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The start of the year has been volatile in the stock markets in India. To describe what is likely to happen, I paraphrase what the legendary banker, John Pierpont Morgan, said in the early 1900s in the US, "The markets will fluctuate".
This is not a flippant remark in India's context at the moment. The reason for the volatility is the extreme sensitivity the markets are likely to show upon the unfolding of events in India. India goes for a very crucial election and while it is unlikely to be momentous in the long run, it is key to our understanding of how the Indian economy is likely to progress. The surprise showing of the new political party in the Delhi Assembly polls upset the conventional wisdom around a large anti-incumbency wave. Now, it is much likely that it points to a much more fractured mandate than before.
Since the Indian economy has lurched between weak macroeconomic indicators, high interest rates and high inflation, the markets have remained range-bound. Growth has remained elusive as the investment cycle remains static, and infrastructural bottlenecks continue to impact the economy.
However, there is a silver lining to each cloud. India has seen a time correction in its markets over a five year period. Alternative assets such as gold and real estate have dominated asset allocations domestically. The international reference price for gold has come down by nearly 35 per cent from the peak. Stabilising global capital markets will likely see this erosion to continue. Fixed income markets are showing a significant rise in inflows since the beginning of the year and the rupee, too, seems stable on the back of these flows, as well as an improving current account deficit (CAD). Early indications also point to a drop in inflation, led by lower food prices on the back of a surge in supply following a record rabi crop and moderating core inflation.
This can lead to continued inflows from asset allocators globally, and may provide support to the markets. After the elections, markets might take a direction that they perceive the next government will take. The appearance of a pro-reform government may lead to a significant re-rating in the stock markets. However a perception of a weak-willed and anti-reform government may lead to a reverse outcome. Volatility, as a result is inevitable. The US Federal Reserve's taper has already set the proverbial cat among the pigeons (emerging markets) and currencies of Argentina and Turkey have taken a serious toll. India has been relatively unscathed so far on the back of a much improved CAD and a steady inflow from foreign institutional investors (FIIs) in the debt markets, while Argentina and Turkey have some serious domestic issues. We feel, the recent RBI policy move to increase interest rates might lend confidence to the international investing community about its seriousness to tackle inflation and keep the currency stable.
This, in no way, is a denouement on the markets in the long-run. India continues to enjoy pretty significant advantages as a market versus competition namely, demographics, relatively lesser levels of penetration of most goods and services and under-investment in infrastructure leading to sustained growth. But in the near term these positives are often overshadowed by roadblocks that may daunt even the staunchest believers in the India story.
We feel that, given the long-term valuations being in the fair value range, and with a consensus earnings per share growth estimate of nearly 18 per cent for FY15, a return to some stability and a new government, equity markets may deliver handsome returns vis-à-vis other alternatives. Fixed income rates appear to have peaked and there may be a rally in the bond markets before we see a sustained bull phase in the equity markets as well.
The near term, however, will be marked with volatility. Weak fundamentals will persist much into 2014 and better economic data can only be expected to appear until after the economic recovery has well and truly begun. However, markets always discount a recovery much in advance of the numbers being evident and can defy logic in the near term. If we wait for the numbers to change and then become confident of investing in the markets, the horse may have already bolted by then.
The author is chief investment officer, HSBC Asset Management India (P) Ltd
