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sandip
sabharwal
2012
Posted: 31 Dec 2011 12:24 AM PST
It is
quite amazing but true that the year 2011 has been the second worst year in the
history of Indian markets with a decline of 25% in the Nifty and 35% in the Mid
cap indices (since the 1980s atl east). No prizes for guessing which was the
worst year i.e. 2008. In USD terms the performance was even more disastrous
with losses of 44% given the 19%decline in the value of the INR. The year began
with cautious optimism after the fall that the markets had seen post peaking
off in November 2010. However a sequence of events, foreseeable and
unforeseeable made this a disastrous year for equity investors. A lot will be
written on the year ahead and I have touched on some subjects in my previous
articles a few weeks back. However sentimentally one thing is very apparent
from all the strategy reports that I read today, as well as the commentary in
various media.
2012
will be a very tough year for equity investors and it is unlikely that
there will be significant returns during this year.
India
will continue to under perform given concerns on inflation, high interest
rates and poor governance.
I have
infact not read more pessimistic commentary on India for a very long time as we
see today. The same brokerages/research houses that were predicting Sensex at
23-24000 by the end of 2011 a year back are now forecasting markets at 12000
(at the lower range) to 18000 (at the median ofthe upper range). There are some
who, albeit apologetically are predicting a move above 20,000 levels this year.
However this is being done with a lot of caveats. The funniest are those
reports where there are bull case, base case and bear case views where the
difference between the bear case and the bull case is over 50-60%.
My take
on the markets in 2012 is that we will see the Nifty/Sensex return anywhere
between 15-25% and the broader markets by 25-35%. I believe that sentimentally
the markets have bottomed out and the bottoming out, value wise will happen
over the next few days or weeks. This should lead to a durable bottom being
formed for the markets. I have touched on the logic for the same to a large
extent in my article on the 5th of December, an updated version of which I will
present in brief and then more on the domestic situation and the markets.
The
Euro zone Crisis – The Euro zone crisis and the debt issues
related to Greece, Italy and Spain have been the main contributory
factors to the nervousness in the global equity markets over the last several
months. The crisis has got accented by a lack of faith in the political system
and its ability to resolve the issues. This issue has been discussed a lot so I
will not go into the details of all of this, however I do have a contrarian
view on the future direction of news flow from Euro zone. We now have new
governments in Italy, Spain and Greece i.e. all the troubled countries.
Two of them are lead by technocrats and one by the right wing party. As such,
in my view the worst of the news flow from Europe
is now in and we might not get incremental negative news flow over the next
4-5weeks. This is likely to be similar to the negativity due to news out of the
US
around3-4 months back, which suddenly died out as the economic data started to
improve. The entry of the IMF in the entire discussion combined with greater urgency
to resolve the issues is also encouraging. Overall I do not expect Europe to create any deep cuts in the markets going
forward. This was the view that I had put out a few weeks back and seems
to have played out well. It seems clear now that although Euro zone will go
through a cycle of de-leveraging, slow growth, intermittent issues related to
fiscal issues of troubled countries etc, the probability of a Euro zone breakup
seems remote at this stage. Intermittent occasions of bond issuance of Italy and Spain will create volatility on those
days. In-fact if investors were so concerned on the Euro it would not have fallen
by just 2-3% against the USD in the year 2011. As I wrote a couple of weeks
back“Europe has clearly avoided its Lehman
Moment”
US
News flow – The news flow from the US has been
mixed. Over the last few weeks there seemed to be clear indications of an improvement
in economic activity. The Fiscal issues will keep on creating volatility
periodically, however low borrowing costs and an improving economy could lead
to a Fiscal surprise next year. Overall economic activity seems to be improving,
albeit at a slow pace in the US
and there does not seem to be the likelihood of a double dip recession at this
stage. Most corporates in the US
are cash rich and market valuations are at just around 11X P/E for next year. Earning
expectations for the year 2012 are pretty low with earnings growth forecast in
the range of 0-5%. As such US
news flow will create volatility but it does not look that it can create a
fresh down move at this stage.
Infact US has not only
created conditions for a down move, but it has actually supported global
markets due to continuously improving economic data, especially related to
employment numbers. Technically too the movement of the key indices above
200DMA’s and the breakdown of the similarity of the move from 2008 indicates
further gains for US equities. The breakdown of VIX below 23-24 levels also
indicates reduced risk aversion and greater confidence. Typically such
breakdowns are followed by multi-week up moves.
GOLD – As I have written in detail in my
previous article I expect2012 to be a difficult year for gold. I expect a
20-25% correction before prices come to a level where actual demand rather than
pure investment demand can support prices. Since I have written in detail earlier
I will not repeat, however the most fancied asset class will have a tough time
holding on.
China – China is one aspect about which I have
not written earlier mainly due to the fact that it is difficult to analyze it.
