Sandip Sabharwal - Uncategorized - SIX MONTHS TO THE ELECTIONS

As I sit to write this article we are just about six months from the general elections. Elections will be announced by the Election Commission in early March of 2014 and we will have elections running from around the first week of April to the first week of May.  As such the effective working life of this government (working?) is five to six months now.  It is important to analyse investor behaviour prior to the elections now.

Over the last two general elections markets have been very volatile immediately after elections.  In 2004 it was the shock of the UPA winning with Left support which took the markets down and in the year 2009 it was again the shock of UPA winning handsomely which took the markets up.  However as we saw in both the instances the immediate market behaviour tends to be irrational and in the first tenure of UPA after the initial crash the markets gave very strong returns in the following years. Vice Versa is true for UPA 2.  As such the positioning of investors prior to the elections is a difficult task.  I believe the positioning should be more about the expected direction of the economy rather than what happens immediately.

In my humble view the winds of change are very clear. The first good move that happened this year was the appointment of Raghuram Rajan as the RBI Governor. The rupee and CAD crisis saved us from the appointment of another bureaucrat like Subbarao which would have been disastrous for the country.  He realizes that in the short run it is important to stabilize the currency and avoid panic. That is the reason why he has opened up two swap windows to attract US Dollar inflows in the short run. This will cover the needs of the country for the next six months. It is no one’s case that inflows from these swaps which should be around $ 30 billion do not have to be repaid. However in a crisis the first step has to be to douse the fire. That has now happened.  The next steps will involve resolving the issue of high CAD in a more sustainable manner by rebalancing the Trade Deficit and attracting more FDI flows.  RBI will slowly move away from being reactive to being proactive under Rajan and that will be the big change.

Now, as I wrote in my last article, the first signs of improvement in the economy are visible now.  Bank credit growth has picked up. Agreed there is no lending for new projects, however the fact of the matter is that no industrialist will launch new projects just six months prior to an election when the Capex cycle has been dead for the last three years.  Strong agricultural growth, easing pressure on the INR, export revival and some restarting of stuck projects will create an initial bump up in Industrial Growth.  The base of growth also will become quite low going forward. As such incremental improvements will be seen in the form of growth revival.

I do believe that the next elections will throw up a decisive verdict for change. The BJP under Narendra Modi should be able to slowly improve its position. The crowds at the rallies of Mr. Modi are not the typical paid crowd. It is clear that it is pull rather than push at work here. As such the probability that we will get a growth oriented government in the next elections led by a person who is believed to be strong and decisive is increasing by the day.  Allies that come by pull are always better than those whom you have to push to join you.  Already we have seen both the main opposition parties in Andhra Pradesh making overtures to the BJP. Normally I do not touch politics, however this time it is important in my view.  I also believe that once Modi comes to power he will not go for at least 10-15 years and this could be the golden period for India. Now obviously every one can have a different view on this, however being active on social media platforms I see the mood of young India very clearly.

I believe that from here on lot of foreign investors will also start taking this view and start building strong positions in the Indian markets into sectors that are linked to the growth of the Indian economy and that have underperformed for the last five years.  Today we have a situation that Consumer Good stocks are trading at extremely high valuations and the other sectors that have done well have been the export plays of IT and Pharmaceuticals.  We will now see a build up of positions in Indian economy linked sectors. Despite the strong moves in IT, Pharma and FMCG we today have a scenario where the Market Capitalization to GDP ratio of India is down to just 56% and near the lowest in the last decade. This is unlikely to sustain. Remember this ratio went to 160% plus in January 2008.

The reason why market capitalization to GDP is important is that economies go through cycles of profit expansion i.e. when profits are moving up more than sales and profit compression i.e. when profits rise less than sales. We are right now at the worst part of the profit compression cycle due to poor economic growth, high interest rates and high input costs. Where in a country like USA this ratio is near an all time high in India is it approaching the lowest levels in several years. This will reverse as growth picks up and contribute to a market up move.

Overall we are at an interesting period of time and it’s time for equity investors to take a call.

Most equity strategists have come out with reports predicting markets to fall in October. This is nothing but an extrapolation of past data which shows that markets do badly in October.  Investors should best ignore these short term views and take long term action now. 

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