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India Equity Research Reports, IPO and Stock News
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…but who said surfing’s easy?
Not exactly a joyride…
We are witnessing radically different economic battles being fought in different parts of the world
In the largely open economic environment, policies in one part of the world create unintended consequences for another
The marginal driver for this year is likely to be Chinese policies as they attempt to rein in inflation and property prices
A large part of 2011 will continue to be a transition year for financial markets before definitive trends are borne out
We continue to believe that we are in the midst of a major asset inflation cycle over the next 2-3 years
Navigate the ‘breakers’ and it’s going to be a good ride
Surf-zone 1: USA
What happened to the economic cycle?
Markets continue to wait (and wait) for the recovery…
US corporate profits and cash flows are at record highs
This would usually trigger an investment cycle, where new jobs
are created once again
This would set in motion a virtuous cycle of higher incomes-higher
spending-higher growth till inflationary pressures creep in and a
tightening cycle begins again
So far though, clearly, something is amiss in the US economy; US
businesses are not yet investing and hiring as they should be
Manifestation of a longer-term trend
One of the factors could be the impact of globalization
US businesses may prefer to invest outside the US until the
local economy regains its competitiveness
The other could be simply that US consumers are tapped-out after
several years of binging. They need to repair their balance sheets
further and this process may take several years to play out.
Moreover, there remains excess capacity already in most parts of the
economy
Another reason could be the erosion of the manufacturing base in
the US over the last 3 decades
Even a weaker USD may not yield quick results
Forget the light, it’s just a very long tunnel…
Other key indicators in the US though recovered from the lows still
remain soft
Median home prices are still falling, so are new home sales
Credit is still contracting
GDP growth has so far largely been driven by inventory-rebuilding
Not unusual for the early stages of a recovery but a lack of
follow-through end-consumption growth could stall the
recovery
Next wave of liquidity: Coming soon
The Fed will keenly watch for signs of a sustained recovery before
taking away its promise of an extended period of low rates
Core inflation is still very low and gives the Fed a lot of leeway to
pursue its quantitative easing policy
The challenge for the Fed is that the current form of QE is not
leading to flow of credit into the economy
The banks are piling up the cash back into the Fed and the
money multiplier has collapsed
Our expectation remains that this is going to be a longer grind for
the US than what markets are expecting
The Fed will have to resort to more rounds of QE and one cannot
rule out direct monetisation of treasury issuances to get the money
actually into the economy
Surf-zone 2: Euro zone
The winter freeze
The peripheral countries are in serious distress and deflation
Bond spreads have widened again
Fiscal austerity measures have reached their limits
The Financial Stability package in 2010 had solved only the liquidity
problem for these countries, not the solvency one
Difficult choices awaits Europe
Letting these countries drop out of the Eurozone and
devaluing their currencies significantly (effectively putting the
whole EU experiment at risk)
Taking on the excess debt burdens of these countries through
budgetary provisions (amounting to about 6% of EU GDP) –
politically a very difficult choice for Germany
A restructuring of these loans with its potential fallout on
European financial institutions that hold most of these loans –
not a great option post the 2008 experience
ECB monetizes the bad loans by buying these loans directly –
a huge ideological challenge for the ECB – but perhaps the
most plausible solution
ECB’s hand will be forced
Our base case remains that Europe will ultimately be forced to bite the
bullet
The challenge is that it remains a financial union without a political union
At the same time, too much political capital has been invested by
Germany and France that they will ultimately have to back, in most
likelihood, an ECB-led bailout/monetisation.
But clearly, this will not happen overnight
Both, the ECB and the political leadership, will drag their feet for a
while and the Euro economy will continue to suffer
However at some point this year, the ECB will be forced to step in.
