What is in store for Calendar Year 2014

Highly speculated US Federal Reserve is finally putting an end to uncertainties surrounding the Federal Reserve action. Though the anticipated quantum of the tapering was to the extent of USD5 billion has been exceeded with and now it stands at USD 10 billion. The reasons for the action is well justified with the fact that US economic recovery seems stronger and the recent GDP data and other data like the unemployment and inflation data reflects a resilient recovery in the economy. Though, Janet Yellen seems quite savvy in dissipating the QE reversal with a caveat that the whole quantitative easing policy withdrawal hinges on the kind of recovery they see in the economy. 

Emerging market like India were eyeing the Fed action with a hawkish eye as the general perception remains that the stimulus withdrawal and its quantum will decide the foreign money flowing into Indian shores and equities and also its effect on Current account deficit (CAD) and currency. The announcement as of yet didn’t have any meaningful impact on the currency per se, which is the immediate indicator of the kind of impact it could have on Indian economy. More so, the credit goes to Raghuram Rajan, for taking charge at the helm of RBI and since then adopting measures and steps which not only controlled the rowdy INR at that point in time but also brought in fundamental changes in India’s macro picture by reining in the boisterous CAD. The data in table below gives a clearer picture of the material changes happened in the past couple of months. 

This has been a major reason for the market not reacting to the taper news in a jiffy. The general conclusion of a QE”s gradual winding going forward would be the USD strengthening, long-term real interest rates in US becoming more attractive and CAD deficit countries to see their currencies depreciating against USD. It all depends on how swift the FED wants the withdrawal to take place and how the economic data pans out. But the general trend should be one of a strong US market and weaker emerging market currencies, till the time they don’t have material difference to their trade deficit figures.

For Indian markets in calendar year 2014, a couple of domestic events will be the key deciding factor apart from the global events like the FED action and the Euro-zone economic recovery. 

First would well be the General Election likely to be held in May’2014. A strong and stable government is the desired outcome. BJP coming with full majority will be the ideal one for the market and the economic recovery. A coalition government will be the biggest risk to economic recovery and hence market will dislike and drive down the market on this outcome. Generally early stages of any economic recovery or a emerging bull market coincides with political uncertainty, high NPA’s in the banking system, weak currency, high inflation and low retail appetite for investing in stock market. This time it’s nothing different. Though the election impact has had major short term gyrations but they haven’t predicted the course of economy or the market in any meaningful way. During the P. V. Narshima Rao regime, some of the finest reforms were laid down and economy was liberalized and that was the time of a unstable coalition government. Market was knocked down sharply when NDA went out of power in 2004 but during the UPA-I regime we saw one of the finest spell of Indian economy and the equity market. When UPA-II regime got re-elected market was locked in upper circuit and we saw one of the worst performance of the economy and the market and also big time scams got un-earthed during this regime.

Second, would be the Inflation factor. Inflation remains elevated for a long time and the driving force to reckon with is the primary article inflation. Manufacturing inflation trajectory remains quite low and well below the comfort zone of RBI. It’s the food inflation which makes the overall WPI looks bloated and CPI remains elevated because of the major weight of food inflation in it. So in that sense, a better monsoon would do well to inflation and drive down interest rates which will then have a cascading impact on the investments and other moving parts of the economy. Expectation is for a declining trend in inflation mid-year and at present it seems to be peaking out.

Third would be the supply of papers with primary market comming with supply of papers worth USD 6 billion in first half of the calendar year 2014.

Outperforming Theme for 2014

First half of 2014 will be highly volatile for obvious reasons like the legislative election, expectation of monsoon and tapering effect of US Federal Reserve. But the yearend will be 7000 plus in Nifty, on back of growth returning, interest rates coming lower and inflation remaining benign. Serious outperformance of the market hinges upon the legislative election results and monsoon. At present if we look Nifty as a absolute number, index may look too high but from a valuation standpoint, we are trading at 14 times one year forward p/e and other valuation metrics like the p/b, dividend yield and earning yield to bond yield ratio, Nifty is trading below its long-term average multiples and hence remains undervalued. Expansion of valuation metrics will be the key driving force and those will come back once the companies start delivering growth at 15% plus i.e., above the average nominal GDP growth potential.

We think Information Technology, financials (on interest rates coming lower and economy picking up) and beaten down infrastructure stocks (to add beta to the portfolio since they are down significantly from their peak) will be the biggest outperformer for calendar year 2014. IT seems to be the most confident of all and is completely insulated from vagaries of domestic turbulences if any. We think that with US growth coming back will benefit IT companies the most. As the discretion spending power comes back with the multinational companies on better growth prospect, IT spend by the companies will rise and pricing power will come back for Indian companies. Along with it, INR settling at newer levels is an added boon to the IT companies. If incase any untoward political and economic development happens in the domestic space (whether it is political uncertainty, or lack of reforms, or tapering of bond purchase programme leading to flight of capital and risk averse) the direct impact will be the weakening of INR which will benefit IT companies the most. So, US growth picking up will lead to increasing business volume along with operational efficiencies and uncertainty in domestic market if any will lead to weakening of INR which will again be beneficial for IT companies. More importantly along with all these factors, IT companies across the sector is reasonably valued hence gives you ample amount of margin of safety. Infosys looks to be the star performer for calendar year 2014. In the midcap space NIIT Technology and Zensar Technology looks promising. Other stocks we choose for this year are FDC Ltd and Bajaj Finserve.

