Fundamentals above incidentals, Opportunity above Volatility

Fundamentals above incidentals, Opportunity above Volatility

If you are an investor, stop worrying about the market as a whole for a while. Instead, think of the wholesome market that chosen quality scrips offer. This way, you look at the opportunity, not the volatility. Focus on fundamentals and don't get unduly judgmental.

I am a firm believer in the long term potential of Indian equities. However, if you specifically ask what can take the market higher in 2015, there's a hardly a trigger, save for the plain vanilla fact that Nifty has fallen 1,000-odd points from its peak and so it must rise at some point, sooner or later.

On the other hand, if you ask for reasons why it won't rise, one can think of several of them. The market trepidation is a function of many intertwined factors. What began as a small-scale apprehension following the Greek crisis is today a full-fledged conundrum of diverse roots. The principal trigger - the Chinese turmoil, its consequences on world economy, possibility of US Fed rate hike, deficient monsoon, parliamentary logjam and earnings scenario back home are the other factors. There is both good news and bad news, depending on your relationship with the market.

First, the bad news. If you are an index observer, you aren't going to be blessed with a 1,000-point Nifty recovery any time soon. The remaining part of 2015 and possibly the rest of FY16 are likely to be volatile, with little chance of substantial index returns. Talking of China, some find it on the brink of a deep-rooted crisis predicting a growth fall to 2-4%, while there are a few who believe the dragon will bounce back. Who has the last word, time alone would tell but looks like more pain is in store for its economy on the way to improvement, even if we assume a recovery in the offing. All eyes are on US Fed now. In a way, it would be great if it hikes rates on September 17-18 and we put the eventuality behind us; but that's unlikely. Given the current global situation, the Fed is more likely to maintain status quo. Besides, it has two more occasions this year for imposing the rat! e hike. I believe it would do so before the year ends. We will have to wait to see if our Governor Raghuram Rajan cuts rates ahead of the Fed decision (a cut is on the cards this year even with the deficient monsoon threat looming large).

The Fed hike, for all the hue and cry, can also be read as a reflection of a spiraling US economy. A bigger concern than Fed hike, in my opinion, would be another round of yuan depreciation, which could spark off another currency war. Clearly, given the backdrop of global events, foreign liquidity flows would always be in question this year. Global investors are already looking to cut their emerging market exposure in favour of the safer haven that US looks now, especially with China in turmoil and Brazil downgraded due to fiscal incontinence. EMs could see reduced exposures, partly due to the fact that exit from Chinese equities would be far from easy. On the other hand, sovereign wealth funds will retreat to support their respective governments now staring at current account deficits, in a low price commodity environment.

I personally think slowdown in some EMs only improves India's relative attractiveness, since it is growing at a reasonable pace without major macro-economic risks. But in the near term, everyone tends to get painted with the same brush, in the mad exit rush. To add to that is India's own political logjam and subdued earnings, which are not providing margin of safety at current valuations (15.5x FY17 earnings). FIIs have been selling $70-100mn worth Indian stocks on a daily basis. Upcoming tax-free bond issuances could attract incremental HNI money in the coming months, reducing domestic liquidity support at a time when FPIs are selling.

Having mentioned the present pain areas, let's come to the good news. The best returns are invariably made when shares are bought in such mayhem. When the dust settles, you reap the fruits. It's not unthinkable to find Nifty at ~7,200, but there's no better time to pick stocks than now and also on every correction.

We cannot ignore the macro-economic tailwinds on the fiscal and current account fronts. Next year, the interest rate cycle will trend significantly downwards. The strong government mandate and demonstrated intent, although constricted at present, will undoubtedly pave the way for a market-led growth. Once the GDP growth picks up (the current number looks higher due to change in calculation but isn't a true reflection of economic activity), corporate earnings will witness a CAGR of 16-20% for 3-4 years.

If you are a trader or short term investor, stay away by all means, and wait for the Fed event before taking a fresh call. However, if you are an investor, stop worrying about the market as a whole for a while, think of the wholesome market that chosen quality scrips offer. This way, you look at the opportunity, not the volatility. Focus on fundamentals and don't get unduly judgmental.

I began by saying that there are hardly any positive triggers to cite in the current market. But these are one of those times when something typically triggers an unexpected change and trends begin to reverse. That time, I believe, is not too far away.

Warm Regards,

Amar Ambani
Head of Research
IIFL