This will lead to a weaker Euro and yet another important economic zone
in the global economy that starts to pump liquidity into the global financial
system
Most likely timing – H2 2011
Surf-zone 3: China
The key region to watch out for
Getting the call on China correct is the key to getting the call on
2011 right
The reason for that is that the Chinese monetary policy now, in
absolute terms, has a bigger impact than the US monetary policy
at least for the time being as the US money multiplier has
collapsed
China has been the marginal driver of global commodities, including
most agri-commodities for several years now
Inflation has been rising in China rapidly, like most emerging
markets, driven by rising food prices
Core inflation though, remains soft. We expect this to
continue as China’s boom has been essentially driven by
capacity creation and excess capacity exists across almost all
areas
The Chinese central bank has however been tightening policy in
their bid to curtail property price speculation
Property prices though high have not outpaced nominal GDP
growth and may not necessarily be in a bubble zone
The coming storm…
While the Yuan has appreciated against the USD, it has actually
depreciated significantly on a trade-weighted basis
This is actually offsetting the Central Bank’s tightening agenda
At some point this year, as the USD appreciates, in turn triggering an
RMB appreciation, the full impact of Chinese tightening will be felt
This will create a not-so-insignificant shake out in global commodity
markets
And probably trigger another double-dip scare across the global
economy
Expect equities to correct and bonds to rally sharply
This shakeout will wipeout the speculative excesses in the commodities
markets
This will temper inflation and interest rate expectations and lay the base
for the next big speculation mania in financial markets
Commodities Outlook
A bullish outlook is now commoditized
Commodities, is again, an asset class where there is almost universal
consensus that we are in a long-term bullish phase
Driven by rising consumption from countries like China, India etc. and
the impact of global liquidity
While rising consumption has been a factor, the Baltic index (which
measures shipping freight rates) does not reflect the same degree of activity
Liquidity clearly has been a major factor in feeding prices as also price
expectations
A slowdown in China triggered by the ongoing tightening will be a stern test
for most commodities
Our base case view remains, that economic activity in the US, EU and
Japan will remain sluggish for an extended period
This will create headroom for growth in consumption by fast growing
emerging markets
There will always be dislocations or cyclical shortages in different
commodities from time-to-time
Rising commodity prices, beyond a point, move from being reflective to
restrictive in nature
They effectively become taxes and hurt consumption leading to
demand destruction
Gold
India: The big driver as well as the beneficiary
We continue to remain long-term bulls on gold
No surprises there!
Low interest rates will continue to support gold through a low opportunity
cost
Institutional money managers as well as central bank diversification into
gold is very miniscule and even a slight reallocation could cause significant
moves in gold prices
One of the other key reasons to remain bullish on gold is that as per-capita
income continues to rise rapidly in India, the largest gold-consuming nation
in the world, gold demand can only go one way, and that is up!
Surf-zone 4: India
Getting whiplashed by breakers after breakers…
In the space of 3 months, the outlook has gone from euphoric to ‘what hit us??’ !
We seem to be fighting battles across the board - gigantic political corruption, parliamentary stand-offs, corporate governance, offshore
black monies, back-breaking rise in food prices
But in this free-for-all milieu, we should not lose sight of the key battle that is really relevant for the long-term economic growth and
financial markets performance
That is inflation, and inflationary expectations
It’s not to make light of the other issues that have come to the fore
But those are issues that have existed in India forever, and for all the song-and-dance by the media, may very well continue to exist
Our view remains, though, that while growth and market performance could be that much better without these issues, markets have and
will learn to live with them
The fact also remains that public memories, unfortunately are short. It will be only a little while before news channel figure another
method to bump up their TRPs and these issues fade into the background
India: Fixed Income
Pessimism is universal…
There is a universal consensus that interest rates in India can only rise and that
inflation is a big issue
This is also the key variable for the equity market outlook
This at a time, when inflation has most likely peaked, bond yields are at close to
long-term highs (barring a few months in 2008) and liquidity is at its tightest in years
In our view, India’s inflation is a supply-side issue
If it were demand-led and pricing power were back, manufacturing capex
would have been roaring – It’s clearly not
WPI for manufactured products is still steady
In our view, the biggest risk to the world economy, is a threat of deflation caused
by over-investments in various parts of the world.
As for liquidity, it should only be a while before the government starts spending all
the monies parked with RBI and that should address liquidity issues
The government borrowing program for next year should also be reasonable and
we actually expect a reduction in relative terms over the nominal GDP base
While bond yields may remain volatile in the short-term, we expect yields to come
significantly lower (7% and possibly lower) as the year progresses
Also, it remains a key asset allocation call and hedge in the event of a major
correction in commodities and equities
India: Currency
Comeback kid…
Our longer-term call on the Rupee has been extremely bullish
Though INR has been caught in a range for several months now
but we believe that downsides are limited and the longer-term
outlook is Rs40-levels
The shorter-term outlook is clearly driven by behavior of oil prices and
financial flows
As the investment cycle picks up, the trade deficit may not shrink, but
will be balanced by capital flows that come in to finance the investment
activity
RoIs in India are much higher than other parts of the world
including the emerging markets
India is a significantly underinvested economy and therefore the
RoIs should remain high for a while
Availability of global financing will not be an issue
An interesting observation, by our economist team, has been the nature
of the trade deficit
If one adjusts the trade deficit for gold imports (making the
argument that it is nothing more but a currency swap), the current
account deficit actually shrinks from 2.8% of GDP to 0.9% of GDP!
