The Indian markets have remained near an all-time high level over the last couple of months, anticipating a pro-reform, pro-growth government post the central elections in the first half of calendar year 2014. The markets were watching the state election results with keen interest to confirm that hypothesis.
There is a sharp polarisation in Indian markets, with sectors such as fast moving consumer goods, pharmaceuticals and technology trading at near all-time high prices and sectors such as real estate, capital goods and power trading at a little-above all-time low prices. The sharp polarisation towards free cash flow and low debt companies is reflective of the drop in investments by India Inc.
Markets in the near term are likely to remain volatile after an initial bust after the election results. Foreign institutional investors (FIIs) have invested $17.9 billion year-to-date (YTD) in calendar year 2013 (CY13). Slowing economic growth, led by falling investments, is one reason why FII buying is not very broad-based. Fed tapering will create concerns on continuance of strong FII flows as we move into next year. Domestic investors have sold $12.2 billion in YTD CY13. They are unlikely to return to the markets till growth recovers visibly.
The markets will be keenly watching the tight-rope balancing between measures necessary to accelerate economic growth, viz, containing fiscal deficit, lowering inflation and reviving investments versus populist measures that might be necessary in the pre-election period and delay in decision-making that can adversely impact growth.
India's rating is just above investment grade. While it will be fair to assume that rating action will happen post-election after ascertaining the plan of action of the new government, any sharp deterioration in the fiscal deficit can advance the rating action adversely impacting flows.
The markets will witness an increased pace of divestment in the rest of FY14. While this supply is known and factored into the prices, actual supply can put temporary pressure on prices.
The second half of the financial year, known as the busy season, typically gets supported by the year-end spending by government as well as India Inc. This time it will be supported additionally by pre-election spending. According to research by Axis Capital, this impact could be upwards of ~65,000 crore. A good rabi crop, fairly valued currency and seasonal spending boost can push growth to a higher level than priced in by the market in the fourth quarter of FY14.
Markets will be keenly watching the emerging political landscape over the next six months. There will be lots of twists and turns as new strategies emerge.
It will be fair to conclude that bottom-up stock-specific strategy and to handle volatility will come handy over the next six months. The import substitution theme across domestic companies that have got their competitiveness courtesy the rupee depreciation; 'value' private sector banks and financial services companies, as valuation acts as a catalyst on flows, and companies which are leveraged but are taking corrective steps with divestment of assets (at a price higher than factored by the markets) are a few themes which provide an attractive risk-return trade off.
The next six months are going to be more rewarding for a contra investment strategy, rather than a momentum investment one. Global and domestic factors will continue to create volatility in the markets, giving an opportunity to capitalise on.
Nilesh Shah,
Managing director and CEO, Axis Capital
