‘Indian markets can’t rally amid global correction’

Food price inflation,in particular,has been a matter of major concern for the Indian economy for quite some time now. During the last few years agricultural growth has been struggling to keep pace with population growth,resulting in a structural mismatch between supply and demand. The inflation situation has now aggravated with both commodity price inflation and asset price inflation setting in. I believe that in a welfare state such as ours inflation management will always be a priority in political economics as inflation hurts the poor instantly while growth benefits them with a lag. Notwithstanding recent post global meltdown concerns about growth,I expect strict inflation-combating monetary and fiscal measures to be adopted in the days to come. As a result,the high operating leverage that corporates have been enjoying so far in the current financial year will face a headwind from Q4FY10. The fiscal stimulus will be rolled back and high commodity prices will take their toll on corporate profitability. Short-term rates are also expected to go up in Q4FY10 as we expect a CRR (cash reserve ratio) hike and a clearer monetary signal of interest rates hardening going forward. As a result,the yield curve is expected to flatten from the current level.

What changes should investors make to their portfolio to safeguard themselves against this bout of inflation?

I think one should be overweight in stocks with India-centric business models,low leverage,and proven execution capabilities. Besides,I would like to suggest remaining overweight in the financial sector and consumer durables sector as a huge demographic premium is going to have a positive impact on these two sectors in the days to come. Further,those who want to invest in fixed-income instruments must limit their investments to the short term. Borrowers,on the other hand,may borrow for longer durations.

Are you bullish or bearish about the prospects of the markets and the economy over the next one year?

When we talk about a one-year time frame,we have to deal separately with the likely market movement and the prospects of the economy.

The Indian equity market is now fully integrated with the global markets. To a great extent,the domestic economy is open to the globe through the equity-market channel. Foreign Institutional Investors (FIIs) now hold more than one-fifth of the listed space. As a result,the rally that we have witnessed in the domestic market since March 2009 has been very much in tandem with the global equity rally. I agree that fundamentally India should command a premium over other markets,but it is hard to imagine a situation where the Indian market rallies in a big way while the global equity markets are correcting,and vice versa. Essentially,what I mean here is that you have to take a global perspective while forming a view on likely market movements.

Now the single reason I can think of behind the global equity rally is the unprecedented expansionary fiscal and monetary policies adopted by the major central banks all over the world. But as a consequence of such expansionary policies the inflation threat is now looming large in all corners of the globe. Therefore,at some point of time in the next one year some of the major central banks,including our own,will start exiting their expansionary policies. That may lead to corrections in global equity markets. This will affect our market as well. However,my feeling is that the correction in our market will be gradual as,hopefully,by that time we will have enough evidence of a turnaround in the domestic capex cycle.

As for India’s economic prospects,I am quite optimistic. Demand has never been a problem in our country. Private consumption expenditure accounts for 57 per cent of the GDP while investments account for 39 per cent of GDP. Now given the infrastructure bottlenecks in roads,ports and power,the problem in our economy is more from the supply side and not so much from the demand side. I am quite confident that the current government with a long-term mandate is strong enough to address such supply-side constraints through proper reforms. The demand side is also expected to be buoyant as a huge demographic premium is expected to kick in.

For the last three months the Sensex has traded in the 15,000 to 17,000-plus range. What are some of the factors keeping the markets range bound? And what will it take for the markets to move to a higher level?

In the last eight months or so the market has clearly moved ahead of fundamentals. The market consensus of +20 per cent EPS growth of BSE Sensex stocks in FY11 over that of FY10 is built on very vulnerable ground. Three-fifth of the incremental consensus EPS estimate of FY11 will come from energy (Reliance alone accounts for 25 per cent of such incremental EPS growth) and metal sector. Both these sectors are subject to global swings. I believe that the next big rally will start when the capex cycle turns positive in the economy. u

sk.singh@expressindia.com