The year 2012 began with an exceptionally compelling case to buy Indian equities. The rally in January and February, led by strong portfolio flows, points to the revival of global interest. The pause underway now may indicate a reassessment of the forces at work. We believe the case to buy stays strong, even as some of the contra forces persist.
While India’s GDP (gross domestic product) growth disappointed in 2011, it may well be at a cyclical bottom. The pace of rebound depends on the policy environment, uncertain at the moment. The Union Budget for 2012-13 is built on the assumption of a cyclical rebound in GDP, partly underpinned by a return towards normalcy in the developed economies. However, a recovery to seven per cent growth, say, while short of the heady numbers of 2004-08, would mark a significant improvement with positive fallout for equities. Several macro-economic variables, such as inflation, interest rates and industrial growth are near the unpleasant end of their cyclical span and are more likely to swing back into the comfort zone over the next 12 months.
Even after the rally in early 2012, valuations of broad indices are below their long-term stable bands. If supported by a revival in growth and portfolio flows they could rise much more. The impending decline in interest rates would not only stimulate economic growth but would also tend to make equities relatively cheap compared with the alternatives within fixed income assets.
The revival in foreign institutional investor flows in early 2012 made it the strongest start ever, measured by the appetite of foreign investors for Indian stocks. This attests to the persistent attraction of India to global investors in emerging market equities. The measures taken by the European Central Bank to stabilise the economies have enhanced liquidity in equities across borders.
The deeper influence of these measures may be evident through restoration of confidence among investors on the medium to long-term economic outlook for Europe and the US. The relative attraction of Indian equities to global investors is the variety of businesses, whose drivers range from consumption to investment, and local to global demand. The valuation cycles of these businesses often move on different paths. This can provide opportunities to enhance the relative performance of the portfolio.
On balance, 2012 still holds promise as a year where the opportunities may more-than-offset risks, leading to above-average returns for the discerning investor.
The author is ED and head of research , Avendus Securities
