India Equity Strategy Keeping the Faith. But for How Long?: JPMorgan

 Over the last three months, Indian Equities have done well. MSCI
India (US$) is up 12% in absolute terms and has outperformed MSCI
EM by 500 bps.
 But fundamentals have deteriorated. Consensus estimates for FY13E
GDP growth have been cut from 6.5% to 5.5%. The monsoon has picked
up into August. But the damage done early in the season could be
meaningful for consumption. Brent has rallied from a low of US$ 90 in
June to US$115 / barrel putting pressure on the twin deficits and
inflation. Other financial markets are reflecting this stress – the INR has
weakened from 54 to 56 vs. the US Dollar and Yields on the benchmark
10 year Government Bond have increased from 8.08% to 8.24%.

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 Why are Equities holding out? On expectations that the
Government will act. The markets are hoping for measures to a) curb
demand pressures and the fiscal deficit i.e. a diesel price hike and b)
revive the investment cycle over the medium-term i.e. allowing /
increasing direct foreign investment limits in multi-brand retail, aviation,
etc, faster clearances for investment projects, particularly in the power /
coal sector, mining concessions, etc.
 The Bulls’ are now getting edgy. The first volley of reforms was
expected after the Presidential poll in late July. But this has not been the
case. The monsoon session of Parliament has been stalled following the
CAG's report on coal block sanctions. Coalition allies continue to be
reluctant on key reforms. Expectations are now for the Government to
move in the eight week window after the monsoon session of Parliament
concludes (7th September) and before state elections in Gujarat in
November. It is worth highlighting that despite falling growth rates, the
RBI is unlikely to ease monetary policy until it sees the Government act.
 We were positive on Indian equities going into 2H. And remain
constructive over the medium term. But advocate exploring hedging
strategies to lock in upside and protect downside over the near term.
Implied vols are at historic lows and hedging costs are not demanding.
The current political environment puts a question mark on all the markets
reform expectations being met. The global environment remains
challenging too - with weak data flow being offset by expectations of
more quantitative easing. We believe valuations at 12x one year forward
earnings leave enough room for investors to chase the markets once the
roadmap for reforms is established, even if the initial upside is missed.