Deficit Monsoon Can Play Spoilsport

With the improvement in overall economic conditions globally, one of the thing that has definitely changed is the sentiments. This has indeed turned positive towards risky asset classes and, more prominently, towards emerging market equities. India, among the emerging countries, stands as the biggest beneficiary. This is because it has all the ingredients for sustainable economic growth. It has younger population which will drive domestic demand, has high savings which will drive future capital requirements and bring about growth.

On the valuation front now, although the large caps have almost reached the fair value zone, we believe the focus will be on quality mid-caps where a lot of valuation catching up will happen. On a broad basis, the BSE Sensex is trading at 18x and 15x its FY10E and FY11E earnings, respectively. We believe this is reasonable. Even on a relative basis, the Sensex is trading at the median multiple relative to its Asian peers, which are more export-oriented economies vis-à-vis the domestic driven Indian economy. Nevertheless, one of the things that may prove dampener is the deficit in monsoon. This will have an impact on the Indian economy to the extent that it will impact the agriculture yield. This, in turn, will lead to a spurt in food prices and resultant food-based inflation. The major impact of this would be on sectors like FMCG and auto, as rural markets are the key growth drivers for the above businesses. As far as Q1FY10 results are concerned, these were better than expectated as PAT growth was mainly led by increase in operating margins as raw material prices had come down significantly. We believe that Q2FY10 would be in line with Q1FY10 results with some improvement expected in topline growth of India Inc. mainly from the infrastructure and financial sectors.

Going forward it will be IT, infrastructure and metals which will report better sequential results as there has been some demand recovery on this particular front. Banking may be a laggard in this quarter, as there will remain some pressure on their margins due to higher provisioning. We would put our money into sectors where visibility of revenues is high and companies whose quality of earnings and condition of Balance Sheet is optimum in terms of capital structure. We are, therefore, bullish on the power sector and infrastructure because of visibility of revenues. We also like FMCG due to the high amount of cash flow generating capacity. One should also look at some agri-commodities like sugar and tea where there is a genuine case of demand-supply mismatch. As far as allocation of total portfolio is concerned, I would advice to allocate 50-55 per cent towards large-cap stocks, 20-25 per cent towards quality mid-cap stocks and 5-10 per cent in gold as hedge while the rest would be cash. As of now, my advice for retail investors would be to buy into well-researched quality companies and not invest merely on ‘hot tips’. They should make it a point to buy at every decline with a view of two to three years.