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On a wing and a prayer

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The pain could last for one more quarter, after which things may start improving.

There’s an opportunity in every threat, they say. Given that are headed nowhere, the top managements of large financial firms are finding more time on their hands and they are utilising it to address long-term business needs. Motilal Oswal, chairman and managing director of Financial Services, is one of them. He’s using this time to plan for the long-term needs of his business.

That’s probably the best way to view Indian markets in the current situation. Even as the short term looks rather bleak, the long-term prospects remain relatively robust. Says Oswal: “If you look at the short term, it is going to be very uncertain and volatile due to domestic macro issues and global issues. But India still remains attractive from a valuation perspective. Markets are in the process of bottoming out unless you see some surprises from the political side.”

The way ahead is clearly not certain. The near-term outlook for the markets going into 2012 remains weak, as domestic issues that plague India are affecting investor sentiment a lot more than global issues. However, as the rate cycle reverses, the equity markets are expected to see a bounce-back, says Girish Nadkarni, executive director and head - equity capital markets, Avendus Capital. He believes rate cycles impact equity markets in a unique way.(Click here for table & graph)

Thanks to the concerns over India’s economic growth and global uncertainty, most global investors are largely underweight on the country from an equity market perspective. Not only global investors, domestic investors also seem pessimistic about the prospects of the Indian markets, given the fund flows into equity funds. The returns delivered by the benchmark indices only tell half the story. The BSE Sensex has fallen nearly 25 per cent since the start of 2011, whereas the mid-cap and small-cap indices have fallen between 32-40 per cent. It gets worse when it comes to individual stocks, with some down as much as 90 per cent in value. Data also show that 2011 (returns till December 22 for Indian markets) has seen its second worst annual returns in the past 10 years.

Even from a global perspective, India has done poorly and figures among the top underperforming markets.

The trend in flows into Indian equities is also far from exciting. On the other hand, debt instruments have barely managed to beat the average inflation of 9.59 per cent in 2011, indicating the real returns are not positive.Given the broad picture, it’s not surprising that investor senti-ment is running low. However, there is a contrasting side as well. “My mother has turned quite bold when it comes to shopping these days as she feels quite rich, thanks to the rise in gold prices,” says a hedge fund manager. He says as is the case with many other women, his mother has been gradually accumulating the yellow metal over the years, and the rise in gold prices has boosted her sentiment. Gold prices in dollar terms are up 13.05 per cent in 2011 so far, with rupee-denominated returns far higher at 33.67 per cent thanks to the depreciation in the rupee.

Meanwhile, with large sections of the developed world on the verge of slipping into recession, the situation hasn’t changed significantly. And, given the concerns surrounding India, it surely isn’t among the favoured destinations for many global investors. Apart from global headwinds that have played on the minds of investors, insufficient policy action by the government and the RBI’s hawkish stance continue to weigh on investor sentiment. In fact, a consistent decline in earnings projections, a trend which may continue for some more time (see graph), has added to the woes.

These issues have led to India’s structural growth story turning into a cyclical play. Even though cycles turn, investors believe it’s been a rather long wait. “What has made it worse is that with all its domestic issues, India is caught in three major cycles overlapping globally. While the first is a business cycle, the other is a deleveraging cycle, which will take much longer to unwind,” says Vinay Nair, managing principal of Ada Investments, a hedge fund. Governments have to deleverage and in the process write off some debts, which will result in some pain. The third cycle is one of transfer of wealth, says Nair. Governments need to cut entitlements and move money from one generation to the other. This trade-off is creating a political divide in most countries. And, India is no exception.

In these circumstances, investors need to view the world in a different light and become more global, at least till the domestic growth story starts playing again. Experts, thus, believe the days of absolute and steady returns are almost over. From here on, returns will be relative as investors will have to make relative bets, says Nair, adding that so far (the large) portfolio investors have viewed capital markets from a returns point of view and have bought or sold certain geographies. But, today, the notion of appreciating volatility and capturing relative returns is fast gaining ground.

The biggest issue that bothers investors — both domestic and foreign — is that the business cycle has slowed down dramatically for many industries, impacting cash flows of companies. Issues pertaining to land acquisition, environment, and resource crunch (coal and gas) have brought projects to a standstill for nearly two years now. And, investors are not willing to bet on companies with balance sheet stress, explains of Avendus. Their woes are unlikely to end in the near term and, hence, investors should also avoid companies with high leverage, say experts. In fact, many companies will be on test in 2012, when their foreign currency-denominated instruments (both debt and convertible equity) come up for maturity.

But, till a change in the trend emerges, experts advise that investors remain focused on protecting capital than on maximising returns. Investors could, thus, look selectively at stocks from the so-called defensive spaces like FMCG, pharma and IT, given the reasonable revenue visibility and very low leverage. The other way is to invest in ultra short-term or short-term debt funds.

In the medium term, though, things could start changing for the better. Those with a longer-term perspective of over two-three years and an appetite for risk could start looking at companies that do well in the early economic cycles.

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