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>KEY CONCERNS IN 2012
2012: A 2011 Hangover
"October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” - Mark Twain
At the outset I would like to take this opportunity to wish you, your colleagues and family members a Very Happy and Prosperous New Year with lots of good health and peace of mind. In this note we present our brief overview of how 2012 is likely to pan out from a market and economy perspective in the backdrop of the view we had for calendar 2011.
Outlook 2012
Calendar 2011 has been a very tough year for the equity market, losing almost 25% in rupee terms, with large-cap stocks down much more than that and mid-caps being a different story altogether - totally decimated. Pessimism is extremely high right now and it is very hard to imagine it changing in a hurry. We retain our view of 14700 and 4400 on the Sensex and the Nifty for now.
Key Concerns in 2012
1. Politics
The polity of this country has taken a huge image beating in 2011 and in our assessment can do little to redeem itself at the immediate onset of 2012 at least. The lack of passage of any major reforms in 2011 - including the Lokpal Bill, FDI in Retail, Insurance and Aviation and no concrete signals on the Direct Tax Code and the Goods and Services Tax, to name a few – have put the government on the back foot. Not to mention that the corruption tag is going to take some time to shrug off and hence a governance discount with the ruling party will be maintained.
2. Economic Concerns
In the backdrop of a complete absence of economic policy reform by the government, the borrowing programme of the country continuing to rise (some media reports claiming its up by over 25% of Budget expectations) and the rupee depreciating by over 20% in the last five months of 2011 and stuck stubbornly in an immediate range of 52 – 54, the macros for the immediate future at least, don’t look too exciting.
With the fiscal deficit number almost certain to well exceed 5% (some estimates pegging it at even 5.5%), with no disinvestment in sight, and a widening current account deficit, as we saw from Friday’s numbers as well (US$16.9 bn for the September quarter at 3.6% of GDP, already on the higher side), there will be sustained pressure on the currency if the fiscal and current account deficit situation remains as bad or deteriorates further unless the regulators and policy makers are able to create an environment to attract capital flows into the country through FDI or FII investments, and on both counts a lot needs to be done, which is not looking likely or remains a priority right now.
It would not surprise me if the rupee depreciated in the range of 55 – 57 at some point this year even though the RBI has tried to intervene from time to time. Our forex reserves cannot continuously be used as a tool as that too would have its implications on current account deficit, and with the recent moves on curbing currency speculation by the RBI it remains to be seen what further tools, if any, the central bank has to stop the rupee from depreciating if there is a surge in outflows from the country, given the overall macros.
Some of the other major concerns would be growth slowing further, no visible signs of investment in the economy, inability of the government to attract significant capital inflows, corporates finding it difficult to roll-over shortterm forex debt, pressure on forex reserves from maturing short-term forex debt, and the resultant impact on the outflow of capital. Note, nations cannot increase fiscal deficit to provide stimulus to growth furthermore as well, as financial markets are not giving governments any leeway and are punishing sovereign bond yields for any relaxation in fiscal deficit. So, at least in the immediate future, things don’t look all that positive from an inflows perspective as well.
The question is how much is priced in? I think even if you assume the Lehman crisis as a benchmark of how low valuations and indices can go, then I think for the first quarter and the first half of 2012, there is a risk that 4400 on the Nifty can be both tested, and broken on the way down, though at this point its anyone’s guess how much lower it can go, given how uncertain and fluid the European picture is as well.
3. Growth Slowing
IIP: With the latest set of Index of Industrial Production numbers dropping to -5.1%, within which Manufacturing fell -6%, Mining -7.2%, Capital Goods -25.5%, Intermediate Goods -4.7% while Durables and Non-Durables also witnessed a contraction, The worst of the interest rate tightening is also being felt. While the latest Core Sector growth data does give hope at 6.8%, the question is: a) How believable these numbers are in the backdrop of fudged export numbers admittedly by the government and b) How sustainable are they?
GDP Growth: This concern over IIP is already being reflected in the GDP numbers, with the Q2 number coming in at 6.9%, leaving many experts to state that FY12 GDP growth will be less than 7% and FY13 less than 6% as well. This will have its bearings on earnings growth too and I do believe that FY13 earnings run the risk of a further downgrade and thereby FY14 too. While it is tough to put a number to what the extent of the downgrades will be compared to Bloomberg estimates currently in an ever so fast changing environment, expecting about a 10% revision lower, at least from current estimates for FY13 and FY14 (in line with the downgrade for FY12’s earnings over the last one year), does not seem unrealistic.