India: Equities
Intermission…
The late 2010 correction notwithstanding, we have a strong conviction that Indian
equities are in the midst of a major structural bull market
Most of the current constraining factors like inflation, politics etc. should recede
by H2 of 2011 allowing markets to scale back previous highs
The story in Indian equities though is not in 2011, but actually in 2012 and 2013
We expect a major investment cycle to hit the ground beginning with infra
investments and followed soon by manufacturing
An investment cycle always leads to explosive earnings growth and catches
analysts off-guard
There is a additional accounting rationale for this earnings growth
When a sale is made, revenues are booked at one-go, whereas in most
cases, the buyer capitalizes the purchase and expenses it over 5-10 years
So while the markets are assuming a 20% range of earnings growth for FY13,
one should not be surprised if one sees earnings growth of 40 to 50%-types in
FY13 / FY14
This can translate into a Sensex EPS of ~1700 for FY13 which combined with a
bull market PE of 25 can bring us to 43000 – 45000 Sensex levels by FY13 end
It also follows that in this bull market, the investment theme should outperform
the consumption theme after lagging for the last 3-4 years
Summary
The world economy is in a transition phase
The liquidity pumped into the system has created significant cross-currents while raising asset prices broadly
The current concerns around inflation will fade as tightening in China weighs on commodities and hopes of strong recovery in the US fade
We continue to expect swelling liquidity infusion from the developed world spawning bigger asset bubbles
In India too, inflationary expectations should temper significantly by second half of this year, allowing equities to resume their uptrend
The big years to watch out for are calendar 2012 and 2013
As investors you would rather be out there surfing in some volatile waters than sunbathing by the shore
..'coz when the big one comes, you wouldn't want to miss the fun!
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
…but who said surfing’s easy?
Not exactly a joyride…
We are witnessing radically different economic battles being fought in different parts of the world
In the largely open economic environment, policies in one part of the world create unintended consequences for another
The marginal driver for this year is likely to be Chinese policies as they attempt to rein in inflation and property prices
A large part of 2011 will continue to be a transition year for financial markets before definitive trends are borne out
We continue to believe that we are in the midst of a major asset inflation cycle over the next 2-3 years
Navigate the ‘breakers’ and it’s going to be a good ride
Surf-zone 1: USA
What happened to the economic cycle?
Markets continue to wait (and wait) for the recovery…
US corporate profits and cash flows are at record highs
This would usually trigger an investment cycle, where new jobs
are created once again
This would set in motion a virtuous cycle of higher incomes-higher
spending-higher growth till inflationary pressures creep in and a
tightening cycle begins again
So far though, clearly, something is amiss in the US economy; US
businesses are not yet investing and hiring as they should be
Manifestation of a longer-term trend
One of the factors could be the impact of globalization
US businesses may prefer to invest outside the US until the
local economy regains its competitiveness
The other could be simply that US consumers are tapped-out after
several years of binging. They need to repair their balance sheets
further and this process may take several years to play out.
