Equity market outlook: Improvement in earnings to provide support

Year 2013 has been extremely tumultuous for the equity markets, particularly emerging markets (EM). At the beginning of the year, it appeared, the macroeconomic backdrop globally was improving with growth picking up. In India, too, the policy environment was becoming more constructive, with the government showing full commitment to fiscal consolidation and undertaking politically difficult reforms. However, towards mid-2013, with the US Federal Reserve's QE (quantitative easing) tapering concerns dominating the global risk environment, EM assets witnessed a widespread sell-off. India was among the worst hit with its large current account deficit.

As we progress in 2014, the market momentum will be shaped by three important considerations: Global cues, domestic political scenario and the upcoming earnings season.

As far as global markets are concerned, developed markets outperformed EMs by 30 per cent in 2013. This was because there were early signs of economic recovery in the western world and the tapering fears of QE led to a large sell-off in emerging market asset classes. Now, it appears, markets have largely overcome the tapering concerns. Indeed, a gradual economic recovery in the developed economies in an environment of low inflation and accommodative monetary policy offers a very favourable backdrop for emerging markets. Rising US bond yields and US cyclicals outperforming defensives clearly suggest that markets are anticipating global economic turnaround and this historically is bullish for EM equities. So far, EMs have been lagging far behind developed markets but if global environment continues to improve, this anomaly should correct. Within EMs, the case of India is stronger, given that it is one of the few which will see monetary easing during the year.

Meanwhile, the domestic political situation is evolving rapidly. The outcome of the Assembly polls was greeted with euphoria as remarkable performance of the Bharatiya Janata Party in the states fuelled hopes of a decisive mandate in the general elections, as well. However, with the Aam Aadmi Party forming a government in Delhi and its campaign gaining momentum, the political outlook has become a bit uncertain. In the coming months, markets will be taking cues from developments on this front. Thus, the opinion polls in the run-up to the elections could be important triggers for the markets. In my view, in crisis-like situations, the electorate tends to deliver a decisive mandate and since India has been in a crisis-like situation for some time (currency fall, high inflation, etc), I would expect a decisive mandate in the general elections. Nonetheless, if the expectations of a deeply fractured mandate gather ground, market sentiments could turn jittery.

On the earnings front there are signs of recovery visible. The stabilisation of the rupee at weak levels is clearly acting as a stimulus to the economy. Bottom line growth for our coverage universe companies is expected to further accelerate during the quarter. The sectors that are the main beneficiaries of a weaker rupee - namely, information technology, pharmaceuticals and metals - are expected to lead the recovery. Domestic consumption and infrastructure-oriented sectors, however, are expected to continue to witness slowdown. Nonetheless, the fact that margins of the industrial companies are expected to make a bottom is comforting. Also, we expect the general corporate commentary to be more encouraging.

Overall, considering the improvement in earnings, as well as cheaper valuations compared to the developed world, the Indian market should be well supported.
The author is chief executive officer, wholesale capital markets, Edelweiss Financial Services