Extracts from Unifi's Monthly Newsletter

MARKET COMMENTARY

Springing Up

Global markets witnessed a remarkable bounce-back in January led by improved risk appetite and hopes of policy action driven growth momentum. Upbeat economic data from U.S and China lifted the sentiments worldwide and abetted equities to rally through the month. Copious FII inflows, shift in monetary policy stance and largely in-line domestic corporate results boosted the Indian markets performance further. The benchmark Sensex rose sharply by 11.2% during the month and closed at 17193 points. With about a 7% rise in rupee against the USD, MSCI India was among the best performers in Emerging Markets with a 20.8% rise. The mid and small cap indices outpaced the large caps by increasing 14.4% and 16.5% respectively. FIIs were aggressive net-buyers of about USD 2.03bn worth of stocks whereas domestic funds were on the selling side taking out USD 371.62 mn.

ECONOMY

Liquidity revives Sentiments; Can they ensure growth?

European Central Bank’s gargantuan refinancing effort (nearly half trillion Euros credit line to European Banks against their illiquid securities) is far greater than all forecasts and could turn out to be a game changer for the regional crisis if the banks utilize the funds to re-build their capital and core lending business instead of buying bonds. Further, the U.S Fed’s comments about maintaining interest rates at near zero levels until 2014 (earlier it was 2013) has minimized the possibility of liquidity crunch induced global slow-down. Meanwhile, IMF has reduced 2012 global growth forecasts to 3.3% from 4% citing increased downside risks – advanced economies to grow by 1.2% instead of 1.9% and emerging economies to grow by 5.4%. Given the revival in liquidity and sentiments, it will be interesting to wait and watch if the actual growth turns out to be better or not.

Domestic Macros – Upturn possibilities increase

The industrial production growth of November 2011 jumped to 5.9%, as against the street expectations of 2.1%, reversing the steep decline of 4.7% reported in October.  The sharp rebound was led by consumer goods that grew by 13.1%. Both the credit as well as deposit growth for December have accelerated to 17% levels. Headline WPI inflation for December eased sharply to 7.47% (a 2-year low) from 9.11% in November, reflecting both seasonal drop in food prices and favorable base effect. However manufactured inflation continued to remain sticky at elevated level of 7.41%, slightly lower than 7.7% recorded in November. We expect the headline inflation to trend below 7% in the coming months.

Figure 1-Industrial Production growth since Nov 2010         

                            

Figure 2 – Wholesale Price Inflation movement from March 2010 

Although the government is likely to overshoot its FY12 fiscal deficit targets, FY13 position could be a lot better with the emergence of two lifelines – 

1. The restitution of global risk appetite and liquidity would energize the proposed divestment of stakes in public sector companies, and 

2. The recent Supreme Court verdict cancelling the 2G licenses awarded in 2008 has thrown open the possibility of auctioning the restored spectrum at market driven ates (2010 3G auctions fetched USD 15 bn). 

Further, the steep 7% appreciation of Rupee against the dollar in January (highest monthly gain since 1980) and the continuing trend in early February would ease some pressure off the government’s crude oil imports amidst its forex reserves dropping to a 17-month low. Both IMF as well as RBI are of the opinion that FY13 GDP growth would be better than FY12 growth. In fact, IMF has pegged the FY13 growth at 7.3% while bringing down the FY12 number to 7%.

Q3FY12 Monetary Policy Review – Signaling a change

The central bank, in its recent review, surprised the markets with a CRR cut of 50bps while leaving the repo rate unchanged at 8.5%.  The Cash Reserve Ratio cut will inject primary liquidity of Rs.320bn into the system and would help in addressing the structural liquidity deficit seen in recent months (LAF deficit had gone up to Rs.150bn). However, RBI considers that rate cuts are not warranted at this juncture as upside risks to inflation persist. The policy document indicates that a reduction in the policy rate will depend upon ‘signs of sustainable moderation in inflation’.  In our opinion, RBI will wait for the FY 2013 Union Budget to be presented in parliament, (during mid-march) before making any decisive move on rate cuts. The RBI has reiterated its concerns about the rising fiscal deficit besides revising its FY12E GDP growth target downwards from 7.6% to 7%. RBI retained its inflation estimates for year-end March ’12 at 7%, considering the lagged impact of the rupee depreciation.  On the whole, it is clear that the growth-inflation balancing stance of the monetary policy stance has now decisively shifted towards supporting growth.  

