 where it unleashed an extremely strong bull market which eventually ended with the crash of October 1987. A similar phenomenon is likely to recur over the next three years. However as Saturn is a slow moving planet it might take some time to give its fruits. Normally Saturn requires Jupiter to either conjoin or aspect it to trigger it off and given that both planets will face each other from November 2011 till May 2012 we should see the trigger sometime during this period. More on financial astrology later.

Purely fundamentally speaking we are more near the bottom of the market than near the top and the next year should be good for the markets. How good is a question that will be determined more by the pace at which data improves.