Catch - 22
The current market conditions present a classic dilemma
before the investors in Indian equities.
There are reasonable indications to suggest that the global
equity rally may extend little further into the summer; and along with the
Indian markets may also show strength. However, the trends in macro
fundamentals of Indian economy are suggesting a likely deterioration as the
summer heats up. The actual corporate performance might also be sub-par in next
couple of quarters, leading to another round of earnings downgrades. Even if
RBI cuts rates aggressively, it will take at least 2-3 quarters for it to
reflect positively in earnings.
In this Catch-22 situation – the investors broadly have two
options – (a) continue to remain underweight on equities; wait for the
macroeconomic conditions to bottom out and show some signs of recovery; let
this rally happen and fizzle out; or (b) participate in the rally by investing
in selective stocks that may tangibly and/or sentimentally benefit from the
recovery in global economy (mainly US and Japan) and therefore logically
participate in the global markets led rally.
In our view, the investors should opt for the second
alternative.
To implement this decision, it is important to understand
the characteristics and direction of the global rally and identify the likely
beneficiaries on the Indian shores.
We feel, the global economic improvement will be primarily
led by (a) reduced level of stress in financial system (b) productivity gains
through cost savings (mainly energy and wages), & technology innovations, (c) continuation of low rates & benign liquidity and (d) fiscal corrections
(austerity in public spending and higher taxes).
These theme shall manifest, inter alia, in lower employment
growth (more outsourcing), lower public spending (outsourcing of government
jobs, lower defense and security, budgets, lower healthcare budgets etc.,),
large scale migration to tax arbitrage jurisdictions (Singapore, Dubai etc.)
lower consumption growth and new wave of manufacturing revolution in west
triggering a price war with Asian giants like Korea and China.
Thus, the sectors that may lead the rally will likely be –
US financials, EM ITeS outsourcing companies, EM pharma, technology innovators,
Dubai and Singapore real estate, etc. The losers would include consumers,
materials and low productivity manufacturers.
The key risks would include a serious global political
crisis leading to failure of economic cooperation seen since 2008; elevated
geo-political risks and security threats as defense budget cuts take place in US and
Europe, leading to spike in energy prices; and major collapse in commodity
world.
We add Voltas, Hindalco, Mind Tree, Siemens, to our Watch
List disclosed last week.
We also propose to launch a model macro long short
portfolio, with a12-15months time frame, on these assumptions from April 2013.
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