MARKETS

Confident beginning - Downside risks muted but remain

After ending 2011 as the 2nd worst performing emerging market, Indian markets have rebounded sharply in the first month of 2012 aided by a host of positive global as well as domestic cues. The activity in bourses has also gained momentum with average cash volumes touching a 13-month high. Besides the CRR cut and EU developments, the Q3FY12 (Oct to Dec 2012) results of corporate India have also been supportive of market rally. At little more than the half way mark, the consolidated performance of BSE 200 companies that have declared their results so far have been marginally ahead of consensus expectations. Topline growth has been fairly robust at 25.6% yoy punctuated by shrinking EBIDTA margins (17.4% in Q3FY12 vs. 21.2% in Q3FY11) and earnings growth of 5.6% year-on-year. Most importantly, the overall downgrade cycle has been relatively benign with a 1% cut in FY13 Sensex EPS so far.

The upcoming central budget is going to be a very important event in the near term and would provide indicators as to how the government proposes to move ahead with policy reforms and fix problems in infrastructure, power and mining. Considering the fiscal deficit, the budget per se may not be corporate friendly as there is a possibility of increase in all taxes ranging from excise duty, service tax to surcharge on corporate tax. Nevertheless, a bullish view on India could emerge from better governance and policy reforms which would determine the sustainable long-term growth trajectory. The quick rebound from the 2008 crisis lulled the policymakers into believing that 9% growth was routine and double digit increases were round the corner. However, 2011 has provided a clear warning that poor governance would significantly jeopardize the India growth story. Going by the recent posture of the government in terms of fast tracking project approvals and resumption of concerted efforts to clear pending bills, it appears that introspection is on and amends would be made going forward.

Mid-Term Outlook for Metals

Contributed by: Sathyamurthy U, Unifi Research

Global political and economic events such as the sovereign debt crisis and the slowdown in recovery from the last crisis in economically sound countries have rendered the industrial metal prices directionless.   However, copper and aluminium prices have increased by 5.7% and 4.7%  since the beginning of the year.

China, the world’s second largest economy consumes significant share of primary raw materials such as iron ore -60% (of global iron ore trade) , copper – 41 percent, aluminium – 40 percent. Demand outlook for these industrial metals can be explained by import, export and value creation activity in China.

Copper

The metal is currently on an uptrend due to strong fundamentals – supply disruptions due to labor issues in some of the world’s largest copper mines, depleting stocks in LME warehouses, and potential demand supply mismatch.  The following chart shows the monthly import growth of China and Copper prices. (superimposed over one another with same time base). Copper prices have corrected along with the decline in import growth in China. 

Aluminium

A similar trend is seen in aluminium prices during the same time period.  

The impact of slowing imports on GDP is shown in the following chart. The current level of import growth and the corresponding GDP growth are exhibiting similarities to the crisis 2008-09.

The Chinese economy is buffeted by two forces - slow global growth is hurting exports to European union, which is the primary destination for Chinese  exports.  China’s exports have slowed down recently. The domestic consumption due to rise in wages in China might not be enough to make up for the shortfall in foreign orders. (Source – WSJ)

Another problem is the housing prices in China. Government is trying to control prices by making it difficult to finance development of luxury apartments and requiring 60% down payment from buyers.  The low cost housing is not progressing as planned.  These problems will likely have an impact on the GDP growth in China which has already slowed from 10.4% in 2010 to 9.2% in 2011.

Further slowdown in consumption of industrial metals (lower imports) either through slower growth in EU or domestic weakening in the Chinese economy appears likely and will have an impact on metal prices especially copper and aluminium.

Hence my outlook for copper and aluminium is negative.  

Steel

Steel consumption in India has slowed considerably from 14.5% to 2.9% in 1H12, with project offtake slowing down and other macroeconomic challenges cropping up. According to ICRA, 25 MT of new capacity are coming up in the next 18-24 months (30% of current production capacity) and keep the realizations under check despite the weakening currency scenario.

The higher interest payments arising out of the capacity expansions will also decrease margins for steel makers and raise working capital requirements, thereby affecting the liquidity profile of steel companies.  Companies with better capital structures such as Tata Steel  will be able to withstand the competitive pressures.

