Look beyond the near-term humps

In a largely open economic environment, policies in one part of the world create unintended consequences for another. The marginal driver for this year, in our view, however, is likely to be Chinese policy, as the country attempts to rein in inflation and property prices. While we are in the midst of a major asset inflation cycle, the current calendar year could be a year of transition, as markets try to decipher trends amid the noise.

Currently, a lot of the renewed optimism centres around hope that the US economy is returning to a more steady growth phase. While US corporate profits and cash flows are at record highs, job growth is anaemic. Such strong profits would usually trigger an investment cycle, creating more jobs, something which is not visible now.

China continues to tighten aggressively. The real impact of tightening will, however, be felt when the renminbi begins to appreciate on a trade-weighted basis. This could cause an imminent shakeout in surging commodity prices.

In this deflationary outlook, the Indian story presents different perspectives. We seem to be fighting battles across the board — political corruption, corporate governance, offshore black money, and rise in food prices. We should not lose sight of the key battle that is really relevant for the long-term economic growth. That is, inflationary expectations and interest rates.

In our view, a lot of concern around inflation will prove to be misplaced. The biggest risk to the world economy still remains a deflationary shock due to excess capacities created in the last cycle around the world. Also, while corporate profits may disappoint for a few quarters in 2011-12, as margin pressures mount from both rising input costs and interest rates, one has reasons to be more optimistic about 2012-13 and 2013-14. This is because we believe a major investment cycle in India will unfold which will be bigger than anything we have seen in this country before. Infra investments, is a no brainer, and will lead the major hiccup being around execution delays, which we believe the government will sort out through regulatory and other measures.

An investment cycle is great for equity markets as earnings growth tends to be front-loaded in such cycles. We would not be surprised seeing earnings growth of 40-50 per cent for the broader market as the cycle kicks in. This, coupled with sloshing global liquidity, could lead to a massive upward move in Indian equities over a 2-3 year period. In the short term, however, markets will have to deal with a lot of noise around inflation, earnings disappointments, etc. But, these are transient in nature. It pays for investors to look beyond the near-term humps. It is just that the pay-offs could be surprisingly high if one is able to stay the course.

The author is managing director of Anand Rathi Financial Services