Tuesday, March 5, 2013

Gimme some hope!


Gimme some hope!

Now that the euphoria over “Reforms” unleashed by the government after the incumbent FM took over last summer has yielded the way to “Reality” and the market expectations have been mostly aborted, we find it pertinent to find reasons to stay invested in Indian equities. The task is not easy, especially when you are standing at the precipice staring down at the abyss that lies ahead.

As highlighted in the yesterday’s issue of Morning Trekk, we do not see much reason to increase allocation towards Indian equities at this point in time. Nevertheless, the incorrigible optimist in us believe that the current economic phase will not lead to a structural collapse of “India Story”, and the next 5years will see Indian economy’s potential growth rate improving from the current 6-7% to 8-9%. Which essentially implies that over next 5years Indian equities might provide decent returns to investors.

Remember, the five year period between 2008-12 the benchmark indices have given negative (-)4% nominal return in absolute terms. Taking the impact of inflation and dividends, the return would be (-)30% negative.
In this background we tried to work out the best and worst case for Indian equities in next couple of years.

The best case

The best case for Indian equities in next two years would be that:

(a)   The global economy stabilizes, especially US and China, leading to improvement in external demand environment;

(b)   the benign liquidity conditions continue to prevail at least till end 2014, keeping the rates low so that investors keep chasing that extra few bps of yield thus sustaining the flows to India;

(c)   the next general election in India produce a truly coalition governments where the constituents genuinely agree on a common minimum program and such CMP is implemented in right earnest.

The key risk in this scenario could be sharp rise in global commodity prices, especially energy that would strain the macro fundamentals of Indian economy further.

In this scenario, we could have a repeat of 1998-1999, where a large but selective market rally occurred in new economy stocks, following a global trend.

It is however critical to note that such a rally would be very selective and fizzle out as the valuations of selective sectors become excessive soon.

In this case the exporters, especially IT services and large unleveraged pharma companies could gain substantially. The austerity drive in US and EU may also support more outsourcing of public services to cheaper labor and demand for cheaper pharmaceutical products produced in India.

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