Think Far Ahead

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In the current calendar year the Indian market has declined the most (by 15 per cent) whereas the other emerging markets remained flattish or corrected in a smaller range of 2 - 7 per cent. This correction was on the back of two successive years of out-performance by the Sensex over most of the emerging markets. The out-performance last year was led by a stronger recovery in the GDP growth rate, pick-up in the pace of domestic consumption, positive outlook on corporate earnings, and robust FII inflows. But macro issues like higher inflation rate,rising interest rates, rising commodity prices (especially crude), and a series of news flows on scams spoiled the mood of the investors who sold off over Rs 6,700 crore of equity in 2011.
The impact of a rise in interest rates and input costs was seen on corporate earnings in Q3FY11 which resulted in earning downgrades. The BSE Sensex is currently trading at P/E of 16x FY11E earnings which is still at a premium to most of its global peers (except China) which are currently trading at 12-15 times.We expect headwinds to continue for the next few months with the H2CY11 looking better. The third quarter results were a mixed bag with sectors such as banking, auto, and IT remaining the frontrunners with most of the larger players in the sector beating the street estimates. However,sectors like infrastructure, construction, cement, FMCG, etc remained laggards on delay in project awarding and execution, rise in interest rate, and higher commodity prices.
Besides the budget, the Q4FY11 results would also play an important role going forward. Additionally, the FY12 guidance by companies would also drive the markets. On the global front one will have to watch the developments in the Middle East region which may have a significant impact on world politics and energy prices.Inflation will ease out to certain extent after the several rate hikes by the RBI in the current financial year, but we believe it will continue to remain  above the RBI’s revised levels of 7 per cent, which is still above the comfort zone. Therefore, further monetary action of 50-75 bps is expected till June 2011.
The hike in the monetary policy rates has already impacted adversely the interest cost of the companies as witnessed in the third quarter results.The coming into effect of the base rates has given more transparency to the banks in the pricing of loans. Banks are likely to respond slowly in this declining interest rate scenario and become more responsive in a rising interest rate scenario as in the latter case they will be more prompted to pass on the incremental higher cost to the borrowers. [PAGE BREAK]

Hence, with the expected increase in the interest rates the banks will further increase their deposit and BPLR rates. We expect near-term out-performance by the developed markets driven by a shift in funds from the emerging markets to the developed markets by the FIIs. The shift in funds is triggered by inflationary pressures and a rise in the commodity prices in the emerging markets and economic recovery in the developed markets.In the recent correction a lot of mid-cap stocks with strong earnings’ growth corrected by 30-50 per cent and hence the valuation of those looks attractive once again.Our advice to investors is to buy stocks that are backed by strong fundamentals and good corporate governance. We see the current as well as any future correction as a buying opportunity for long-term investment.