As I sit to write my prognosis for the year 2014 I am also looking back at the last two years and how the forecasts went. My view at the height of pessimism at the end of the year 2011 was that the markets would rise by 25% in the year 2012. The forecast turned out to be bang on with a market rise of 24%. Given the slack in the economy and poor governance at the government level my view for the year 2013 was for a rise of 12%. As we have ended the year the markets have moved up by around 9% thus underperforming my expectations by a couple of percentage points. The other key calls for the year 2013 from my side was that easing credit conditions will stop the downward spiral in Euro zone economies and the stock markets of these countries will do well. The other big call was for a collapse in gold prices and the breakage in the linkage between the US Dollar and Gold. This call also went off quite well. The last major call was that it will be a year of two carry trades i.e. Yen and USD and this played out through the year. I expected the Yen to decline by a minimum of 10% in 2013; the actual decline was more than double of this.
Where the call did not go off very well was of my view that mid caps will do better than large caps this year. The major reason for this was the pressure on the Indian Rupee in the mid part of the year as well as persistent inflation that kept interest rates high. Normally mid caps do well when liquidity conditions are benign. We have seen a turnaround in sentiments for mid caps over the last three to four months which should now carry through the year 2014 where I expect the overall mid caps segment to do much better than large caps.
My overall view for the year 2014 is that the year will be strongly positive for equities, especially in Emerging Markets. The bogey of Taper and its impact on Emerging Markets has already played out. It was very clear that Taper for the right reasons has to be bullish for risky assets and this is something that will play out going forward. The bullish strategists across broking houses turned extremely bearish in the middle of the year when Bernanke mentioned Taper for the first time. One year forward Sensex and Nifty targets were revised down to the 18500/19000 & 5500/5800 levels by most. It was then when the markets actually turned around.
In the Indian context I strongly believe that an economist who understands global macroeconomics at the helm of the RBI is a welcome change from bureaucrat Governors. This will hold India in good stead going forward. The biggest event for 2014 will obviously be the general elections where I personally expect a strong BJP led government to take over with support from some other parties. The key will be to see the strength of the mandate. My forecast of a NIFTY level of 7654 corresponds to around 25678 for the Sensex. I expect this level to be achieved even if there is a weak mandate in favour of the BJP. A stronger mandate will be more bullish.
This view will be driven by the fact that we are at the absolute trough of economic growth and at a peak of the interest rate cycle. Going forward interest rates will ease and growth will pick up. There are certain themes that should play out well in the year 2014 and some of these will be contra themes.
Banks, especially state owned ones – This will be one of the biggest contra plays of the year 2014. Most analysts are bearish on state owned banks given NPA concerns. However the reality is that the fact of the NPA problem is built into the valuations of these banks already. Investors are frustrated at buying these banks at lower and lower valuations and now no longer believe in the story. The larger banks in this category are cheap and will be direct beneficiaries as the economy recovers and the bad asset problem first moderates and then turns around. Some of the larger private sector banks are also well positioned and one of my big calls for the next 2-3 years is the improving perception of ICICI Bank in the minds of investors where a reducing risk profile will bridge the valuation gap between ICICI Bank and HDFC Bank.
PSU Oil Companies – I believe that the first action of the new government at the Centre will be to address the issue of fuel subsidies. This will obviously help the government in reducing the Fiscal Deficit by over 1% but will also help unlock the value in PSU Oil companies. To be very frank I have never invested in these companies myself due to government interference in their operations. However the value gap between their intrinsic value and the market value is today quite sharp. These stocks will be strong pre election plays and could provide huge returns post elections. This will be the strongest contra play of 2014.
Capital Good and Infrastructure Companies – The biggest valuation hit has been taken by companies in this segment. The reasons for the same are not only linked to the economic slowdown and poor governance related to project awards and environmental clearances but also due to the aggressive bidding by companies in this segment during the boom years. These companies are as much responsible for the mess they find themselves in as is the government and high interest rates. One of the first actions of the new Central Government will be to revive the investment cycle. This will lead to significant value coming back in a large number of companies in this segment which have seen their stock prices fall to as low as 5-10% of peak values. There are some segments like companies that are only focussed on the Transmission& Distribution segment as well as those are into road construction which hold lot of value today and should do well in 2014.
Automobiles – Automobiles as an industry segment has suffered due to high interest rates in the economy as well as poor consumer demand. However this has not been felt so much by investors into these companies due to various factors. Companies like Tata Motors & Bajaj Auto have done well in the overseas markets. Eicher Motors has benefited due to superior products and improving market share. Hero Motors has benefitted from rural prosperity and a company like Mahindra and Mahindra benefitted due to strong demand for its products in the first phase and then a revival in the Tractors business. As such, one of the most interest rate sensitive industry has gone through the trough of the cycle very well. These companies have substantial surplus capacity and will show good profit growth once demand recovers and will be a good play for the next few years.
Exporters – Exporters which have been a big story for the year 2013 should continue to do well going forward. A weak rupee and stabilizing global economy helped these companies in 2013. The year 2014 might not be a story of support from a weak currency; however an improving global growth outlook as well as relative currency advantage over China will continue to assist companies in this segment. Given the fact that Tapering will continue to accelerate through 2014 and ultra loose monetary policy will be slowly removed it is difficult to build a case for significant appreciation in the INR. I have previously written on making a case for a weak INR policy which should be in place till the CAD falls below 0.5% of GDP and till then the RBI should focus on building Forex Reserves. I do think that RBI has taken a lesson from the crisis of the last few years and will not let the INR appreciate due to capital flows. This should keep exporters happy and keeps the case for keeping export oriented stocks in the portfolio.
Economy and the Markets
The growth rate of the economy has fallen from over 7% to below 5% in two years flat. The reasons are not global but totally and completely local. As such the reversal can be as fast given a positive policy prescription. As the new government takes over and focuses on addressing subsidies and reviving the investment cycle we will see growth trend back very fast. Most domestic manufacturers today are sitting on substantial slack capacity. As revival takes hold the growth in profitability and corporate earnings growth will be much faster. Over the next two years corporate profit growth should move back to the 20% plus range. Most market analysts are forecasting a much lower growth at this point of time. This will be extremely positive for the stock markets as markets normally move on a beat of expectations.
As growth picks up we will also see a deleveraging cycle play out where out of the total Enterprise Value of a company value will also shift from Debt to Equity. This will add to stock market returns of the relevant companies. As profit margins expand the Market Capitalization to GDP which stands at 70% and peaked at over 150% in 2007 will also expand. Normally as markets move into a new range after taking out their previous highs the move is quite strong. This time the move over the previous highs will be after a period of more than 6 years and after several attempts at the same. As such the move will be much move sharper as we have seen in the case of the US and German markets among the major stock markets of the world. I enter the year 2014 with much greater confidence than I entered 2013. My overall Index outlook with an upside target of over 20% is the most bullish that I have seen till date among all strategist and analysts. I am confident we should do as much or better.
Best wishes for 2014. I will leave you with a couple of thoughts to carry forward for the year.
“Your success in investing will depend in part on your character and
Guts, and in part on your ability to realize at the height of the ebullience
and the depth of despair alike that this too shall pass.”
– John Bogle
“The stock market is filled with individuals who know the price of
Everything, but the value of nothing.”
– Phillip Fisher