Equities in a rollercoaster in 2013, thus far
The macro climate is stabilizing, with the current account deficit,
inflation and fiscal deficit seemingly peaking and the worst for
GDP growth likely behind us. Yet, share prices have been
volatile, up just a tad since December 2012. Arguably, equities
were anticipating this positive macro delta at the start of 2013.
Our view is that the earnings trajectory will be better than what
consensus is forecasting or what appears to be priced into
equities. We see margin expansion, given the steadying
investment rate, and a greater fall in the CAD relative to the fiscal
deficit as the key earnings driver. We forecast that broad market
earnings growth will reach ~20% by end-F2014. Our end-2013
Sensex target implies a further 15% upside, mostly from earnings
progression.
Leading indicators are bullish for equities
Of the 27 leading indicators we track, absolute and relative
valuations, real rates, our proprietary earnings growth leading
indicator, and global liquidity are the most supportive of equities,
followed by hesitant sentiment (our market timing indicator) and
an improving macro (suggested by the yield curve).
What’s not in favor of equities
The most worrying signals for equities are the high level of FII
flows, the market’s apparent complacency about tail risks and
upcoming general elections. The biggest positive delta
for equities in recent weeks has been the fall in rates in
response to a fall in inflation. The lack of strength in
confirmatory signals (reported economic growth, M2 growth,
monetary policy, interbank liquidity and earnings revisions
breadth) is challenging conviction.
Our portfolio strategy
GARP over GAAP (high FCF, high ROE, low capex).
Cyclicals over defensives.
Active sector positions vs. stock selection.
We are overweight Financials, Energy, Consumer
Discretionary, Technology, Industrials and Materials, and
underweight the other sectors.
Key assumptions (and risks):
No major risk-off in the world – so correlations do not rise
back to record highs.
Some domestic policy tailwind, especially in terms of
continuing fiscal consolidation and infrastructure spending.
Elections not before year-end, although elections are not
necessarily bad for equities.
Range-bound crude oil and commodity prices.
No major leg down in capex; importantly, public capex
seems to be turning around.
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The macro climate is stabilizing, with the current account deficit,
inflation and fiscal deficit seemingly peaking and the worst for
GDP growth likely behind us. Yet, share prices have been
volatile, up just a tad since December 2012. Arguably, equities
were anticipating this positive macro delta at the start of 2013.
Our view is that the earnings trajectory will be better than what
consensus is forecasting or what appears to be priced into
equities. We see margin expansion, given the steadying
investment rate, and a greater fall in the CAD relative to the fiscal
deficit as the key earnings driver. We forecast that broad market
earnings growth will reach ~20% by end-F2014. Our end-2013
Sensex target implies a further 15% upside, mostly from earnings
progression.
Leading indicators are bullish for equities
Of the 27 leading indicators we track, absolute and relative
valuations, real rates, our proprietary earnings growth leading
indicator, and global liquidity are the most supportive of equities,
followed by hesitant sentiment (our market timing indicator) and
an improving macro (suggested by the yield curve).
What’s not in favor of equities
The most worrying signals for equities are the high level of FII
flows, the market’s apparent complacency about tail risks and
upcoming general elections. The biggest positive delta
for equities in recent weeks has been the fall in rates in
response to a fall in inflation. The lack of strength in
confirmatory signals (reported economic growth, M2 growth,
monetary policy, interbank liquidity and earnings revisions
breadth) is challenging conviction.
Our portfolio strategy
GARP over GAAP (high FCF, high ROE, low capex).
Cyclicals over defensives.
Active sector positions vs. stock selection.
We are overweight Financials, Energy, Consumer
Discretionary, Technology, Industrials and Materials, and
underweight the other sectors.
Key assumptions (and risks):
No major risk-off in the world – so correlations do not rise
back to record highs.
Some domestic policy tailwind, especially in terms of
continuing fiscal consolidation and infrastructure spending.
Elections not before year-end, although elections are not
necessarily bad for equities.
Range-bound crude oil and commodity prices.
No major leg down in capex; importantly, public capex
seems to be turning around.
Catalysts and What to Watch
What’s in the Price?
Trades and Themes
OW: Financials, Energy, Consumer Discretionary, Technology, Industrials, Materials,
UW: Consumer Staples, Telecoms, Healthcare & Utilities
Stocks: See page 33 for Focus List and stocks to avoid, as picked by our analysts.
Themes
The macro influence on stock prices is pertinent – keep sector positions wide.
Small- and mid-caps very attractive.
Cyclicals look cheap relative to defensives. We are UW defensives.
Use “growth-at-a-reasonable-price (GARP)” criteria to pick stocks.
Market Outlook: The probability-weighted outcome for the BSE Sensex is 23,069 for December 2013, implying 14% upside (and multiple of 15x F2014E earnings).
Base Case (60% probability) BSE Sensex: 23,097
Fiscal prudence, steady improvement in infrastructure spending, no major global risk-off, with range-bound crude oil prices and steady monetary easing. Corporate margins expand with declining CAD and stabilization of investment rate. Sensex earnings growth at 19% in F2014 and 17% in F2015.
Bull Case (20% probability) BSE Sensex: 28,137
Global calm and a modest recovery in global growth, strong policy action, range-bound crude oil prices, and rate cuts in response to a fall in inflation. Sensex earnings growth rises to 22% in F2013 and 25% in F2014.
Bear Case (20% probability) BSE Sensex: 17,918
Weak policy action, a fragile global situation culminating in some sort of crisis and/or supply shock in crude oil prices, causing liquidity tightness. Sensex earnings rise 12% in F2014 and 10% in F2015. Macro/Market VariableWhat the market is implyingLong Bond Yield8.8% (current 7.4%)Equity Risk Premium7.3% (our estimate: 6%)Short Yields15 bps rate cut in the remainder of 2013 (our economist expects 25.-50 bps)Nominal IIP Growth13% in 2H2013 (Mse = 12%)Earnings Growth10% in F2014 (our top down 19%)Long Term Earnings Growth47% of index value assigned to future growthLong Term Equity Returns15% 10-year CAGR12M Forward Equity Returns24% to 36% (our target => 14% to 2013 end)Tail Risks99%/1-month Historical VaR = 5.3% suggesting little tail risk in the price
Global overtures: Equity return correlations have collapsed to multi-year lows as India's tail risks have receded, thanks to QE. Global growth, euro- zone issues, commodity prices and US bond yields remain key.
Twin deficit & RBI policy: Inflation is a vital input for the RBI as much as fiscal consolidation and the current account deficit – all highly correlated macro variables.
Domestic liquidity: Money supply aggregates have put in a bottom, and their growth will be critical for equities.
Politics, reforms and capex: The government is pushing reforms through the executive but several pieces of legislation are on the anvil. News around the fiscal deficit, CAD, GST, DTC, divestments, power sector reforms, infrastructure spending and overall capex are important for the market.
Corporate earnings and guidance: Expectations appear low, and this augurs well for equities.
Market positioning: Sentiment is at best diffident. The volatility in the markets suggests disbelief in the markets’ strength among participants, and they are accordingly hedged.
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