What will drive the market in 2012?
Srujani Panda / 16 Dec 2011
My guess is that 2012 will be a good year for the markets, as most concerns will reduce in intensity. This will also set the tone for much bigger moves in the following years.
Prominent Market Drivers
Euro-zone Crisis –
The Euro-zone crisis and the debt issues related to Greece, Italy and Spain have been the main factors contributing to the nervousness in the global equity markets over the last several months. The crisis has been accented by a lack of faith in the political system and its ability to resolve the issues.
However, I have a contrary view on the future direction of news flow from the Euro zone. We now have new governments in all the troubled countries – Italy, Spain and Greece. Two of them are led by technocrats and one by the right wing party. In my view, the worst of the news flow from Europe is now in as such, and we may not get incremental negative news flows for the next few months. The entry of the IMF in the entire discussion, combined with a greater urgency to resolve the issues, is also encouraging. Overall, I do not expect Europe to create any deep cuts in the markets going forward.
US News Flow –
The news flow from the US has been mixed. However, the overall economic activity in the US seems to be improving, albeit at a slow pace, and there does not seem to be the likelihood of a double-dip recession at this stage. Most US corporates are cash rich, and market valuations are just at around 10x P/E for next year. Earning expectations for the year 2012 are pretty low, with a growth forecast in the range of zero to five per cent. As such, the news flow from the US will create volatility, but it does not look like it can create a fresh downmove at this stage.
Domestic Factors –
Governance and Policy Making: I believe that the major reason for India’s underperformance vis-a-vis most other emerging markets has more to do with domestic factors than with global ones. There has been a lack of policy making, and governance has come to a standstill. While of late there have been some signs that the government wants to move forward, events like the rollback of FDI in retail create doubts. Overall, though, this aspect seems to have bottomed out at this stage, and can only improve.[PAGE BREAK]
Constant Monetary Tightening Amidst Signs Of A Clear Slowdown: The RBI has stood out as the only central bank that has continued to hike rates despite clear signs of a drastic growth slowdown and in an uncertain global environment. This has further accelerated a slowdown in the economy, as the cost of funds has become prohibitive. I believe that this cycle is clearly likely to reverse now, and we will see interest rate cuts from the RBI much sooner than is held by the general consensus. As the rates start coming down, the markets will improve.
Decline in The Rupee: A sharp decline in the value of the rupee has also impacted sentiments. This has mainly been due to the lack of faith in the Indian growth story in the short term. However, from the current levels, the possibility of a great fall is limited. As the rupee stabilises, we should see foreign flows coming back into India.
Taking most factors into account, as also the market psychology as well as the valuations, I am of the view that the current market situation is akin to that in early 2009 when one could see only negativity, and that was the time that the markets bottomed out. Valuations, especially those of the broader markets are nearing historic lows today. The overall market is also trading at 12x the 2013E earnings, which is very attractive. My view of the markets over the next one year is that the Sensex will remain at 14800-15000 (at 12x P/E) in the worst case of, and will touch 26000 (at 20x P/E) in the best case.
The year 2012 will be one for patient investors. Equities never yield returns in a straight line, rather, they are in waves. However, the trend is normally up over the long run, especially for an economy like India, where nominal growth will be upwards of 15 per cent for a long time to come. The last four years have given no returns to investors and negative returns if the investment was in the broader markets rather than the Large-Cap indices. The market capitalisation has come down from more than 150 per cent of the GDP to 60 per cent of the GDP today. At some point over the next few years, we will see this ratio move up to its earlier highs again. Investments made at this period of despondency will certainly yield strong positive returns, as investments made in euphoria during 2007 or early 2008 yielded strongly negative returns.
There are a large number of stocks that are trading at valuations from which they can grow multifold as the cycle reverses. Individuals can chose to invest in banks, which will be the biggest beneficiaries of a pickup in the economy and interest rates coming down, Large-Cap stocks that are trading at 50-60 per cent of their peak prices, or well-established Mid-Cap companies with strong business models and franchises that are available much below their peak price levels due to high interest rates and short term stress in their businesses. The markets are positioned such that investors do not really need to take excessive risks to get strong returns.
Investors should increase allocations to equities and then wait patiently for the returns, which are certain to come
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