After being extremely bullish right through the phase prior to the start of 2014 and more specifically after Raghuram Rajan took over as RBI Governor I turned cautious on the markets in September/October when the markets were around 8000 levels. Infact I still remember being in a TV interview the day markets hit a peak of 8175 and to me that seemed to be a decent peak to give an 8-10% correction. The reasons were both domestic and global as global risks seemed to be growing and the pickup in the domestic economy was slower than expected. However markets continued to rally after giving two minor corrections and have reached a new all time high today. As such it’s important to look back and reconcile the view to what’s happening on the ground and what could happen going forward.
Narendra Modi’s image- I had written in April last year to ride the pre NaMo wave inorder to participate in the post NaMo wave. This came true as the new government came with a huge majority. The positivity created by the PM combined with the strong reputation of the RBI Governor seems to have placed India in a preferred position as far as foreign investors go. It seems most investors are willing to look past a few months to ride the India wave. The impact has also been strong domestically where domestic investors have poured in huge money into Equity Mutual Funds where the total inflows have crossed Rs 30,000 Crores. The success of the BJP in subsequent state elections has also added to the positivity. It has also become clear over time that the government is focussed on getting the economy going as most issues impacted due to the parliamentary logjam have been cleared through ordinances. It might be debatable whether this is the right way to go, however investors have taken it positively. Although recovery and action has been slow to start of investors seem to be playing for the long haul. I am also personally sure of the delivery from the government.
Crash of commodities, especially Crude- At the time when I gave the initial cautious view Brent Oil was trading at $ 95 per barrel. We have seen prices rapidly crash to $ 50. This obviously gives a huge impetus to India both in terms of contributing to a lower Trade Deficit as well as putting nearly $ 50 billion into the pocket of Indian Consumers which is a huge stimulus for consumption. However the crude price fall also has negative consequences for Oil Producing countries and a crisis in Russia or the Middle East could have global ripples. The bonds outstanding of US Shale producers are also to the magnitude of $ 550 billion where we could see some defaults. Normally such a crash in commodities would see its ripple effect across other Asset classes. However the Quantitative Easing programmes of various central banks have distorted the normal response. India is obviously one of the biggest beneficiaries of the crude crash. However it impact on global fund flows will be seen going forward. The negative impact for India could be in the form of lower remittances as well as lower investment by Oil nation Sovereign Wealth Funds.
US Dollar Rally- We have normally seen that a US Dollar rally creates a liquidity squeeze in Emerging Markets. The rally of the USD did create a selloff in a vast majority of Emerging Market currencies as well as their equity markets however India did not participate. This was a rare event in an era of interlinked global markets and funds flow. Additional stimulus by the Bank of Japan and expected QE by the ECB seems to have reduced the liquidity scare this time. While we saw many markets like Brazil, Russia and even South Korea move to years lows the Indian Markets held on. Given the likely policy divergence between the USA and other countries the probability is high that we will see a further rally in the US Dollar this year. This should reduce overall flows into Emerging Markets and is something we need to watch.
Sharp fall in inflation – The Consumer Price Inflation as well as the WPI fell rapidly over the last two months as a result of the crash in global commodities as well as the base affect of last year’s spike in food prices. As a result the RBI has started cutting rates earlier than expected. Now since the RBI Governor has always said that when the policy stance changes it will be directional we can expect a 100 basis point fall in policy rates this year. This should support economic growth in the later part of the year and was always expected. It is also likely that inflation will now remain subdued for a good part of this year unless we have a food price spike during the summer months. Rabi planting has been much lower than last year and could impact food prices at that time.
Risks remain- Risks related to global events, Central Bank policy failures as well as some sort of Sovereign crisis due to the commodity price crash remain. Concerns related to Chinese wealth management products as well as high Debt to GDP ratio also remain. The impact of cross currency moves on Indian exports at a time when the INR is becoming increasingly overvalued will also have an impact at some stage. There have been huge flows into Indian Debt last year and over the last few weeks. Unlike FDI this can also move out very fast.
Markets at the current levels now trade at near 20X current year earnings. At the beginning of the year the expectations were for a 15% earnings growth this year. The actual delivery has been much lower. The assumptions for next year are also in the region of 18-20% which looks to be a tall task as of now.
CONCLUSION
In conclusion I would say that the long term picture still remains very bright and with the interest rate cycle actually turning this will be the year where the stock specific approach will work very well. On the other hand it is also true that for the short run both the Indian markets as well as global markets seem to be priced for perfection with no scope of disappointment. We have now had a 17 month up move in India without a single negative 5% month which is a record of sorts. Normally a rise in markets is followed by earning upgrades whereas we have actually seen downgrades this time. The results season in the US has also started off with disappointments. A major selloff in the US will impact other markets.
Despite record stimulus by Central Banks the economic growth globally still continues to be anaemic. The risk of a decent selloff sometime over the next few months remains.
On the other hand opportunities related to improvement in domestic macro economics, lower interest rates as well as in companies operating in areas where the Government proposes to focus on remains. We have seen markets rally 5% plus in January itself YTD which is almost half of the 10-12% I thought they would do this year. Let’s hope I am wrong and this turns out to be a much better year. I would hold my horses for now.