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Strategy
Valuations reasonable but macro worries
could remain an overhang in the short term
During 2QFY2012, Indian markets fell in tandem with peers
on heightened global macro concerns, registering their worst
quarterly performance since the 3QFY2009 fall following
the Lehman crisis. Uncertain global macro environment,
moderating domestic growth with persistently higher
inflation and concomitant policy rate hikes by the Reserve
Bank of India (RBI) have overshadowed the reasonable
valuations of domestic equities.
The key triggers for Indian equities are likely to be in the form
of a) peaking of the domestic inflation and interest rate cycle
and b) restoration of some degree of certainty in global markets
on the back of structural reforms in the Eurozone.
Hence, in the short term, Indian equities are likely to gyrate
depending on global cues, despite reasonable valuations.
However, over the longer term, we remain confident on
the long-term prospects of the Indian growth story due to
benefits of demographic dividend, a primarily internal
consumption-driven economy, better positioning vis-à-vis peers,
reasonable earnings growth trajectory and reasonable
valuations in the context of India's structurally positive outlook.
In the near term as well, cooling global commodity and energy
prices also bode well for the Indian economy and are likely to
lead to peaking out of the WPI inflation cycle in September
2011. Inflation is likely to see meaningful deceleration from
January 2012. As inflation peaks out, we expect the interest
rate cycle to peak out with expected policy rate cuts from CY2012
to stimulate the moderating domestic growth momentum.
Growth vs. inflation conundrum
In spite of slowing domestic growth, inflation has stubbornly
remained above the RBI's indicated comfort level of 5-5.5% for
21 consecutive months. In fact, headline WPI inflation in
August 2011 approached the double-digit mark at 9.8%. The
acceleration in core (non-food manufacturing) inflation in
August 2011 indicated the persistence of inflationary pressures,
which in the RBI's words has remained high, generalised and
much above its comfort zone.
Based on the historical relationship of WPI inflation with Reuters
CRB Index and considering the remaining pass-through of oil
and electricity prices, we believe inflation is likely to remain
closer to (or possibly above) the double-digit mark in September
as well as October 2011.
High inflation readings are likely to force the RBI to persevere
with its hawkish stance, considering the RBI's unequivocal
guidance of change in stance only if the inflation trajectory shows
a downward movement. Hence, we do not rule out further policy
rate hikes until December 2011. However, the recent sharp fall
in global commodity and energy prices following the Fed's
abstinence from adopting quantitative easing (QE)-III and
weaker global demand prospects are likely to aid in pulling
down headline inflation to at least the 8-9% band from
December 2011 and is likely to be a meaningful case for the
RBI to pause and even think of cuts depending on the domestic
growth scenario and international macro environment.
Global macro worries loom large, leading to risk
aversion among global investors
The recent economic news flow from both the sides of the Atlantic
has been disappointing. The Fed gave a stern warning in terms
of significant downside risks to growth and cautioned on the
financial market stress. Sovereign debt crisis concerns among
Eurozone countries remain unresolved and measures adopted
by policy makers seem to be focusing solely on the short-term
postponement of the problem rather than on a long-tem
resolution once and for all. However, the expanded bailout fund
(EFSF) is large enough, in our view, to avert a sudden financial
shock. The IMF also cautioned, in no uncertain words, that the
global economy is entering a 'new dangerous phase'.
Increased volatility and uncertainty across global markets, be it
equities or commodities, have led to risk aversion amongst
global investors, which has led to FIIs pulling out over US$2bn
from Indian equities and a 10.2% fall in the benchmark index
over the past two months.
2QFY2012 earnings likely to disappoint
Margin pressures have dented the profitability of Indian
corporates over the past few quarters and are likely to continue
in 2QFY2012 as well. While top-line growth for Sensex
companies is expected to remain healthy at 21.1% yoy
(muted 2.6% qoq), margin pressures are likely to result in PAT
growth falling to sub-10% (at 8.2%) level. However, on a
sequential basis, both operating and net profit margins are
expected to improve, albeit marginally. Earnings for Angel
coverage universe are expected to grow at 7.4% yoy, driven by
18.6% yoy top-line growth.