The major steel consuming sectors in India – construction (65%), capital goods (15%) and automobiles (8%) are witnessing slowdown.  Project offtakes  are affected by land acquisition issues and interest rate scenario.  The near term outlook for steel is weak.  India’s GDP growth rate for Q1 and Q2 FY12 was 7.7% and 6.9% while steel consumption growth for the same period was 2.9%. (Typically steel growth rate is 1.2-1.5 x GDP growth). According to GoI projections of 7.5% growth rate for India in FY12, this will be ahead of steel consumption growth.

Hence the mid-term outlook for steel sector is negative.

Views expressed are personal and do not constitute to the market outlook towards commodities at Unifi. 
Email: sathya@unificap.com

Market Commentary for the month of December

Grinding Down

Indian markets slipped further during this month, which was choppy for most parts, disappointed by falling industrial output, worsening fiscal deficit position and government’s rollback of its proposal to allow Foreign Direct Investments in Multi Brand Retail segment. Despite decent advance tax numbers, marginal moderation in inflation and RBI’s hint about reversal of hard money stance going forward, the domestic sentiments remained subdued pulling the benchmark Sensex down by about 4.14% in December.  MSCI India was among the worst performers for the month as well as for the calendar year with a decline of 6% and 37.97% respectively as compared to MSCI EM (Emerging Markets) which dropped 1.29% and 20.41% respectively. The Rupee depreciation of over 16% against the US dollar in 2011 accentuated the adverse impact for India. The domestic mid and small cap indices continued to underperform the large caps by falling 8.75% and 8.97% respectively. Although FII’s were marginal net buyers of about USD 31.79 mn worth of equities in December, they have withdrawn about USD3.81 bn for the year as a whole. Alternatively, the domestic mutual funds have been net buyers in 2011 bringing in about USD 1.2 bn to the equities segment with USD 112 mn coming in during the month.

Snapshot Review of the ‘Chaotic’ Year 2011

Year 2011 is best characterized as an eventful year but mostly for the wrong reasons. Global Asset Markets squirmed as the sovereign debt issues in peripheral Europe snowballed into a full-blown crisis scuttling the global economic recovery process besides raising the specter of a double dip recession. Indian economy and consequently its markets were further hit by persisting inflation, multiple rate hikes and inertia in government policy making amidst a background entangled with periodical news of grafts and scams. Interestingly, all seemed well for the Indian Markets in the beginning of the year 2011. The indicator of Indian corporate performance, BSE Sensex, was near its peak levels of 20,000. Output of six core infrastructure industries such as finished steel, cement, crude petroleum, petroleum refinery, coal and power had recovered sharply after a moderate quarter. RBI had forecasted WPI inflation to drop to 5.5 percent by March 2011. Current account deficit as percentage of GDP was a manageable 3.6 percent.

To top it all, India’s growth rate was projected to grow at an annual rate of 9+ percent overtaking China as the world’s fastest growing economy. With the benefit of hindsight, one would note that whatever could have gone wrong at the start of the year indeed went wrong in Year 2011.  WPI Inflation remained at elevated levels of 9 to 10+ percent levels through the year on account of rising food, fuel and commodity prices despite RBI’s successive rate hikes (from 6.25% in January 2011 to 8.50% in December 2011) to curb demand. Slowdown in IIP, which was seen to be more of a short-term issue solvable by affirmative policy actions, turned out to be a long-run problem affecting national GDP growth and corporate earnings due to increase in input and borrowing costs besides government’s complete inaction on the reforms front.

The monetary tightening did have an impact on inflation which started cooling off in November, however at the cost of slowing industrial and economic activity.  Industrial performance deteriorated further during the end of the year and declined by 5.1% on yoy basis, due to contraction in manufacturing and mining activities, while capital goods witnessed a yoy decline of 25.5 percent. GDP growth for Q2 FY12 moderated to 6.9 percent from 7.7 percent in Q1 FY12.  On the expenditure side, investments also showed a significant slowdown.  Flow of foreign capital into the country which was in an uptrend during the first half of the year due to strong FDI inflows, rise in ECBs and trade credits, initially offset the sharp decline in FII inflows due to Euro zone debt crisis and concerns of double dip recession. However, as global risk aversion continued to build up and domestic markets continued to fall, flow of capital dried up considerably, widening the current account deficit further amid faster decline in exports than imports. Global concerns such as the European sovereign debt crisis, slow economic recovery in the U.S., political unrest in Middle East nations, and natural disaster in Japan were initially believed to have little impact on the Indian economy due to its domestically driven demand.   However, there were significant indirect effects - spike in oil prices led to increased current account deficits. Accommodative monetary policies in Europe and U.S. which were rolled back in June 2011 adversely affected the global trade and capital flows.

