Equity outlook: Post-poll hopes from govt, RBI

Frontline stock indices are now trading in uncharted territory, with cyclical stocks leading the current rally, along with banks. When the frontline indices reached their previous respective highs (in December 2013), the rally was fuelled by information technology (IT), pharmaceutical and fast moving consumer goods (FMCG) stocks. The current one appears stronger with higher breadth and a number of sectors contributing to the rise. The recent all-time high in Nifty is accompanied by new highs in 10 stocks from oil & gas, automobiles, banks, IT and pharma.

Consistent foreign institutional investor (FII) inflows of Rs 12,700 crore have lifted indices to a new record this month. FII inflows have picked up pace lately, especially on the debt side. The inflows into Indian stocks between September and December 2013 totalled $8.5 billion.

The strength in cyclical stocks is because of the expectations of improving growth once a new government starts to take corrective measures after the Lok Sabha elections. This is why the outcome of the April-May general elections is seen as crucial for medium-to long-term economic prospects. The improvement in India's macroeconomic landscape over the past few months has coincided with growing expectations of a decisive mandate in these elections. We expect cyclical stocks like L&T, GMR Infra, Apollo Tyres, Bharat Forge and Bank of Baroda to do well in the short term.

One major positive macro development has been the rupee's stability vis-à-vis continued weakness in other emerging market (EM) currencies, notwithstanding the quantitative easing (QE) tapering by the US Federal Reserve. The rupee lost 28 per cent from the end of 2010 through last year, making it the worst performer among 12 Asian currencies. It has rebounded by 13 per cent (to 61 per dollar) from its August 28 record low near 68 per dollar. Compared to the rupee, other EM currencies like the Brazilian real, South African rand and Turkish lira have under-performed as much as 20 per cent. These countries have not made significant progress in curtailing their current account deficit (CAD), which ranges from 3.7 per cent to eight per cent of their gross domestic product (GDP).

Back home, the local currency touched a seven-month high of 60.60 against the dollar earlier this month after data showed a sharp drop in the CAD for the third quarter of FY14 ($4.2 billion, or 0.9 per cent of GDP). A stable rupee has helped improve India's external profile and consequently exports, especially in IT, pharmaceutical, chemicals and textiles.

A majority of opinion polls have shown the possibility of a stable government at the Centre, raising the prospect of market-friendly reforms from the new government. The latter will have to work in close co-ordination with the Reserve Bank of India (RBI) to gradually steer India's economy to a high growth path. Decisive policy measures by the new government can go a long way in giving RBI the much-needed room to cut interest rates and maintain price stability as inflation is showing signs of cooling. Until such time, the RBI is unlikely to make any major alteration to its current monetary stance, whereby it is clearly focusing on taming inflation.

While we expect the Nifty index to rise to 6,800 to 7,000 in the next few months, it would be prudent to structure the short-term approach to the markets with appropriate risk management, using a mix of cyclical stocks and a dedicated focus on options segment for hedging any unwarranted volatility due to the election results.

The author is Head-Research, Retail Capital Markets, Edelweiss Financial Services