Moreover, there remains excess capacity already in most parts of the
economy
Another reason could be the erosion of the manufacturing base in
the US over the last 3 decades
Even a weaker USD may not yield quick results
Forget the light, it’s just a very long tunnel…
Other key indicators in the US though recovered from the lows still
remain soft
Median home prices are still falling, so are new home sales
Credit is still contracting
GDP growth has so far largely been driven by inventory-rebuilding
Not unusual for the early stages of a recovery but a lack of
follow-through end-consumption growth could stall the
recovery
Next wave of liquidity: Coming soon
The Fed will keenly watch for signs of a sustained recovery before
taking away its promise of an extended period of low rates
Core inflation is still very low and gives the Fed a lot of leeway to
pursue its quantitative easing policy
The challenge for the Fed is that the current form of QE is not
leading to flow of credit into the economy
The banks are piling up the cash back into the Fed and the
money multiplier has collapsed
Our expectation remains that this is going to be a longer grind for
the US than what markets are expecting
The Fed will have to resort to more rounds of QE and one cannot
rule out direct monetisation of treasury issuances to get the money
actually into the economy
Surf-zone 2: Euro zone
The winter freeze
The peripheral countries are in serious distress and deflation
Bond spreads have widened again
Fiscal austerity measures have reached their limits
The Financial Stability package in 2010 had solved only the liquidity
problem for these countries, not the solvency one
Difficult choices awaits Europe
Letting these countries drop out of the Eurozone and
devaluing their currencies significantly (effectively putting the
whole EU experiment at risk)
Taking on the excess debt burdens of these countries through
budgetary provisions (amounting to about 6% of EU GDP) –
politically a very difficult choice for Germany
A restructuring of these loans with its potential fallout on
European financial institutions that hold most of these loans –
not a great option post the 2008 experience
ECB monetizes the bad loans by buying these loans directly –
a huge ideological challenge for the ECB – but perhaps the
most plausible solution
ECB’s hand will be forced
Our base case remains that Europe will ultimately be forced to bite the
bullet
The challenge is that it remains a financial union without a political union
At the same time, too much political capital has been invested by
Germany and France that they will ultimately have to back, in most
likelihood, an ECB-led bailout/monetisation.
But clearly, this will not happen overnight
Both, the ECB and the political leadership, will drag their feet for a
while and the Euro economy will continue to suffer
However at some point this year, the ECB will be forced to step in.
This will lead to a weaker Euro and yet another important economic zone
in the global economy that starts to pump liquidity into the global financial
system
Most likely timing – H2 2011
Surf-zone 3: China
The key region to watch out for
Getting the call on China correct is the key to getting the call on
2011 right
The reason for that is that the Chinese monetary policy now, in
absolute terms, has a bigger impact than the US monetary policy
at least for the time being as the US money multiplier has
collapsed
China has been the marginal driver of global commodities, including
most agri-commodities for several years now
Inflation has been rising in China rapidly, like most emerging
markets, driven by rising food prices
Core inflation though, remains soft. We expect this to
continue as China’s boom has been essentially driven by
capacity creation and excess capacity exists across almost all
areas
The Chinese central bank has however been tightening policy in
their bid to curtail property price speculation
Property prices though high have not outpaced nominal GDP
growth and may not necessarily be in a bubble zone
The coming storm…
While the Yuan has appreciated against the USD, it has actually
depreciated significantly on a trade-weighted basis
This is actually offsetting the Central Bank’s tightening agenda
At some point this year, as the USD appreciates, in turn triggering an
RMB appreciation, the full impact of Chinese tightening will be felt
This will create a not-so-insignificant shake out in global commodity
markets
And probably trigger another double-dip scare across the global
economy
Expect equities to correct and bonds to rally sharply
This shakeout will wipeout the speculative excesses in the commodities
markets
This will temper inflation and interest rate expectations and lay the base
for the next big speculation mania in financial markets
Commodities Outlook
A bullish outlook is now commoditized
Commodities, is again, an asset class where there is almost universal
consensus that we are in a long-term bullish phase
Driven by rising consumption from countries like China, India etc. and
the impact of global liquidity
While rising consumption has been a factor, the Baltic index (which
measures shipping freight rates) does not reflect the same degree of activity
Liquidity clearly has been a major factor in feeding prices as also price
expectations
A slowdown in China triggered by the ongoing tightening will be a stern test
for most commodities
Our base case view remains, that economic activity in the US, EU and
Japan will remain sluggish for an extended period
This will create headroom for growth in consumption by fast growing
emerging markets
There will always be dislocations or cyclical shortages in different
commodities from time-to-time
Rising commodity prices, beyond a point, move from being reflective to
restrictive in nature
They effectively become taxes and hurt consumption leading to
demand destruction
Gold
India: The big driver as well as the beneficiary
We continue to remain long-term bulls on gold
No surprises there!
Low interest rates will continue to support gold through a low opportunity
cost
Institutional money managers as well as central bank diversification into
gold is very miniscule and even a slight reallocation could cause significant
moves in gold prices
One of the other key reasons to remain bullish on gold is that as per-capita
income continues to rise rapidly in India, the largest gold-consuming nation
in the world, gold demand can only go one way, and that is up!
