Year end thoughts

Proceeding to a vacation at the year end, I thought I would just put out some year end thoughts and also try to summarize what I thought should happen in various market segments and how it has actually panned out.

The year obviously has been an amazing one with most dire predictions going out of the window (at least for now) and recovery in most asset classes being better than expected. After a long time period I have spent the last 15 days meeting up with a large number of companies across the spectrum of industries and one thing that is coming out clearly is that the recovery in India is here to stay. The second key thing I have observed is that the benefits of growth has now started to percolate down into mid size companies and they are now much more confident about their growth prospects.

The benefits of easy liquidity and low interest rates is also now coming to mid tier companies with most mid cap companies saying that interest rates for them after holding up even after the significant monetary easing did not really come down till around 3 months back. However now, suddenly banks are becoming desperate to lend and competing against each other and as such on an average the rate of interest for working capital loans for mid cap companies has come down by 200-300 basis points. This should contribute towards profits growth next year. Smaller companies are also benefiting from easy fund raising possibilities from the equity and debt markets.

I see the next year to be highly constructive for alpha investing as the possibilities of picking out companies that will deliver strong results will be there next year. At the beginning of the year I was very bullish on Airlines as my view was that the industry has gone through a period of consolidation and most companies have realized that they cannot continue to fund their operations thought equity funding and will need to go back to making operational profits. The state of the industry has improved significantly and now as volumes pick up and capacity addition remains subdued the next two years should bee good for the industry. Most stocks of the industry have rallied this year and should continue their performances going forward.

Similarly I see consolidation benefits in at least two other industries on the mid cap side on whom I will write later.

On the ground growth in India has picked up strongly. Today we are in a scenario where consumer durable, non durable, auto etc sales have picked up and expected to remain strong for the next year at least. The capital investment cycle has also started to pick up now, especially with investment activity picking up on the infrastructure side. The only risk seems to be on the inflation front where a reactive move from RBI towards largely supply side driven inflation (mainly food) can slow down the recovery process. As of now the policy makers seem to be aware that tightening liquidity and increasing rates is unlikely to control this kind of inflation. Lets see how they respond going forward as the Hawks in the Economic Advisory Committee of the Prime Minister are rooting for some sort of rate tightening with their logic being that high food inflation will lead to secondary inflation with demands for higher wages and also the fact that once prices move up they tend to be sticky. I would not say that their logic is without merit, however any step that is taken should be a baby step not large scale moves as we saw last time when the RBI started to tighten.

My view is that inflation in India will largely be cyclical and will move up till around the middle of next year to a level of 8-8.5% largely due to the base effect as well as high food prices. Subsequently it should ease out and settle at 5-6%. The change of the WPI series that is expected next year should also be more representative of the current consumption patterns vis a vis what existed when the last series was made.

The rally in the markets, gold, movement of currencies has largely been in line with my expectations. I had expected the rupee to be stronger than what it has been and that is one area where I have gone wrong for this year. However I expect the rupee to appreciate by an average of 4-5% against the USD over the next two years.

The current consensus is moving towards a 15-20% market correction. However given the economic fundamentals and the funds flow scenario I really do not see any big sell off coming to the markets in the near term. The markets are shaping up to move towards new highs in the year 2010 and any big sell off should happen more towards the end of next year where we could see the markets giving one of its big bull market corrections. However this will be after a further upmove. Mid caps should outperform large caps by a wide margin next year as the results of mid caps finally start reflecting the improved fundamentals.

The US dollars strength could remain for some time given the improving economic numbers, however might not sustain in the long run unless investors are confident that the monetary and fiscal stimulus of that country can be withdrawn without leading the country into a recession. I think this is something that I will watch carefully. Returns for gold and commodities might slow down with the US dollar strength and consolidation.

Lastly I would like to reiterate my point that although valuations might be looking stretched at this point of time as I wrote a few weeks back valuations should not be a concern at this stage of a bull market as growth is generally underestimated and valuations adjust as growth comes through. The second point is that the reality of the markets is that in bull markets things are never cheap and in bear markets when things are cheap there are no buyers.

On an overall basis the next year looks very interesting and exciting. I am not sure I will be writing again till the end of the year so I will take this opportunity for wishing every one a Happy New Year and hoping that it is good for all. I thank all my readers and specially those who have been sharing their views on the blog frequently.

“A pessimist sees difficulties in all opportunities; an optimist sees opportunities in all difficulties”