4. FII Inflows Not in Sight!
Do note that this year FIIs are only marginal sellers for the year 2011 as compared to the US$29bn they pumped into the equity market in 2010, so if the situation does get worse domestically, there could be pressures in store on this front.
However, this particular concern is going to largely depend on how the global picture pans out (in addition to overall domestic concerns highlighted above, but largely on how the world behaves in 2012). If Europe continues to be as bad as it is or worse (and there is no concrete evidence to suggest things are going to be much better in 2012), then it would be hard to imagine monies coming in from that part of the world.
From the time of the US downgrade by S&P, the dollar index has run up from about 74/75 to nearly 81, clearing indicating that dollar in times of crisis is still being viewed as a safe haven (gold in the same period has shed around 20%). And a stable-to-improving US economy is not going to make it easy for incremental FII flows to come into India. So unless we have policy-related inflows through instruments like FDI, FII inflows too don’t look like they are going to come into the country in a hurry like they did in 2010.
5. Europe
The second-half of 2011 was plagued with reports of the euro debt crisis reaching huge proportions, reports of a split of the euro region, the currency itself falling below 1.30 to the US dollar, countries losing sovereign status, new governments taking charge in the European Union and the possibility of massive liquidity injection which became a sort of reality towards the end of 2011 with a euro 489bn euro lifeline given to European banks for three years at a 1% interest rate (which also could not help revive sentiment). Stability in the region could lead to a huge sigh of relief globally, but as mentioned before in this note, it does not seem like its happening in a hurry on current evidence.
What Could Turn Market Sentiment Around?
1. Change in Government Stance to Pro-Policy or an Overall Change in Government Itself in India Passage of bills, whether it is FDI in Retail, Aviation and Insurance, the Lokpal Bill, a roadmap of definitive implementation of the DTC and GST and a strong image makeover to go with it would be taken as market positive for sure. Budget 2012, thereby, could be critical in terms of the roadmap the government presents on its finances and a reform agenda going forward. Whether is it the Bharatiya Janata Party that comes to power in 2014, or the Congress in a new avatar (a more policy assertive make-up, if it does) or we have a pre-2014 election, either ways, it will be a change and it will be market positive as the current establishment has led us to a ‘fed up’ situation. But in each of these scenarios the change, if it comes, is not going to be overnight and hence the probability of a national election-led rally is miniscule, if anything, it would be more reform-led.
The Uttar Pradesh assembly elections will be very closely watched and it could have some key signals for the 2014 general elections (if not before).
2. Inflation and Interest Rates
A good monsoon has helped primary and food inflation drop to low single-digit at 2.7% and 0.4%, respectively, and nonfood article inflation too has dropped to 0.3% as per the latest data available and the Reserve Bank of India (RBI) too has paused on rates for the moment (perhaps indicating that rate cuts could be a reality soon in 2012. Also, six major central banks too have cut rates recently and China looks like its falling in line, so peer pressure could be another thing weighing on the RBI’s mind). I think this inflation concern will arrest itself in 2012 and the base effect will also play in favour of the government (global growth slowing will have commodity prices cooling off and another good 2012 monsoon will aid in keeping inflation in check). Sustained positive news flow on inflation and interest rates could be a positive theme in store for the market in 2012. But here too, sustainability is the key.
The biggest risk to this view is Iran and should anything go awry in the Middle East and North Africa, it would have a significant bearing on crude oil prices and inflation too domestically coupled with a substantially weaker rupee from even the current levels.
Top BUY Ideas for 2012 from Stocks under Coverage
- IT: Infosys and HCL Technologies
- Oil & Gas: ONGC and GAIL
- Banks: HDFC Bank
- Pharmaceuticals: Sun Pharmaceutical Industries, Torrent Pharmaceuticals and Glenmark Pharmaceuticals
- Infrastructure: Reliance Infrastructure, IRB Infrastructure, IVRCL Infrastructure and GMR Infrastructure
- Metals: Sterlite Industries
- Real Estate: Oberoi Realty
- Mid-caps: Bata India and JBF Industries.
RISH TRADER