A combination of all the above problems discussed i.e. high inflation, burgeoning current account deficit, decline of capital inflows resulted in a massive 16+% fall in the value of rupee (from Rs.45 levels to Rs.53 levels) against the U.S. dollar. This in turn has considerably jeopardized the position of several Indian companies that have significant dollar denominated /linked debt in their books.  

2012- Transformational Year? - Focus to shift from Inflation to growth

The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!

Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  We expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  We also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, we will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 

Any adverse global economic developments are obviously not in our control. What’s more disconcerting is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  We don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, we do hope and feel that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% at least in FY 2014 if not earlier.

MARKETS

What lies ahead?

Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown and hence domestic market benchmark indices underperformed their developed as well as emerging counterparts. Mid and Small cap Indices witnessed a steeper sell-off compared to large caps. The sell-off was also broad-based with all the sectors except FMCG closing in the negative territory. Real Estate, Metals, Power and Capital Goods were the top losers amidst concerns of slowdown in investment activity and coal shortages. Trading volumes in equity market is presently at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Although Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”. 

Direct access for foreigners to the Indian stock market - Is the excitement for real??

Glenn Roger Carr, Vice President, Unifi Capital

The Indian Government has made a strong bid to strengthen the domestic markets by proposing to allow Qualified Foreign Investors (“QFIs”) to invest directly into the Indian equity market vide press release dated January 1, 2012 issued by the Ministry of Finance. The proposed new investment route is aimed at providing the much needed stimulus and to improve the sentiment of our markets

Currently, investing through the FII route directly or by going through a sub account of an FII are the only means for foreign individuals or institutions to invest into India.  In August 2011, the Securities and Exchange Board of India (SEBI) had permitted QFIs to invest into mutual fund schemes, thereby providing an indirect way of making foreign investments into Indian equity markets, and that was the starting point of the current policy which we shall carefully analyse

Key Highlights of the Proposed New Regime as provided under the Press Release

1.    RBI to grant general permission (i.e. under the automatic route) to QFIs for investment under PIS route similar to FIIs.

2.    The investment by QFIs would be subject to an individual investment limit of 5% of the paid up capital of the Indian company and an aggregate investment limit of 10% of the paid up capital of the company. These limits are over and above the limits applicable in case of investment by FIIs or NRIs under PIS route.

3.    QFIs would be allowed to invest only through a SEBI registered qualified depository participant (“DP”) and all the transactions would have to be made through this DP only.

4.    DPs would be the ones who would be required to ensure that the QFIs comply with the KYC norms and the stipulated regulatory requirements.

Pros and Cons of the policy

1.      Under the current SEBI (Foreign Institutional Investors) Regulations, 1995 there are stringent conditions imposed on the registration of FIIs and sub-accounts such as if an asset management company or an investment advisor has to be registered as an FII, it has to indicate that it is proposing to make investments on behalf of broad based funds. Further, funds can be registered as sub-accounts only if they fulfill the broad based criteria. Similarly, if an individual wants to register as a sub-account, then inter alia he has to fulfill minimum net worth criteria of USD 50 million. With these conditions not being imposed on a QFI it makes it easy and gives the investor the incentive to register and invest directly as a QFI.

This would allow a large group of foreign investor’s direct access to the Indian equity market instead of investing through FIIs/sub-accounts and at the same time will provide wider opportunity to the Indian companies to raise funds.

2.    If we look carefully at the regulations, it states that the individual limit of 5% and the combined QFI limit of 10% of paid up capital per stock is over and above the FII and the NRI limits that are already in force. This could mean that QFI’s could now buy into stocks that were earlier blocked due to the FII or NRI limit being breached. I would actually think that some of these stocks would see substantial fresh investment into them thus pushing their prices up.

3.   There are questions about whether NRI would be classified as QFI’s? Even though there is no direct mention to the contrary, it is quite clear that the QFI   limits are over and above NRI limits, which could lead us to conclude that NRI’s do not qualify under the new QFI regulations.

