Risk-reward looks good now

The government's fiscal consolidation effort is serious but a balance with growth is critical, too, given the weak state of the economy

We are positive on Indian stocks, as we believe a gradual, though mild, economic recovery lies ahead, based on stabilisation or improvement in three economic imbalances - trade deficit, fiscal deficit and inflation. Recent positive data points on trade, inflation and benign commodity prices lead us to be optimistic. India's high current account deficit (CAD) has emerged as the new worry, which implies that the rupee will remain high beta, with a depreciation bias. However, lower oil and gold prices mean there are benefits which will flow through in a virtuous cycle - lower CAD, lower fiscal deficit, lower inflation, lower interest rates, higher income/savings and higher investment. Of course, the government still needs to do a lot to support its sustainability. The fiscal consolidation effort is serious but a balance with growth is critical, too, given the weak state of the economy. Also, it means weak economic data points near-term, and even March quarter corporate results are likely to be weak.

Government announcements on reforms over the last six months somewhat revived sentiment. Yet, we wish to see the pace of administrative actions pick up and would watch for signs of a sustained investment cycle recovery before the mood turns structurally bullish. On the political front, growth recovery and dampening inflation are critical, while a spending binge is not, despite this being a pre-election year. This is key to our view that government commitment to reforms is likely to sustain. Key steps/ingredients for an investment cycle recovery in our view are: fiscal consolidation, sentiment improvement from policy stability, administrative support, corporate profitability and reforms. We believe front-loaded disinvestment in FY14 can be a catalyst for the markets and aid plan/capital expenditure and lend credibility to fiscal arithmetic.

We believe there is a modest monetary easing cycle ahead, given limited room for the Reserve Bank of India. Despite the weakness in macro data points near-term, over the mid-to-long term, equities should get support from secular earnings growth; our bottom-up forecasts suggest mid-teens growth for the Nifty in FY14/15. We think current assumptions are conservative (excluding consumption) and are not building in any meaningful economic recovery, and hence these might not be difficult to attain.

Markets are trading at inexpensive valuations of 12.5 times one-year forward earnings and the risk-reward is attractive post recent correction. We estimate the Nifty to range-trade between 5,500 and 6,400. We are overweight on banks, infrastructure & capital goods, informaton technology services, media, metals & mining, mid-caps, petrochem and telecom. We are underweight on automobiles, cement, consumers, pharma and power, and neutral on oil & gas and real estate. We expect consumption (staples, discretionary, autos) to underperform in both scenarios - either economic recovery (as investors turn to cyclical sectors) or continued slump (since it will further affect corporate profitability and hence wages). Our most preferred stocks are Bharti Airtel, Cairn India, Coal India, State Bank of India and Sun TV. Our least preferred stocks are Adani Power, Titan Industries, Jubilant FoodWorks and Tata Global Beverages.

The author is MD and head of equities at UBS Securities (India)