Markets always tend to discount the current and set sights on what can change. Last year, Indian markets, too, priced in all the negatives and once the government showed signs of action, it led to a sharp rally in the second half.
Going forward, it seems clear the ruling party wants to contest the next election on economic growth and reforms. So, the coming Budget is likely to be growth-oriented, rather than populist. The government might also push the reforms agenda with direct cash transfers, implementation of Goods and Services Tax (GST) and an aggressive disinvestment policy. These will set the pace for growth, with a softening of interest rates.
Globally, developed economies seem to be stabilising. Some progress has been achieved on the US fiscal cliff and tail risks seem to have been curtailed in the Euro zone, with peripheral economies showing signs of structural improvements. This augurs well for Indian equities.
FY14 could see at least 13-14 per cent earnings growth compared to 10-11 per cent in FY13. On a 12-month forward basis, India is trading at 14.5 times, around the historical average. As the environment begins to settle and growth returns, earnings forecast upgrades are likely.
The key risks in the short term relate to political instability impacting the reforms process, inability to contain the current account deficit (CAD) and its consequent impact on currency value, worsening of border tensions with Pakistan and a strong comeback by China, which could impact commodity prices. But, if the first three are averted and the third muted, the next six months would see the markets rallying significantly.
We, therefore, expect equity markets to remain buoyant in the first six to eight months of CY2013. If structural reforms like GST get implemented, we might see an even sharper rally. But the market rally tends to mask some structural issues with the economy, like absence of an investment environment, huge CAD, sustained corruption, lack of political will and stability.
As India gets into election mode, worries of populist measures by the government and uncertainty of the election outcome might become an overhang on the markets.
We expect stocks in the banking, infrastructure and industrial segments to lead the rally. A banking rally will move from receding asset quality concern to margin expansion to credit growth at various stages. Currently, we are in the first stage. This cycle should pan out over the next few years. Metals, too, could perform well, given the recovery in China and the suppressed valuations. Information technology will continue to do well, given the natural hedge against our currency and undemanding valuations. Recovery in developed markets can help. fast moving consumer goods (FMCG) stocks could produce a negative surprise, thanks to over-ownership and high valuations. However, if GST gets implemented, the sector will benefit immensely.
The media sector is set for significant structural changes, following the recent regulatory changes. This sector can achieve a different scale on both broadcasting and distribution over the next four to five years. Another key theme would be export-oriented/import-substitution plays, given India is weak on CAD. Similarly, given the high replacement cost and sustained inflation, manufacturing plays trading around book values hold much promise.
The author is president & head, wholesale capital markets, Edelweiss Financial Services Ltd