However pessimism on China
seems to be at its peak with the Chinese markets trading at valuations that are
at multiyear lows. The expectations of some, of a hard landing in China do not seem
to be playing out. The move from investment to consumption led growth seems to
be moving slowly. By letting the Yuan appreciate in light of pressure on
exports seems to have played out well. Inflation has also been controlled well
by demand & supply led measures as well as administrative dictates(which
can only work in that country and not in countries like India). The moderation
in economic growth has been happening at a steady pace. However the key
challenge will be holding up growth in light of falling export demand, controlling
excessive investments in unproductive areas and the biggest factor will be the
asset quality of Chinese banks and how they will hold up in light of
increasingly challenging environment and pressure on profitability of Chinese
corporates. The corporate sector in China is likely to be hit on two fronts
i.e. higher wage costs due to rapidly increasing salaries as well as the strong
up move of the Yuan against most other competing currencies. Just as an example,
over the last one year the Indian rupee is down 20% against the USD and the
Yuan is up nearly 6%. The way things look to me it seems the base case will be
a soft landing rather than a hard landing for China in the near term. The two big
surpluses that China
has i.e. Current Account& Fiscal are vastly undervalued by the markets in
my view. Officially China
seems to be aiming at an 8% growth next year which is extremely strong in the current
environment. The challenge is health of the banking system and how much it
needs to be capitalized in order to support this growth as well as the state of
health of the Provincial Governments about which there is very less transparency.
India domestic factors & outlook
The
Indian markets had to make do with not only global issues but also several
domestic issues in the year 2011making it one of the most turbulent years in
recent memory. Although 2008 was challenging for India, it was generally perceived
at that stage that the factors are largely external and as such should not have
a lasting impact on the performance of the economy. We had also started giving
lesser importance to the government as the economy became more and more open.
However 2011 was a year which showed the importance of governance in promoting
and sustaining economic growth as well as macroeconomic stability. The year
2011 was a year of high inflation, high interest rates, lack of policy making
as well as the most challenging year for the Indian rupee since 1992 (ex of
2008).
The
Rupee - The fall in the rupee is being attributed to high current
account and fiscal deficits, which is true to some extent. However it is more
due to a lack of confidence in the economy in the near term as well as cash
flow mismatches on exports and imports. This aspect is extremely important to
understand. Given the way the rupee fell and the continuous statements by
policy makers that we are helpless in managing the rupee all importers have run
to hedge their positions and no exporter is hedging. This creates a very huge
mismatch in the short run. Let me try to explain. India has exports of broadly USD 20
bn a year and imports of USD 30 bn. Now this is a gap of USD 10 bn which is
bridged by invisible flows, capital receipts, foreign borrowings, FDI etc etc.
Now in a situation where everyone believes that the rupee can only fall all
importers want to hedge, however no exporter wants to do the same. This creates
a huge mismatch in the short run till the export proceeds flow in after a
period of 90-120 days. This also creates a tendency to delay export inflows in
order to realize a better rupee value. This actually makes me believe that the
first quarter of 2012 can be a good period for the INR as the panic fall period
now seems to be over and export realizations will start to come in. Other
measures like reduction in holding period of Government and Infrastructure
bonds as well as higher interest rates on NRI deposits should boost inflows. My
base case view will be for a 3-4 % rupee appreciation in the first quarter of
2012 unless and until there are huge capital outflows.
Policy
making – Initially we had a period in late 2010 and early2011 when a
large number of projects got held up on environmental issues. Later on after
the 2G issue we have seen a significant decline in project approvals, takeoffs
etc. This has got exacerbated by the continuous increase in policy rates by the
RBI which has made lot of projects unviable. Reform measures have also got
stalled. I believe that we are now at the absolute nadir of the decision making
cycle and things can only improve from here on. I expect this to happen post
election in February after which things would be much better.
Inflation would have come off much more sharply had
it not been for the decline in the rupee. However the absolute correction in
commodities and food prices combines with the strong base effect will take
inflation down to nearly 5% by March 2012. In case the rupee also appreciates
as I expect it too the overall scenario could be much better in 2012. As such
we should have improving liquidity and much lower interest rates as we go
through 2012 and this will provide a tailwind for economic activity to pick up.
Markets
Taking
most things into account and also taking into account the market psychology as
well as valuations I am of the view that the current situation of the markets
is akin to early 2009where one could see only negativity and that was the time
that markets bottomed. Valuations, especially of the broader markets are today
nearing historic lows and the overall market is also trading at 12X 2013E
earnings which is very attractive. My view of the markets over the next one
year is that of a worst case of 14500-14800 for the Sensex (at 12X P/E) and 26000 as
the best case (on a 20x P/E.)
The
markets are today trading at a Mcap/GDP of 50%; in the beginning of 2008 this
had gone up to as high as160%. The Profits to GDP ration of corporates goes through
phases of compression and expansion. Right now both gross margins as well as
net margins are suppressed due to the huge input cost pressure that we have
seen over the last 18 months as well as high interest costs. This is likely to
reverse over the next two years. Eventually the Market capitalization will move
towards the100% level to GDP, if not more. This will provide strong returns
over the next3-4 years.
Markets
seem to have taken most negatives in their stride as of now. The risk reward is
strongly in favor of investing into equities at this stage. As inflation falls
and interest rates come down there will be a revival in the economy and growth
prospects will start improving. The timing of the bottom formation is difficult
to predict, however it will happen in weeks not months.
Markets
should be able to return 15-25% at the middle of the
pessimistic/optimistic range over the next one year.
BEST
WISHES TO EVERYONE AND HOPING FOR A GREAT 2012
--
"When
someone shares something of value with you and you benefit from it, you have a
moral obligation to share it with others" :)........
i shared .....happy new year 2012
