Trend is friendly

Markets are likely to be northbound till the honeymoon period of the new government is over.

Coupling" and "decoupling" are two buzz-words amongst global investors. An economy is coupled if it's closely correlated to the global economy and de-coupled if the correlation isn't strong. India was de-coupled in the early 1990s when the economy opened up.

The coupling has got progressively stronger. Macro-economically, exports have started to contribute larger shares to GDP. Tariff rates have fallen and increasingly aligned to global rates, leading to stronger correlations in commodity markets. Cross border investments in both directions have risen. Portfolio investors have pumped money into Indian stocks.

Therefore, in the past six or seven years, Indian markets have increasingly marched in step with global markets. There have been few periods when the Indian price-trend has been out of sync and those periods have been very short.

In the past two months, a surge in global liquidity has triggered a bounce across most stock markets and India has been no exception. In the past 10 weeks, foreign portfolio investors have poured close to Rs 16,000 crore into Indian equity, despite the overhang of political uncertainty.

Those flows should now accelerate. By and large, the stock market was expecting a weak centrist coalition with some chances of a loony 3rd or 4th front combination getting into power. At the time of writing, it appears the UPA is coming back stronger than anybody predicted, without the burden of pandering to Left allies.

That implies stability and continuity and it means the coupling will remain intact. It also gives rise to hopes that Dr Manmohan Singh can pursue an agenda of faster reforms than between 2004-09. It's an open question whether those hopes will fructify, given entrenched opposition to reform inside the Congress itself. But continuity itself is a big deal since the bulk of investment during the current recession will come through infrastructure projects which are extremely policy-dependent.

In terms of immediate reactions, the prospect of stability could be enough to make the market zoom. A lot of investors will come off the fence. Also, it will not cost the UPA enormous sums to buy the outside support of 20-30 MPs that it will probably need. It would have budgeted for 70-100 outsiders. So, UPA-supporters will not need to pull funds out of the market. A few disappointed NDA supporters may sell off in disgust but support from politically-uncommitted investors should more than compensate.

Unfortunately valuations are likely to get tight if the market is pushed up another 5-10 per cent. The bull run of the past few weeks has already pushed Nifty PE ratios to 16-17. That's fair-value if we look at historical records. It's on the higher side of fair value if we look at consensus earnings and GDP estimates for 2009-10. Also the spreads between commercial bank rates and treasury bills is still too high and no bull run will seem sustainable until real interest rates ease down.

Nevertheless traders know that "the trend is your friend" and regardless of valuations, the trend is likely to remain Northbound until the honeymoon period of the new government is over. The investments are likely to be focussed in specific industries.

One obvious area is banks. Rate cuts must be around the corner and very likely to happen over the next three months now that the political situation is clear. Another obvious area of interest is the power sector where the government is doggedly pursuing an agenda of reform and liberalisation. Practically every player across every segment of the power sector will do well in terms of attracting investment interest at least.

In general, infrastructure focused investment should outpace the overall economy. Plays like GMR, GVK, L&T, HCC, Punj Lloyd, Mundra Port should all do well. Telecom will be a little opaque until the 3G and spectrum auction mess is sorted out but growth is a given in this sector.

The fate of oil and gas is more difficult to ascertain. There are policy uncertainties such as the tax treatment of exploration and lack of clarity on the retail pricing front. Real estate could bounce if interest rates fall since liquidity has been the major factor in retarding demand and causing a cash crunch. But there is probably some pain left in this sector as well.