Dec 29, 2011

Crystal Ball Gazing: Bullish for Jan-Feb 2012

2011 has certainly been an exciting year for most investors and traders. Exciting and painful thanks to the vacillating political and policy response to the sovereign debt crisis in the Eurozone, continuously deteriorating conditions in the shadow banking system and increased perception of systemic risk in the international financial system. The NIFTY has declined approximate 24% in rupee terms and approximately 43% in dollar terms!

This article is really focused on the next 30 to 45 days rather than a longer period. My view for the Jan-Feb 2012 period is unequivocally bullish on Indian equities. An important qualification - I am not making any claims for the next three, six or twelve months; just a short term view. A longer term view is reserved for another article.

Banks aren't going to fail

Globally, the macroeconomic news flow and data should hold ground over the next 4 to 6 weeks. No major financial institution is going to blow up in either Europe or America. Unlimited money is needed to prevent a systemic collapse and the actions of central banks around the world show that they are willing to provide exactly this.

The Fed has been printing money for quite some time with its balance sheet, with the exact figure debatable, certainly is in excess of $3 trillion. The Swiss National Bank has expanded its balance sheet and the Bank of Japan is a seasoned monetizer. The ECB, while making very all noises to the contrary, has printed even more aggressively and is already over $3.5 trillion.

The Euro isn't breaking up

 The Europeans are not going to let the Euro fail or change in the near term - much more civil and political unrest is needed for the shape of the EMU to change. Germany needs the Euro desperately to grow, banks in France and Austria have retail exposure to peripheral economies. Greece, Italy, Portugal, everyone needs the single market for their economies to survive. The integration is far too deep and intricate for politicians to simply pull the chord.

Too much damage will happen if the progression of events is allowed to become discontinuous in the current situation. The fate of Europe has not been decided, and perhaps rightly so. What is needed in the present is perhaps exactly the can-kicking which is happening since the pain from cutting debt sharply is not politically palatable or feasible.

The final outcome for the Euro will be a function of civil and political opinions which will change over time and no single decision making collective has control over this process. To assume that the problem can be simply 'fixed' is naive - it will find its own dialectic eventuality.

India: Rate Easing Begins

The Reserve Bank of India is amongst the most hawkish central banks in the world today. Perhaps also one of the few central banks who are presumptuous enough to believe that domestic monetary policy in an economy the size of India can influence imported inflation. Few central banks believe that food inflation in a developing economy, where large sections of population are malnourished or at subsistence levels, can be influenced by raising interest rates. The RBI is one of them.

Recent data shows inflation levels have started tapering off, especially food inflation. While growth is weak globally, the industrial production data in India has been abysmal thanks to RBI's aggressive tightening. Recent RBI policy statements show that the RBI is concerned about growth, but not at the cost of inflation.

Since inflation and growth both are headed down in India, the RBI ought to adhere to its economic ideology, and probably will ease in January 2012 marking the peak of the interest rate cycle - a huge positive of equities.

India: Political Cycle Potentially Turning

The political cycle in India shows the potential for turning if the Congress maneuvers deftly and uses the recent failure of the Anna Hazare led protest for the Lokpal anti-graft legislation. If the Congress plays its cards correctly over the next two months, it can fatally cripple the Anna Hazare led movement and disable the opposition which has not been the smartest political opponent this year with its own internal problems.

The public debate in 2011 has not been about poverty or growth or economic management; its been singularly focused on corruption charges against the Government. The Congress has the opportunity to capitalize on the present weakness in the protest movement, coupled with the convenience of the Parliament not being in session, to take executive decisions which can improve business confidence. This followed up with a reasonable Union Budget in March can turn things around very quickly.

While measures will take time to roll out, we feel that there is more than even chance that the Congress will take decisive steps in January can set the desperately required policy momentum rolling.

India: cheap valuations and potential near term triggers

Market valuations are on the cheaper side of historical bands in India. The prevailing mood does not assume that interest rates will start falling in January or that the political process has the potential to turn around before the UP elections in the summer. My bullish hypothesis rests on positive surprise on the policy front, positive potential on the political front, cheap rupee, cheap stock market valuations and exaggerated short-term pessimism on the global scenario where nothing decisive, positive or negative, will happen in the next quarter. The NIFTY can rally to levels between 5200 and 5500 while the rupee should not depreciate further.

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