Indian markets started 2012 on a positive note. Ridham Desai, managing director & strategist and head of India equity research, Morgan Stanley, told Puneet Wadhwa he expected a 15 per cent upside in the Sensex this year. Edited excerpts:
Most equity markets, especially India, began 2012 on a positive note, with strong foreign institutional investor inflows. Has anything changed fundamentally and is the uptrend here to stay?
There were strong reasons why equity markets started on a strong note. First, early signs of easy liquidity set in. This came from the fact that deposit growth exceeded credit growth for the first time in 21 months. This is usually a precursor to easier rates and even better equity markets.
Second, market positioning was very bearish. December witnessed near-capitulation in equity values. It was the worst December in 20 years and followed a November that was the worst in 15 years. Equity market participants’ bearishness was best evident in the put-call ratio, which was at multi-year highs.
Valuations were attractive. Earnings expectations were also low and the season thus far has been a bit ahead of expectations. All these domestic tailwinds were helped by calming of liquidity fears in Europe, with the success of long-term refinancing options by the European Central Bank.
Economic data, particularly from the US, has beaten expectations. Are we out of the woods? Is the slowdown in China a cause for concern?
China slowdown fears may have been overdone, but the US could easily go into another soft spot. We expect growth to slowdown in the US in 2012, whereas we expect it to accelerate in China. Growth surprises have been positive recently, but that may not be a lasting phenomena in the West.
How do you see the situation in the euro zone? What are your top concerns as far as the Indian and global economic scenarios are concerned?
The euro zone will take a long time to resolve its problems of high indebtedness. However, liquidity problems may have seen their worst. Policy makers and politicians will have to work through 2012 to ensure the euro zone undergoes orderly deleveraging. If this becomes disorderly, it will not be good news for India.
India runs a current account deficit, largely funded by global capital markets. An upheaval in global markets will bring stress on India’s funding, currency and, eventually, growth. What happened to the currency late last year was a trailer of how things could pan out. So, India cannot afford to be complacent.
The solution for India is to work on its investment cycle and debottlenecking supplies to rein in inflationary pressures. It appears for now that inflation expectations have receded. If that is indeed the case, India can expect a more benign outcome.
Was the cut in the cash reserve ratio (CRR) by the Reserve Bank of India (RBI) on expected lines?
The market did not seem to be expecting a CRR cut. However, the RBI is following a fairly expected path of easing, with open market operations, followed by a CRR cut, which will ultimately be followed by rate cuts. The central bank has also guided the market on what will trigger rate cuts. So, if those triggers are met, rate cuts should also happen this year.
Is there a sector in the Indian equity space where you still find value from a medium-term perspective? Where do you see the Sensex/Nifty at the end of the 2012 calendar year (broad range)?
We expect the market to make upward progress, marked by volatility. We see a 15 per cent upside to the Sensex in 2012, with rising likelihood for better returns, and feel investors are best placed to choose stocks, rather than pursue sector themes. We prefer mid-cap to large-cap names.
Inflation is already moderating, setting the stage for monetary easing. The bad news on policy has stopped, although the volatility emanating from a weak developed world could keep pegging back Indian equities.
Going into 2012, earnings have support from low gross margins, low operating leverage and peaking capital costs. The 2013 financial year consensus estimates bear upside risks. Long bond yields may have topped out.
Valuations are attractive on an absolute basis and market positioning, as evidenced by our proprietary sentiment indicator, is still bearish. Together with the collapse in earnings revisions, this sets up the market for an upward move in 2012.
Our sector calls remain narrow, given our view that this is a stock pickers’ market. We reiterate our preference for domestic over global cyclicals. Consumer discretionary is our favoured rate-sensitive sector. Top sectors to avoid remain materials and SOE Banks.
How do you see the commodity space, especially crude oil, panning out in 2012?
Despite resilience in the Brent flat price, we believe deteriorating fundamentals should continue to weaken in the coming weeks. We have argued since September that growing supply, alongside both cyclically and seasonally softer demand, will combine to weaken crude fundamentals in the first half of 2012.
While the Brent flat price has remained resilient, owing to rising geopolitical tensions and risk appetite, prompt month spreads are flirting with contango after reaching an 11-year high of Rs $3/bbl in October.
This weaker curve structure corroborates our bearish fundamental view and we think the outlook is likely to deteriorate further in the coming months. Geopolitical tensions are likely to continue to keep the flat price higher than we envisioned, but we see inventories continuing to build above normal, which is bearish for structure, and possibly a flat price.