The strong economic fundamentals, reasonable earnings outlook and lower valuations are likely to provide support to the Indian equity markets in 2011 despite the high volatility, according to Sandeep Kothari, Fund Manager, Fidelity Equity Fund, Fidelity Tax Advantage Fund and Fidelity India Growth Fund.
India Outlook 2011
“As we move into 2011, the fundamentals of the Indian economy remain strong while the capex cycle is yet to pick up substantially,” says Mr. Kothari. “The outlook for growth in earnings remains reasonable and the recent market corrections have made valuations a bit more reasonable. We remain constructive on the market for 2011, but believe that it will continue to be volatile.
“The key concern areas in my view would be any shocks emanating from the developed world or the high domestic inflation. There are some positive signs on the economic front in the western world, however, the debt levels remain high. On the domestic side, while inflation is expected to come down over the next 3-4 months, higher commodity prices or sticky manufacturing prices would be an area to watch out for.
“Overall, notwithstanding the near-term market volatility, the longer-term picture for India remains positive.”
About the outlook for the fixed income market in India, Shriram Ramanathan, Fund Manager – Fixed Income, Fidelity Mutual Fund, said: “India’s economic growth has been robust across most sectors despite the global turmoil and is likely to beat the 8.5% mark in FY 2010-11. Inflation remains above RBI’s comfort zone, albeit significantly lower than the peak double digit levels seen during 2010. A combination of supply and demand side factors has still kept inflation at an elevated level, and it is likely to remain the primary concern for the central bank in its policy formulation for the coming year.
The central bank, after a somewhat delayed start to the tightening process in 2010, accelerated the pace of rate hikes and liquidity tightening in the second half of the year, pushing up short rates by 300- 400bps. While the full impact of these measures on growth would be seen over the course of the coming quarters, we expect to see some more tightening measures by the RBI through the course of 2011 to get inflation within its comfort zone.
The key uncertainty stems from the global macro environment, where super easy policy adopted particularly by the US Fed has resulted in a rising trend for commodity prices – potentially impacting both India’s inflation and current account deficit.
For the Indian bond markets, volatility is likely to continue into 2011 with the central bank’s fight against inflation keeping the markets guessing on the extent of further tightening. However, with the effective front loaded tightening by the central bank, market yields discounting a fair bit of inflation worries and more importantly real rates finally moving into positive territory, we believe that returns from the fixed income market are likely to be attractive for investors with a medium term horizon.”
Global Outlook for 2011
Trevor Greetham, Asset Allocation Director at Fidelity International shares his views on 2011:
“2010 can be defined in terms of two significant influences on markets: the eurozone sovereign debt crisis and the authorities’ response to slowing developed market growth. 2011 will probably be defined by a more pronounced decoupling between developed and emerging economies, with significant commodity price rises providing a challenge to central banks hoping to print their way out of trouble.
“In my base case, developed economy growth rates remain tepid, with availability of credit the limiting factor. Housing markets are weak, the tailwind from the rebuilding of depleted inventories is petering out and austerity measures are about to kick in. I expect other central banks, led by the Bank of England, to follow the example set by the Fed by printing more money.
“Inflation is not a tangible concern for developed economies. US Core CPI, excluding volatile food and energy prices, is at its lowest level on record – at least since the 1950s. Mervyn King wrote several letters of apology for overshooting the Bank of England’s one-to-three percent target range in 2010, but inflation risks dropping out of the bottom end of that range if increases in VAT are stripped out. Policymakers are likely to prefer the prospect of dealing with inflation over the medium term using traditional policy tools rather than having to manage a deflationary spiral brought on by weak economic growth in the near term. Even so, rising commodity prices linked to emerging market strength could create political opposition for central banks that print money.
“In contrast, I expect emerging market authorities to continue to tighten their monetary policies. Their growth was not credit-constrained and spare capacity is scarce. Further US dollar weakness associated with QE2 will also provide stimulus to these economies at a time when inflationary pressures are already mounting.
“A pronounced decoupling from weak developed economies should support further strength in emerging market currencies. Stocks in emerging markets are also likely to do well as long as the authorities are not forced to tighten too much. Ironically, a strong recovery in the developed economies could create the conditions for a correction in emerging market stocks, but even then we would be likely to see further upside in the meantime. We are still a long way away from tight policy in economies like China, where nominal growth is in the double digits and interest rates are in low single digits.
“Commodities seem likely to do well if weak US growth leads to further Fed liquidity injections. They are also likely to perform well if US growth recovers, as demand will remain strong for some time even if emerging market governments tighten policy aggressively. In the weak US economy scenario, gold will probably continue to do best as investors use the metal to hedge both inflation risks in the emerging markets and fears of currency debasement in the developed world. Industrial metals would probably do best if global growth picks up in a synchronised way.
“I think developed market stocks could surprise positively once the industrial cycle picks up but it could take 3-6 months to work off excess inventories and ramp up production. I am relatively cautious on the eurozone as the ECB appears unwilling to print money or engage in competitive devaluation and speculative attacks are likely to continue. Spain will be the key to a more positive outcome. Its economy is too big to rescue with ease. However, it is a major manufacturer whose exporters would benefit from improved global demand and a recovery in growth would provide a boost to confidence for the entire region.
