Since early September,2013,Nifty surged 13.6 per cent on the back of strong FII equity flows (~ Rs 28,864 crore) despite mixed signals on the macroeconomic front. Elevated and stubborn CPI (9.84 per cent) and WPI (6.46 per cent) in September; lower-than-expected August IIP (0.6 per cent) growth; and downward revision of GDP forecast were the negatives for the market. Exports growth (11.15 per cent) in September helped to improve sentiments and so did the RBIs October balanced and anticipated monetary policy repo rate hike of 25 bps and reduction of MSF rate by 25 bps but the surprise element was the increase in liquidity through term repos of 7-day and 14-day tenor to 0.5 per cent of the NDTL from 0.25 per cent. Justifying its stance,RBI noted that liquidity conditions have eased in the system with the average drawal on the MSF has declined significantly from about Rs 1.4 trillion by mid-October to Rs 40,000 crore,and money market rates have fallen by 125 basis points.
The market euphoria continued with the US Federal Reserve getting into a wait-andwatch mode before pressing the taper button,which in our view is unlikely to happen before March,2014. The Fed sees the improvement in economic activity and the job market since it began its asset purchase programme as consistent with growing underlying strength in the broader economy but reiterated that it will wait for more evidence that progress will be sustained before adjusting the pace of its asset purchase.
Markets are currently at an all time high (Nifty 6,307) on the back of strong FII flows,receding worries on the domestic macro front; expectations around a political change in 2014 and Q2 FY14 earnings beating expectations and progressing well for India Inc.
However,with retail investors participation at its 10-year low,the euphoria is missing even at such elevated market levels. The next trigger for the market,we believe could be the state elections in four states MP,Rajasthan,Chhattisgarh and Delhi which could have a priming effect on the general elections in 2014.
That said,lingering concerns over fiscal deficit overshooting the budget estimate in an election year,hardening interest rates,slow investment growth,elevated inflation and a sluggish Gross Domestic Product (GDP) growth may create roadblocks for the upward spiral in the equity markets.
However,the downside risks do not seem very pronounced at this juncture given that the government has been reasonably proactive on the policy making front with results showing up in the form of improving current account deficit (CAD),stabilising rupee,credit growth,and growth in the core sectors,particularly power.
Our six-month Nifty fair value target is 5,950,but we expect the Nifty will continue to gyrate in the range of 5,600 6,500 during the same period. In this liquidity driven rally,investors should buy selective stocks on dips rather than getting aggressive as valuation remain stretched at 15.4x forward P/E for the Nifty.
In the current environment we propose the following five investment themes for the next six months:
* Weak rupee and improving economic environment in developed economies to hold exporters in a sweet spot (Information Technology,pharmaceuticals,commodity exporters and auto players with a global footprint).
* Elections (state and central),excellent monsoon resulting in a record farm output and government spending to make rural consumption theme more resilient and also lead to a pickup in rural housing and infrastructure activities (FMCG and cement).
* Diminishing regulatory overhang,benign competitive environment,and improving pricing power to benefit telecom sector.
* NPAs,elevated interest rates,margin squeeze and relatively slow credit growth to extend pain for financials and hardening of interest rates to have a second level impact on discretionary spending (discretionary products,real estate and domestic auto players).
*No signs of revival in the private sector investment cycle to affect performance of cyclical sectors industrials,metals,and utilities.
We are overweight on IT,pharma,consumer staples,telecom,cement and energy; underweight on financials (banks & NBFCs),auto,industrials,materials and real estate; and equal weight on utilities.
Apart from these,mid-cap investment theme appears compelling as their valuation is at a deep discount to large-caps (Trailing P/E premium of Nifty over mid-cap index is 1.25x as compared to 1x at the beginning of the year),although their fundamentals are improving. Our research shows that in a bullish environment,like we are in now,mid-caps tend to play catch-up with large-caps. Investors should try and pick up quality mid-caps with low leverage,higher ROE and high operating cash flows.
Ravi Sundar Muthukrishnan with Vinod Karki
Ravi is senior vice president,co-head,research and
Vinod is vice president,strategic research group at ICICI Securities Ltd.