4.  The tax treatment for the QFI investment will ultimately decide the success or otherwise of this regulation. While it is quite clear that these investors will not benefit from a zero tax regime( which the bigger players who invested through the FII sub-account route benefitted for many years and continue to do so)it remains to be seen what kind of  tax structure and the method of taxation that would apply to the QFI’s. I do believe that the larger investors would any day prefer their tax benefit to the ease of investing option.

It would only be the smaller foreign investor who invested through the non discretionary route of a sub-account (which is a complicated and costly route to take) who would probably consider this trade off worth taking. In that sense one may not see a rush of fresh investments coming in through the scheme but it could definitely bring in a new breed of investors and widen the base of the current investor profile.

5.    When a guru of the stock market was asked about this new regulation he said that opening just one market does not excite him too much, he went on to say that if one opens the stock market they should open up the commodity and currency market also then only will the big boys be interested to invest large amounts into India. This then clearly is another affirmation that the BIG investments may not line up under the QFI route.

6.    The pessimist may ask why an individual foreign investor should choose India, wont he put his money where his mouth is? And even if we assume that he is a diehard Indian market optimist one would think that he would prefer the easy route of an India ETF which is now available in choice especially in the American markets.  This argument I must confess does hold a lot of weight.

7.   SEBI has stated that one of the objectives of this regulation is to broad base investor bases, improve inflows and make the market less volatile. While the first two objectives are definitely achievable to some degree it is difficult to understand as to how QFI investments will reduce volatility. QFI’s are not lateral thinkers they will think and act like all investors who are driven by greed and fear and in market swings these investors will act like any other thus probably adding to the volatility and not reducing the same. Statistics from the American and British markets also tell us that 90% of the investors are day traders and if they now choose to invest into India there is no reason for these individuals to suddenly turn into long term players.

8.  It would be appropriate to conclude the analysis by looking at one big benefit that the QFI will finally have and that is true beneficial ownership. As a client who invested through the FII or through a sub account the client were merely holders of buy positions in a company and never enjoyed  voting rights and other benefits which they will now be able to exercise as “real shareholders”

It would also be very interesting to study the operative guidelines that SEBI is going to put in place. The qualified DP’s/ brokers  who believe that the QFI segment is a one worth servicing would have to ensure new systems and process( the kyc part of it would be a big challenge-unless simplified), beef up research by a huge margin and also gear up to build their brand, and after doing all this there is no assurance of success.

The QFI has thrown up a lot of debate and discussion and the proof of the pudding will be in its eating, so as we wait and watch for the happenings in the next few weeks like all investors I hope that more than anything this would improve the market sentiment more than anything else.

The author is Vice President at Unifi Capital. Views expressed are personal.

glenn@unificap.com

2012 - Transformational Year? - Focus to shift from Inflation to Growth

Contributed By: M. Ravvichandran, Vice President - Investment Strategy

The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!

Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  I expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  I also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, I will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 

Any adverse global economic developments are obviously not in our control. What’s more deplorable is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  The market participants don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, one can hope that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% in  FY2014.

What lies ahead?

Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown.  Trading volumes in equity market is at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Though Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”.

As we are in a transformational phase, it is easy to be bearish on India and equally easy to construct a bullish scenario from here-on. Most of the negatives are now well-documented and debated and hence are already reflecting in the price. Given the macro economic scenario, the beaten down stocks and sectors will continue to under-perform at least for next couple of quarters.  A further correction is likely to be in terms of time rather than value and a good entry point is likely to emerge soon. 

The author is Vice President at Unifi Capital, Chennai.  Views expressed are personal. Email: ravvichandran@unificap.com

From the Sage: A likely Buffett perspective on the Indian Markets

When equity markets crashed in 2008 in US and the rest of the world; as investors were surrounded with news of Lehman collapse, near collapse of banking system resulting in almost frozen credit markets and a series of defaults and negative GDP growth, Warren Buffett wrote an Op-Ed in a leading national daily in US, New York Times with the title “Buy American, I Am”. He wrote this on October 16, 2008 when Dow and S&P hit a decade low with an advice to buy. While the indices continued to drop further for the next few months, they delivered 50%+ returns over the next 2 years. Had he been investing in Indian equities market, this is probably what Buffett would have written today.