“Until such time as growth in the developed world becomes more tangible, bond markets could continue to fare better than equities. However, once a strong global growth trajectory is established, yields are likely to rise from low levels, exposing investors to capital losses they are not accustomed to.”
Commenting on the outlook for markets in 2011, Andrew Wells, CIO of Fixed Income at Fidelity International, says:
“I expect 2011 to be another volatile year in fixed income markets. There are still good returns to be achieved, but investors should expect softer returns than those experienced in 2009 and 2010.
I believe investment grade corporate bonds offer the best mix of risk and reward for next year and it’s likely that we see mid-single digit returns from this asset class. Heading into 2011, companies are in good shape - leverage is falling, rating trajectories are improving and the willingness of corporates to borrow to invest is low. The top-down data supports our bottom-up research as Fidelity’s analyst upgrade-downgrade ratio has turned back into positive territory, after seeing some years of persistent downgrades.
“While the company fundamentals are positive, relative valuations also present no obstacle as we saw only little compression in corporate bond spreads in 2010. At current levels, spreads are still wide versus history and while this is most evident in financials, the same also holds true in non-financials where spreads are around historic averages. Compared against historic default rates, spreads also provide adequate compensation. Absolute valuations are less compelling, with corporate bond yields on the low side of the range experienced over the past decade. However, this is reflective of low government bond yields rather than low credit spreads.
“High yield markets are more fairly priced, with yields currently around 8% and spreads close to historic averages. These bonds will be sensitive to the economic environment, which is still fragile. If slow growth and steady inflation persist in 2011, I think this market can continue generating attractive returns, especially as default pressures recede. Investors have expressed concern about the flow support for this market reversing, however I believe as long as interest rates stay low, investors’ ongoing search for yield will keep demand for high yield bonds elevated.
In the government bond market, I expect a small uplift in yields in 2011 as markets move to anticipate higher inflation. However any rise in yields should be relatively contained as growth stays low. The fears about government bonds are overblown as the debt overhang presents a significant obstacle for growth in developed economies and there is little evidence to suggest inflation will rise materially any time soon. The technical supports for government debt are also strong - ongoing accumulation of emerging market foreign exchange reserves are flowing back into developed government bond markets, demand from pension funds is likely to continue due to ageing populations, and changing regulation is forcing banks and insurers to hold more government debt.
“The outlook for policy rates will also help to keep government yields anchored. Central banks will be very much driven by economic growth and inflation indicators but I expect it will be at least the second half of 2011 before we see any signs of policy normalisation. Employment will be a key indicator to watch as only when there are clear signs of sustainable jobs growth and falling unemployment, will central banks be comfortable reducing support measures. Additionally, the large debt overhang makes developed economies much more sensitive to interest rates, so any efforts by central banks to lift rates will be a very gradual process.
“In terms of risks, sovereign issues are again likely to dominate the news flow next year. Many of the problems facing stressed sovereigns are still unresolved and while fiscal reforms are proceeding in deficit countries, their slow progress coupled with poor prospects to grow out of the debt burden will keep focus on the potential for debt restructuring. The support mechanisms proposed to date have only acted to transfer debt and if extended, could threaten the credit worthiness of core countries, which still face sizable debt burdens themselves. Therefore, I expect ongoing volatility in the peripheral European government bond markets and expect additional monetary policy support measures as well as a high chance of a managed debt restructure in 2011. Close attention will also need to be paid to the trajectory of deficits in core economies such as the US, UK and Japan. The US is less committed to tackling the deficit in the near term while UK progress will depend on growth in the private sector.
“For corporate bonds, sovereign risks are a double edged sword. On the one hand, corporate bonds may benefit as investors shield portfolios against the country risks by investing in companies with stable and geographically diversified cash flows. History has provided many examples of corporate bond yields trading inside those of their respective sovereign and I expect this theme will continue into 2011. However, at some point sovereign problems can be negative for corporate bonds as the combination of uncertainty and cost of debt repayment act to dampen economic growth (and company earnings). There is also the direct risk of sovereigns increasing corporate taxes. But these risks do not apply solely for fixed income markets, but for all risk assets.
“In addition to sovereign concerns, I believe the main risk for fixed income markets over coming years is inflation. Our forecasts are for inflation staying largely unchanged in the developed economies through 2011, but there are risks that inflation pressures start to build. Emerging economies are beginning to see higher rates of inflation and increasing wage pressures. Meanwhile in developed economies, quantitative easing threatens to unlock inflation expectations at some stage later through the cycle and there is a risk of accelerating money supply growth. Overall, I believe investors should start hedging portfolios for the potential that inflation picks up. Inflation linked bonds are particularly useful in this regard, especially global solutions that capitalise on the cheapest markets.
“All of the above themes highlight the uncertainty facing investors and the need for diversification or a more active approach to asset allocation. After strong fixed income performance in recent years, investors must now make their bond investments work harder. We have seen strong performance across our key funds in recent years and our managers are looking far and wide for the best sources of return for 2011. Indeed, directional strategies are likely to be less important next year with renewed focus on cross market interest rate strategies, sector tilts and name selection. High quality corporate bonds are our preferred asset class currently, but now is not the time to let top-down strategies dictate an entire investment portfolio. Importantly, our managers continue to actively diversify not only at the bond level, but also in terms of strategy and asset mix."
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