America, BJP and China are the ABC of market recovery

Things could change for the battered markets if the three factors play out well, says Saurabh Mukherjea, Head of Equities

Indian equity markets have once again begun their descent quickly after giving the impression that they had reached a comfortable altitude. Even as you read this, there seems to be no positive trigger for the markets in the near future. Nothing seems to be working the way the markets want: no relief on the inflation front, unrelenting current account deficit, no hope for a spectacular GDP number, and not to forget Subbarao's mild slaps every now and then.

But things could change, and yes, for the better if the markets get their A, B, & C right, says Saurabh Mukherjea, Head of Equities, Ambit Capital. He is referring to America, BJP and China, which, Mukherjea believes, could contribute to an economic and stock market recovery in India.

A for America

The American economy is on the recovery path and if things continue going right, it will bring good news for India.

"With construction cranes once again dotting America’s urban skyline, with house prices rising again, with the euphoric February jobs print, and with strong retail sales data acting as a tonic, it would appear that almost every section of American society is reloading on risk," Mukherjea says in a report, adding that with rental yields at 5-6% and borrowing costs at 2%, real estate PE funds are going into overdrive.

This risk-on is obviously part of a broader re-allocation from bonds to risk assets, and it is clear that the big US fund houses are planning for a post-QE world, where the Fed starts raising rates.

"In the run-up to this watershed moment, equities will benefit enormously. This helps explain why we are running into so many new ’Emerging Market Small-Mid cap‘ equity funds or better still from our perspective, new India-focused funds," Mukherjea points out.

 

In the past three years, new FII money is entering Indian equities, and FIIs are now willing to engage with India in greater detail than most DIIs.

"Inflows into FII funds and outflows from DII funds have created a situation where the only buyers of Indian smallcaps are sitting miles from home. That is a crying shame for DIIs because with the relative valuation of Indian small caps versus large caps at near decadal lows," he says.

B for BJP

With the cries for “Modi for PM” getting louder and with the ex-Finance Minister Yashwant Sinha’s pro-reform credentials being well established, investors are now contemplating just how reformist an agenda the BJP will launch in the run-up to the General Election.

The ruling party is also likely to make the right noises about reform in its election manifesto, and also try to deliver some reforms, such as FDI in insurance and GST, before the nation goes to polls.

Thus, investors are beginning to envisage a pre-election battle between Modi-Sinha and Chidambaram, where each seeks to outdo the other on the reform-related promises.

Mukherjea says he believes that if such a contest comes to pass, it is likely to perk up the stock market. "So, rather than having to see the stock market sagging in the run-up to the elections, we might be positively surprised," he says.

C for China

It is true that India’s star is not going anywhere at present, but is also undeniable that China’s star is on the wane. From that perspective, it appears that FIIs’ perspective on China has changed. Let's see how:

Till about a year ago, most FIIs were confident that whilst the Chinese banking system is loaded with non-performing loans, the government’s mighty balance sheet could bail out the banking system if required. "FIIs are no longer as sanguine about this issue. In fact, the bears believe that the Chinese banking system is beyond repair," says the report.

Similarly, investors earlier fretted about the real estate bubble in China, but it wasn’t their central concern regarding the country. Now, with most investors having seen empty Chinese cities – with flats, offices and malls but no people – fear about how soon this bubble might collapse is rising. Interestingly, the bears see China as being where Japan was in 1988-89 i.e. on the verge of a crash in real estate which could wipe out the savings/wealth of a whole generation.

A year ago, most investors felt that once the new Communist high command took charge, it would engineer a hefty fiscal stimulus and rev the economy into life. Now that there is no uplifting stimulus in sight even after the new guys have been running the show for four months, the bulls are beginning to fret. Their discomfiture is heightened by the weekly one-page adverts that the Chinese government now takes out in the Wall Street Journal to eulogise its new leadership.

In all, India seems poised for better days if politicans make right noises and deliver on promises, and more important, if the wind of change starts blowing in its favour.