The views expressed here are my own and hence do reflect neither that of Warran Buffett nor my company. The sentences below in italics are an in verbatim extract from Warren Buffett’s letter published on October 16, 2008.

Contributed by G. Maran, Executive Director at Unifi Capital

The equity markets are once again in a mess, both in India and abroad. The problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, investment activity will falter, businesses will struggle and the headlines will continue to be scary. So… I have been buying Indian stocks. This is my personal account I’m talking about, in which I previously owned nothing but Government Bonds. If prices keep looking attractive, my portfolio will soon be 100% in equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread and is gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. However, fears regarding the long term prosperity of India’s leading business enterprises which have   great fundamentals make little sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be enroute to setting new profit records - 5, 10, 20 years from now.

Let me be clear on one point: I can’t predict the short term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher a month-or a year-from now. What is likely, however, is that the markets will move higher, perhaps substantially so, well before either the sentiment or the economy turns up. So if you wait for robins, spring will be over.

A little anecdote from history: In 1991, after successive governments of Rajiv Gandhi, VP Singh and Chandrasekar fell; a financial chaos set in coupled with a cascading downward economic spiral precipitated by the Gulf war, resulting in swelling of oil import bills and decline in exports. With forex reserves of USD 1.2 billion – barely good for three weeks of imports and a likely default in foreign exchange looming large – Yashwant Sinha, the then finance minister, few weeks before the government fell cleared the pledge of gold to raise USD 600 million to honour India’s financial obligations. This crisis created an opportunity for an economist finance minister (Dr. Manmohan Singh) and the equity markets rebounded, delivering above 25% annually over the successive 3 years inspite of the Harshad Mehta scam.

In short, bad news is an investor’s best friend. It lets you buy a slice of India’s future at a marked down price. Over the long term, the stock market news will be positive.

During the decade of the 90’s, we witnessed multiple government changes, global wars, border tensions, South East Asian currency crisis, couple of stock scams, years of inflation in double digits, few quarters of GDP growth less than 2%p.a., 3 governments in 2 years (between 96-98)and yet finally delivered a return of 18%p.a., about 5 times in 10 years.

In the last decade, ending 2010, despite the IT bubble, global terrorism during the Sep’11 attacks, communists controlled governments (in place for half the decade) and frozen global financial markets due to a near collapse of the banking sector; Indian equities delivered have delivered more than 15%p.a.

During the last 20 years, bank deposits have delivered less than 10%p.a. A capital investment of Rs. 1000 with an annual return of 10%p.a would have become Rs.6,700 without any volatility or down years. But the same investment in Sensex that delivered 17%p.a.would have become Rs. Rs.23,100 with yearly returns ranging from -50% to +80%.  

One might think it would have been impossible for an investor to lose money during the last 2 decades which were marked by such extra ordinary gains. But some investors did. The hapless ones bought stocks only when they found comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

If Sensex closes Dec 31^st, 2011 at same levels as it closed the week (sub 15800 levels), calendar year of 2011 will become second worst year for equities over the last 20 years of India’s open economy. We all know 2008 was the worst year and that the subsequent years return was above 80%. Over the last four years, since 2008, the Sensex has delivered negative returns of 22% when the underlying companies have grown 40% in earnings and 60% in book value. We all know stock prices grow as much as business earnings of the company over the long term.

Equities will almost certainly outperform debt over the next decade, probably by a substantial degree. Those investors who cling now to debt are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been”

I don’t like to opine on the stock market and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was”. Today my money and my mouth both say equities.

India inches closer to crisis as rupee retreats

Conributed by Baidik Sarkar, Unifi Capital 

Our belief in the inherent strength of the Indian rupee has blinded us in looking at other drivers of the currency. Our faith in RBI’s monetary management practices has contributed largely to our coherent views on the relationship between INR and USD. They fact that we were unscathed in 2008 was largely attributed to RBI’s prudence in fiscal and monetary management issues and we assumed RBI’s non-intervention was a sign that the current phase of INR-USD volatility will have a short shelf life. We have been in denial a bit too long; any longer from here and the scars might be too deep to heal.

Source Reference: Reuters
India may face its worst financial crisis in decades if it fails to stem a slide in the rupee, leaving the Reserve Bank of India (RBI) with a difficult choice over how to make best use of its limited reserves to maintain the confidence of foreign investors. 
Read on for further insights: http://reut.rs/uwTQ9A