Broad direction remains positive

Two leading market players give contrasting views on sustainability of the market rally

Global financial markets have had a positive stint in 2012 so far, helped by improved economic data out of key nations and additional monetary policy stimulus. Emerging markets have benefited from the easy global liquidity situation and outperformed developed markets this year. India has also gained from the increase in global risk appetite and the Sensex is now trading 12.88 per cent above December-end levels. The rally in India has, however, brought about questions of whether this is sustainable.

One reason for the steep gains has been the attractive valuations after the sharp correction. While the broad issues, such as twin deficits and slowdown in capex remain, there are some signs of improvement on the policy front – over the last few weeks, India’s political leadership has shown heightened resolve to iron out issues impacting growth. Policy changes to plug fuel linkages in the power sector and fast-tracking of project approvals are some such changes. It is important this momentum is sustained and reforms in the areas of infrastructure development, fiscal consolidation, labour and land acquisition should be introduced to help India realise its high growth potential.

Notwithstanding the slowdown in growth, India remains one of the fastest growing global economies and its long-term growth story remains intact. A well-balanced growth model alongside the lack of excesses, high savings rate and a large young population hold the economy in good stead. On the corporate front, Indian companies have done well through the recent challenging times and well-managed companies have been able to hold their ground. The latest earnings point towards sustained growth in the top line, helped by resilient consumer demand. Profitability, however, has been under pressure due to higher input prices, borrowing costs as well as currency volatility. Earnings downgrades have slowed and we may be close to the bottom of the cycle.

While there is reason for optimism over the medium term, there are some issues over the short-term that could weigh on market momentum. Supply-side disruptions due to geo-political tensions surrounding Iran have pushed crude oil prices higher over the past few weeks. Given India’s dependence on energy imports, the current account deficit could widen if prices move higher. Concerted efforts to address inflation and fiscal deficit issues are required to ensure sustained growth. Continued deleveraging in the developed world will pose challenges to growth and the global situation can impact India in an indirect manner (funding linkages).

Volatility can’t be ruled out over the near term, but the broad direction remains positive over the years to come. Companies with strong business models, robust processes and able managements are likely to fare better than others and we believe investors utilising a bottom-up approach with emphasis on strong fundamentals should do well.

The author is Chief Investment Officer, Franklin Equity – India, Franklin Templeton Investments