After a lacklustre performance in the first week of July, the markets picked up briefly due to a positive start from the earnings season with Infosys and IndusInd Bank beating Street expectations. However, these came under pressure again due to short-term liquidity tightening measures by the Reserve Bank of India (RBI) to curb the rupee fall, negatively impacting both debt and equity markets. Going forward, the results season is unlikely to throw any positive surprises, with muted revenue growth and margin gains to drive profits rather than revenue growth. Downgrades might continue to outnumber upgrades, with laggards coming from cement, telecom, real estate, capital goods and banks. The rupee depreciation could continue to weigh on corporate profits this year, with earnings expected to grow eight to nine per cent in FY14.
Concerns on the currency remain paramount for the central bank, even as efforts to reduce gold imports have led to a lower trade deficit, while inflation has remained within the comfort zone at 4.86 per cent. Industrial production dropped by 1.6 per cent in May, signalling delayed growth recovery. RBI's proposed measures are intended to sharply reduce rupee availability in the domestic market and make borrowing expensive, deterring carry trade in the dollar-rupee pair. These measures are also likely to raise short-term rates, hurt long-term yields and could be negative for wholesale-funded institutions and working capital financing. No further rate cuts are expected till the US Federal Reserve's September 15 meeting because of the falling rupee and petering capital flows. All this could be incrementally negative for banks and non-banking financial companies.
After two months of massive gold buying, June saw a sharp dip in gold imports, due to government/RBI restrictions. This resulted in a 19 per cent month-on-month decline in overall imports in June, leading to a significant contraction in trade deficit to $12.2 billion, even as exports declined 4.6 per cent year-on-year. While the trade deficit has been an increasing cause of worry, its funding could get tougher, given the market uncertainty about the 'US tapering'.
There seems no major trigger for equity markets to move up in the short term. Weak exports, rising oil prices and a weaker currency might continue to pose a challenge for the economy. The government has finally taken reform measures to attract foreign flows, by increasing the foreign direct investment (FDI) limit in 13 sectors, especially in defence and telecom, and the overall FDI limit to 49 per cent through the automatic route. These measures could be positive for the economy but from a shorter term perspective, passage of the food security Bill and gas price hikes are expected to put further pressure on the rising fiscal deficit. A good monsoon resulting in lower food prices and rupee stabilisation could make a case again for rate cuts. However, tight liquidity and rising rates might plague the markets in the near term. Meanwhile, global uncertainty has again led the International Monetary Fund to downgrade 2013 global forecasts to 3.1 per cent from the 3.25 per cent expected in April.
The current environment makes a strong case for investment strategies and portfolio a stance biased towards a quality, dollar-dominated portfolio. Export-oriented sectors like information technology and pharma are expected to continue to perform. It is also important to build positions in quality businesses which are low on leverage and could offer significant return on equity, as compared to investing in high beta or deep value stocks. The huge divide in valuations between growth and value stocks is expected to continue till the market stabilises. Also, since volatility is here to stay, portfolios designed with active asset allocation between debt and equity are expected to perform better.
The author is head, investment advisory & research, Religare Macquarie Wealth Management
