Sandip Sabharwal - Uncategorized - AS HEADWINDS BECOME TAILWINDS

The last year was a tough year for the Indian markets for more reasons than one. The impact of the US slowdown as well as Euro zone issues was generic to everyone globally, however the specific issues that were headwinds in the last calendar year are now providing tailwinds for the markets and it is possible that these tailwinds become stronger as the year progresses.
My last article was at a time of extreme pessimism, sentiments seem to be a bit better now after a 10% market up move, however the underlying pessimism and a disbelief in what is happening is all pervasive. I just completed a visit to Gujarat; traditionally a market of bulls and the kind of extreme pessimism I saw all around further reinforced my view that the year 2012 on an overall basis will be a good year. The three most important Headwinds of last year were
High inflation leading to high interest rates – The inflation cycle has clearly reversed. The reversal would have come a bit earlier were it not for the unprecedented fall in the value of the rupee in the last 4 months of 2011. Inflation has come off sharply in December and we are likely to see a further fall off over the next few months. The figure for January in all probability will go below 7%. RBI has refused to cut rates or CRR till now but has changed its monetary policy stance quite clearly by undertaking significant amount of OMO’s. The huge up move in the global commodity cycle has stalled with sharp correction in a large number of commodities. The impact was not felt on the manufacturing inflation in India due to the fall in the rupee. However we will start seeing the impact from February onwards. As such we will see interest rates and liquidity continue to improve from here till the end of the year 2012. This will provide impetus to both consumption and investment demand which got stalled last year due to various reasons which included continually increasing interest rates.
No policy initiative- A lot has already been written on this so I will not write more. However in reality last year decision making came to a standstill and impacted investments across sectors. Over the last few days we have seen initiatives on Retail FDI, Aviation FDI as well as on power sector woes. I believe that this process will further pick up post election in February. From its absolute bottom we should see significant improvement during this year and the expectations today are so low that small initiatives will be taken positively.
The Rupee movement – The movement of the Indian Rupee became the final nail in the coffin last year end. The unprecedented fall by over 20% shook the confidence of investors and also impacted companies with Forex liabilities adversely. However the INR has reversed direction in line with my expectations but at a pace faster than what I expected this year. We have already seen a 5% plus appreciation since the beginning of the year. Typically INR appreciation cycles and stock market movements are positively correlated and we are seeing signs of that in the current month.  The stated policy of the central bank is that they will not provide a direction to the currency but will reduce volatility. However that does not seem to be happening on either side. Overall prospects for the rupee continue to be constructive, however the pace of appreciation should slow down and there is an increased likelihood of two way movements with reduced volatility going forward.
As such the three major headwinds are now tailwinds for the markets. Typically in bearish phases of the markets the markets will always surprise us on the downside and similarly on up moves there are likely to be upside surprises.
Some areas of concern still remain which include the high Fiscal Deficit and the measures taken to address the same. Increasing taxes will be a retrograde step, as in a slowing economy increasing taxes will cause inflation and hurt growth. Steps should be more on the expenditure side. Growth boosting measures will also be constructive for the Fiscal deficit as it will boost government revenues. Although lot of armchair economist will push for higher taxes that is clearly not the way to go. Tax increases will further curtail demand and as a result of that the expected revenues from higher taxes will not flow through as both top line and bottom-line growth gets compromised. The time to address the fiscal deficit in right earnest will be in a recovery cycle as that is the time harsh decisions get adapted in the momentum of growth. An extreme example of this is seen in the Euro zone where troubled countries are being forced to under take austerity measures, however due to its negative impact on growth the Fiscal Deficit targets are going way off mark. Maybe those countries have not option, however Emerging Economies like Indiado have that option as the nominal GDP growth even in the worst of times is expected to be 13-15%. How subsidies are addressed in the budget will be keenly watched.
Growing NPA’s in the banking system is also an area of concern. However a large amount of that can be addressed through policy measures. Most of the stress is coming from infrastructure sector investments where real assets exist. However they are in a situation where the expected returns are not flowing through and projects are stuck due to one reason or the other. These issues should be addressed to a great extent over the next 12 months. The consumer side & the unsecured side seem to be under control.
Results & Markets

Results till date have not played out to the doomsday scenario.  The early birds in the IT sector have shown mixed results which are not bad in the current global macro scenario. Banks seem to be doing better than expectations and some Auto companies that have reported have seen a decent set of numbers. A large number of companies are yet to report.
Markets have rallied sharply in the midst of extreme gloom and doom. We have seen a 10% up move from the bottom. The pace of the up move is clearly unsustainable; however what this move has done, along with the buyback announcement by Reliance Industries is that it seems to have clearly put a bottom to the markets around last years closing levels. Directionally markets still look constructive, especially in the broader market sense. I still stick with my view of this being a 15-25% kind of return year in the absence of any fresh cues to indicate otherwise. This will be a good year for stock pickers as macro concerns recede and investors start looking at pockets of value.
The interesting thing is that some markets globally already seem to be in a new bull phase. India and China do not fit into that right now and we need to evaluate things over the next few weeks to take a bigger call on the same.
Will write more soon as we get fresh indicators of where things could go.

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