Surf-zone 4: India
Getting whiplashed by breakers after breakers…
In the space of 3 months, the outlook has gone from euphoric to ‘what hit us??’ !
We seem to be fighting battles across the board - gigantic political corruption, parliamentary stand-offs, corporate governance, offshore
black monies, back-breaking rise in food prices
But in this free-for-all milieu, we should not lose sight of the key battle that is really relevant for the long-term economic growth and
financial markets performance
That is inflation, and inflationary expectations
It’s not to make light of the other issues that have come to the fore
But those are issues that have existed in India forever, and for all the song-and-dance by the media, may very well continue to exist
Our view remains, though, that while growth and market performance could be that much better without these issues, markets have and
will learn to live with them
The fact also remains that public memories, unfortunately are short. It will be only a little while before news channel figure another
method to bump up their TRPs and these issues fade into the background
India: Fixed Income
Pessimism is universal…
There is a universal consensus that interest rates in India can only rise and that
inflation is a big issue
This is also the key variable for the equity market outlook
This at a time, when inflation has most likely peaked, bond yields are at close to
long-term highs (barring a few months in 2008) and liquidity is at its tightest in years
In our view, India’s inflation is a supply-side issue
If it were demand-led and pricing power were back, manufacturing capex
would have been roaring – It’s clearly not
WPI for manufactured products is still steady
In our view, the biggest risk to the world economy, is a threat of deflation caused
by over-investments in various parts of the world.
As for liquidity, it should only be a while before the government starts spending all
the monies parked with RBI and that should address liquidity issues
The government borrowing program for next year should also be reasonable and
we actually expect a reduction in relative terms over the nominal GDP base
While bond yields may remain volatile in the short-term, we expect yields to come
significantly lower (7% and possibly lower) as the year progresses
Also, it remains a key asset allocation call and hedge in the event of a major
correction in commodities and equities
India: Currency
Comeback kid…
Our longer-term call on the Rupee has been extremely bullish
Though INR has been caught in a range for several months now
but we believe that downsides are limited and the longer-term
outlook is Rs40-levels
The shorter-term outlook is clearly driven by behavior of oil prices and
financial flows
As the investment cycle picks up, the trade deficit may not shrink, but
will be balanced by capital flows that come in to finance the investment
activity
RoIs in India are much higher than other parts of the world
including the emerging markets
India is a significantly underinvested economy and therefore the
RoIs should remain high for a while
Availability of global financing will not be an issue
An interesting observation, by our economist team, has been the nature
of the trade deficit
If one adjusts the trade deficit for gold imports (making the
argument that it is nothing more but a currency swap), the current
account deficit actually shrinks from 2.8% of GDP to 0.9% of GDP!
India: Equities
Intermission…
The late 2010 correction notwithstanding, we have a strong conviction that Indian
equities are in the midst of a major structural bull market
Most of the current constraining factors like inflation, politics etc. should recede
by H2 of 2011 allowing markets to scale back previous highs
The story in Indian equities though is not in 2011, but actually in 2012 and 2013
We expect a major investment cycle to hit the ground beginning with infra
investments and followed soon by manufacturing
An investment cycle always leads to explosive earnings growth and catches
analysts off-guard
There is a additional accounting rationale for this earnings growth
When a sale is made, revenues are booked at one-go, whereas in most
cases, the buyer capitalizes the purchase and expenses it over 5-10 years
So while the markets are assuming a 20% range of earnings growth for FY13,
one should not be surprised if one sees earnings growth of 40 to 50%-types in
FY13 / FY14
This can translate into a Sensex EPS of ~1700 for FY13 which combined with a
bull market PE of 25 can bring us to 43000 – 45000 Sensex levels by FY13 end
It also follows that in this bull market, the investment theme should outperform
the consumption theme after lagging for the last 3-4 years
Summary
The world economy is in a transition phase
The liquidity pumped into the system has created significant cross-currents while raising asset prices broadly
The current concerns around inflation will fade as tightening in China weighs on commodities and hopes of strong recovery in the US fade
We continue to expect swelling liquidity infusion from the developed world spawning bigger asset bubbles
In India too, inflationary expectations should temper significantly by second half of this year, allowing equities to resume their uptrend
The big years to watch out for are calendar 2012 and 2013
As investors you would rather be out there surfing in some volatile waters than sunbathing by the shore
..'coz when the big one comes, you wouldn't want to miss the fun!
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