Bear markets are born on greed or optimism and bull markets on fear or pessimism. Today, we have sceptics in the equity markets. That, by itself, is a powerful reason to restrict the downside for equities.
The Sensex is trading at the same level as in 2H CY2007. But during CY2007-12, the economy has grown over 40 per cent and Sensex earnings on forward basis have grown about 50 per cent.
The US and European crises, coupled with domestic issues, have resulted in derating of equities for pessimists and made it cheaper for optimists. While many players have lost money on momentum, contra investment has always made money in India. It is time for contrarian investment as negatives are factored into prices and any positive event can provide reasonable (though not runaway ) upside.
We can’t control global events. An event like break-up of the euro zone or default by Spain can pull down equities, like in the second half of 2008. However, it will be temporary and will revert to mean, like in the first half of 2009.
Domestic issues like slowing growth, tight liquidity, high inflation, high interest rates, depreciating currency and policy paralysis have pulled equity valuation down over the last five years.
Liquidity continues to be tight since May 2010 to control inflationary expectations. (But) the recent rate cut and liquidity enhancement can support growth and surprise markets, especially when expectations are low.
Inflation has remain-ed elevated for long now. The recent fall in inflation is more a statistical phenomenon. If we take into account suppressed inflation, then real inflation remains elevated.
There are two ways to tame inflation. One, is to curtail demand by raising rates, tightening liquidity and slowing growth. The other, is to increase supply by cutting rates, increasing liquidity and enhancing supply. RBI seems to be moving on the second path and if supported by the government through action on the ground, it will support growth and consequently equities in the days to come.
Higher crude and gold imports widened the trade deficit to $185 bn in FY12, while the rupee fell by over 15 per cent. Hopefully, lady luck will smile on India in FY13 in the form of lower oil prices and higher gold prices.
The other factor impacting growth is policy paralysis. Hopefully, action taken by the Reserve Bank will be followed up in other parts of the government and we will see growth surprising the low expectations of the market. Globally things do appear shaky. In a world where growth is scarce and liquidity is plenty, a little positive trigger could bring a lot of liquidity to India.
The Sensex is now trading at about 13 times one-year forward earnings. Smart money, after years of rise in gold and real estate prices, will be looking for some positive trigger to move into equity. Time is also ripe for individual stock picking.
History is with the Sensex to make an all-time high this year. Since 1992, every leap year, the Sensex has made an all-time high, except in 1996 when it crossed the previous year’s high.
The author is president (corporate banking), Axis Bank
