The anxious road to recovery

When I last wrote this column in November, I argued for a more constructive outlook, seeing 15 per cent upside over a year, but warning the rise was unlikely to be linear. Today, the market is up five per cent, having scaled 20,000, only to fall below 18,500 as worries returned. So, why has the market been so skittish this year? Broadly because the data has largely been disappointing (GDP or gross domestic product growth at 4.5 per cent, CAD or current account deficit at 6.7 per cent, etc) and fears about political risk.

Policy signals were enough to drive markets in 2012, without any improvement in fundamentals. But investors are now more impatient for signs of a turn in the fundamentals. It is hard to call the inflection point, but we think the next six months will see the start of a gradual economic and earnings recovery. This won't be a V-shaped recovery, given the macro imbalances. But India should benefit from a number of cyclical improvements. The fiscal deficit is under control, with a five per cent realistic figure for FY14, inflation is finally falling, with 5.96 per cent in March, and core inflation at 3.4 per cent. This gives room for the Reserve Bank of India to cut repo rates over FY14 by 100 basis points.

That leaves two thorny cyclical issues; CAD and growth. The CAD at 5.1 per cent of GDP has meant financing a $95-billion bill. Whilst not a problem this year, it needs to be brought under control. There was much talk of falling gold imports as prices corrected, but demand in the second half was strong. Besides cultural attractions, gold is a hedge against inflation and a volatile rupee. Gold demand might correct by, say five per cent in FY14, given the recent volatility, but don't expect more. Oil demand should moderate, rising only four per cent assuming relatively stable global oil prices, and the benefits of price reforms in petroleum products. Add to that a mild recovery in exports (up four per cent in dollar terms in January-March), and CAD should see a slight improvement, but the range is quite wide, between four and five per cent.

Growth is the hardest to call. We think recovery to a six per cent type growth rate remains likely, given rate cuts, some improvement in domestic business confidence and a mild recovery in global growth. But the most important factor to watch is success in accelerating project clearances. Currently, lead indicators for the capex cycle look bleak - core infrastructure output is negative, new project announcements falling and stalled projects at best stabilising. But the Cabinet Committee on Investments is showing some success, having facilitated approval of projects worth $14 billion in 2013.

Calling a bottoming in earnings growth has also been tricky, with operating margins stabilising but revenue growth very weak. It might still take a quarter or two to reverse, but FY14 earnings growth should recover to the low teens. Given structural impediments we see no reason for multiple expansion. But until the data on both GDP and corporate profitability point more unambiguously to a recovery in growth we are likely to witness periodic bouts of market anxiety and weakness.

Our message is familiar - maintain a 'quality' bias to portfolios; this is not a climate for trading down to second tier names. Stocks we like include HDFC Bank, Federal Bank, M&M Financial Services, PFC, Max India, L&T, Adani Port, Wipro, KPIT Cummins, Bharti, Cipla, Lupin, JSPL and Motherson Sumi.

The author is country head - India, Espirito Santo Securities