Strategy - Lengthening Shadow:: Edelweiss

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As we step into 2012, the investment scenario is characterised by poor macro backdrop. Externally, China’s slowdown will likely become the focus of markets. Domestically, RBI’s likely rate cuts and REER depreciation will help, but fiscal consolidation and pick up in pace of government project approvals are also essential. Our base case FY13 GDP growth is ~7%, which can slip to ~5.8% in bear case. We believe that a bottom up strategy will continue to work in the near future till state elections get over in March. We are biased towards companies with good quality management, strong earnings visibility and durable cash flows.

Global economy: On thin ice

Western economies remain fragile. Improved US data is surely comforting, but may not foreshadow a sustainable turn-around due to structural overhangs. In Europe, economic outlook is deteriorating as public and private sectors are deleveraging at the same time. However, ECB’s recent actions inspire confidence that if situation reaches the brink, it will shed reluctance to support sovereigns. Meanwhile, China needs close monitoring as the construction boom is losing steam, external demand is weakening and RMB is losing competitiveness. For India, all this is a mixed blessing—slower growth and weak flows on one hand and competitive INR and softer commodities on the other.

Indian economy: More than a normal business cycle slowdown

A multiplicity of factors is weighing on Indian macros. While RBI has overdone the tightening in our view, govt. policy hurdles, large fiscal slippages and uncertain external backdrop are added drags. Our analysis of past crises (FY92, FY01 and FY09) suggests that the current macro deterioration is on 1992 lines, although India’s vulnerability indicators are much healthier. We believe that rate cuts alone will be inadequate to engineer a turnaround. Further, neither big-bang reforms (‘a la 1992) nor synchronised global stimulus (like 2008) are likely, hence the current slowdown could be a bit prolonged. In the base case, we expect FY13 GDP growth of ~7%, which can slip to ~5.8% in a bear case. We believe fiscal consolidation and a kick-start of mining can help bolster the investment cycle. Neither of these steps requires any wide political consensus.

Markets: Concerns persisting, still favouring defensives

In our macro base case, FY13 Sensex EPS is expected at INR1,260 while in the bear case, it dips to INR1,143. As yet, valuations are not compelling as despite converging RoEs, India is still trading above peers (in BRICs) and risk of EPS downgrades looms large. Thus expect markets to be range-bound (14,000-17,000) in CY12, exhibiting high volatility. We remain defensive, favouring sectors/stocks with robust RoEs and strong cash flows. Key themes are: (1) INR to remain weak (OW pharma, move IT from UW to EW); (2) domestic demand still healthy (OW consumers); and (3) no visibility on capex revival yet (move industrials to UW). We prefer TCS, Bharti Airtel, Coal India, HDFC Bank and Lupin in large caps and Glenmark, Hexaware, LICHFL, Petronet LNG and Zee in mid caps.