Investors should look forward to more positive sentiments in markets but given that this time around, the conditions for a market rally are different. They should be choosy about their investments. On a thumb rule basis, investors should bet on strong USD driving equities higher but keeping commodities flat (as commodities are priced in USD and big economies of the world including China are expected to grow below trend rates). The earlier bull run where investors closed their eyes and bought everything under the sun (and ended up with burnt fingers) will not happen this time around.
The government showed its weak hand in the budget 2012-13, where the only positive was that there were not many negatives‼ The budget reflected the government’s ineptitude in carrying out much needed reforms in subsidies and taxes and post a miserable year where all macro factors were negative, the lack of any positive surprise in the budget came as a rude shock to beleaguered investors.
Indian investors have never had it so bad in a while. Equities, bonds and currencies have performed poorly since late 2007 and early 2008. The Sensex is 10% below levels seen in late 2007 while the Rupee is down over 15% in the four year period. Bond yields have not moved much from its levels of 8.4% on the ten year benchmark bond in 2007. Investors are in no mood to embrace markets that have performed poorly and with a government that has shown no signs of moving forward.
To be sure if one looks at the country’s macro fundamentals one cannot get any confidence. GDP growth is down from 8.4% to 6.9% over the last one year while inflation has trended at over 9% levels for the major part of calendar 2011. Fiscal deficit is higher by 1.3% over budgeted estimates for 2011-12 while the current account deficit is higher by 1% over the last one year.
The government has not done anything concrete in taking up growth or bringing down inflation. It has raised taxes to improve revenues but apart from that one cannot see any kind of action to improve the country’s macro fundamentals.
Should investors write off equities, bonds and the currency on the back of the government? The answer is no. The economy and the markets can do well despite the government. As long as the government does not act irresponsibly by populist measures, which it has not do so in this budget, the economy can get back its footing leading to improved market sentiments.
There are signs of the economy coming back on track. The first sign is that inflation as measured by the WPI (Wholesale Price Index) is below 7% levels against 9% and above levels seen in 2011. Inflation has come off on the back of many factors including rate tightening by the RBI, which raised repo rates for thirteen consecutive times in 2010-11. Inflation looks unlikely to go back to 9% and above levels unless there is an oil price shock or a sustained rise in food prices. Economic growth forecast at 7.6% for 2012-13 is below growth rates of 8.4% seen in the years 2009-10 and 2010-11 and well below 9% and above levels seen in the period 2005-2008. Demand side inflation pressures are not apparent as seen in the growth rates.
RBI has enough room to bring down policy rates to bring about economic growth and if inflation is not seen as a threat, rate cuts will start in April 2012.
The global economic outlook is encouraging. US the largest economy in the world is seen coming along well with unemployment rates down from levels of 9.5% to levels of 8.3% over the last eight months. US has added 1.2 million jobs over the last six months upto February 2012, the highest seen since 2006. The country is seeing innovation at its best with Apple becoming the top company in the world in terms of market capitalization and likes of Facebook, Google and Amazon figuring as high cash generators. The US Dollar has strengthened by over 6% from lows seen in 2011 on the back of signs of strength in the economy.
Europe and Japan are flooding the world with liquidity. The ECB (European Central Bank) has added Euro 1 trillion into the system over the last three months through its LTRO (Long Term Refinancing Operations) while Bank of Japan has increased bond purchases by USD 130 billion in the face of a third quarter recession in the economy. The Euro and Yen have weakened by over 6% from highs seen against the USD. The liquidity infused by the central banks will help economies across the world.
India will benefit from a strengthening US economy as software services creates jobs while liquidity infused by central banks will find its way into the country both directly through portfolio flows and indirectly through more trade due to improving economic conditions across the globe.