Markets, as they sometimes do, have been displaying extreme emotions in 2012. In the first two months, Nifty rallied by more than 20 per cent driven by global liquidity boost, followed by a retracement of a large part of the rally.
Sometimes it looked that high beta was the game to be in, at others it appeared that prudent investors were better off betting only on defensive stocks and sectors. This wide fluctuation in mood has been due to a host of reasons, ranging from problems in the global economy, devaluation of the rupee to reasonably attractive valuation of Indian markets.
We see a range-bound market trading in 4,800 to 5,500 with a positive bias for the next one year, while we are bullish on the long-term prospects of Indian markets. This view emanates from what we see are some important positives, which are currently being ignored by the markets.
While the European situation stays challenging with yields in Spain touching seven per cent, the great desire of Europeans to stay together in the monetary union has been a key positive in the recent months.
This is evident from the results of the Greek elections where voters, despite hardships of the austerity, still voted for political parties supporting the union as well as pronouncements of German Chancellor Angela Merkel of doing whatever it takes to keep the Euro zone intact. The European Central Bank (ECB)'s recent pronouncements indicated some sort of stabilisation mechanism for sovereign bond yields is under way. If these yields across the euro zone begin to converge over the next few weeks, it could well be the adrenaline injection that the global markets seek.
Similarly, a slowdown in China could be a key positive for India as it would put a downward pressure on the prices of commodities like crude oil and metals, and reduce pressure on India's current account deficit and fiscal deficit.
On the domestic side, there are early indications that post the change of guard in the finance ministry; we may again see some policy action. Recent announcements on likelihood of environmental clearances for stalled projects or the tentative steps restarting the debate on foreign direct investment in the retail sector are hopeful signs. Though monsoon has played truant with rains being almost 22 per cent below the long-period average, a tight monetary policy has brought the core inflation down to about 4.85 per cent in June, which is comforting for the Reserve Bank of India (RBI). Our view is that RBI will cut rates by at least 100 basis points by March 2013. This could provide significant fillip to the economy and help in stimulating the demand.
Current valuations are another comforting factor. When the Sensex touched 21,000 levels in FY08, Sensex earnings were Rs 791. Over the last five years, Sensex EPS (earnings per share) has increased and is projected at Rs 1,275 in FY13--a jump of more than 60 per cent, while Sensex is down 20 per cent to around 17,000. Indian markets thus have turned attractive with Sensex PE at 13.5 times the FY13 estimated earnings. Further, we expect Sensex EPS in FY14 to grow to Rs 1,430, based on which the Sensex PE is even lower at 11.9 times.
Combination of cheap valuation and expectation of changes in both monetary as well as domestic policy would attract investors. In fact, foreign institutional investors have been strong buyers in equities this year, with total inflows of Rs 50,000 crore. And times like these provide good risk-return opportunity for long-term investors.
The author is head-capital markets (individual clients), Edelweiss Financial Services