Election of Market Direction

Upcoming Lok Sabha election in 2014 would set the direction of the Indian equity market as well as decide the growth prospects of the country. Recent ongoing polling analysis shows that BJP will come in ruling seat by defeating Congress party in majority vote. However it is very tough to predict the election outcomes, especially in politically uncertain environment. The 16th Lok Sabha election in India most probably will be held on May 2014, however the state elections in four states will gauge the response to Narendra Modi led BJP’s elevation as Prime minister. Going forward, it is believed that the election could act as a catalyst to boost the nominal gross domestic product (GDP) growth and return on equity.

Importance of 2014 election

India’s economic condition is going through hard times with GDP growth touching new lows and creeping inflation is not giving room for RBI to lower the key policy rates (repo rates). Moreover, the rupee has plunged against the US dollar, increasing current account deficit and refraining foreign investors from investing in India. Moreover it is witnessed that corporate profitability is shrinking on quarter on quarter basis. These domestic macro concerns put the upcoming 2014 elections in a different context compared to the last three elections held in India. The responsibility of the new government will be to reverse the economic free fall, which will require strong policy action to encourage investments. Hence a government with big majority is best placed to drive India’s growth revival and for that a clear and decisive mandate from voters is needed to allow such government to pursuing reforms with greater vigor and meaningful impact.

Stock market always reacted to the outcomes of the elections held in India. It has been seen that the electoral results have had strong impact on the stock market, following the 2009 election results, the market rallied 17% over two days as the ruling congress won the election with a clean majority sweep. In 2004, after BJP lost decisively to Congress coalition (supported by left-wing parties) unexpectedly, market plunged 17% in two days, proving that there is a strong correlation between election results and stock market as the strong and clear majority government would be able to improve the macro economic conditions of a country. The new government in the country is likely to set the tone for policy and growth over the next five years, deciding the country’s economic growth prospect. The current UPA Government’s populist agenda including the National Rural Employment Guarantee Scheme (NREGS) has been the hallmark of its five year term. However, in contrast, the BJP is more fiscally conservative, with a development focused agenda

                        

                                     

The uncertainty around the election is always a key risk to the Indian economy, when an unclear mandate emerges. This happened when Congress formed government with much weaker mandates in 2004 (145 seats) and 2009 (206 seats). It has been seen that a weak leadership largely made up of regional parties, each with their own agenda were incompetent of pursuing the bold reforms needed to kick start India’s economic growth. In this scenario, it would lead a period of prolonged weak and patchy policy making.

Economic downfall during UPA -II regime

The biggest failure of the current government has been on the economic front, with GDP growth slowing down from an average of 8.5% over FY04-FY11 to 4.4% in 1QFY14 due to lack of policy reforms, delay in large projects approval, resulting in stalled projects and inability to pick up investment cycle. Moreover, the slowing growth is compounded with rising inflation, which is eating the profitability of the corporate as well as lowers the savings of the common people. Headroom for the central bank to respond has been limited due to inflation, high fiscal and current account deficits and rupee depreciation (down 43% in the current government’s rule to an all-time low). Even in 2012, April, the economic condition has been so severe that rating agency Standard and Poor downgraded India’s international ratings outlook to negative, which caused a serious threat to economic growth of the country. Besides economic slowdown, two major scamps which come to the forefront are the 2G spectrum allocation and coal blocks allocation.

Current India’s Parliamentary structure

Opinion poll shows BJP might have an upper hand

The latest opinion poll shows that the electorate is giving a more decisive mandate in favour of BJP with 175 seats as opposed to the findings of July 2013 poll which suggests’s that the base case was of a BJP led coalition forming the Government in the Central. The prediction of BJP getting the 175 seats and at the same time forming the Government, BJP would likely garner the support from seven regional parties namely Shiv sena, Akali Dal, Trinamool congress, AIADMK, BSP, BJD and TDP, thereby generating a tally of 273 seats. Thus it is expected that BJP coalition would form the government, breaching the 272 seat mark comfortably. On the other hand it is expected that the Congress is likely to get 233 seats (Congress + UPA allies + Left Front + SP + DMK + JDU + TRS + YSR Congress + JDS). Narendra Modi’s pro business approach getting popularity among young generation and survey shows that Modi leads popularity by a very wide margin when it comes to first-time voters. The survey only covers the currently enrolled voters and it is expected that the enrolments amongst first time voters are likely to increase as the General Election will approach. This dynamic could increase the number of seat counts for BJP in coming Lok Sabha election.

India opinion polls (seat projection for 2014 election)

State Elections in four states is an important event to watch out

Before the general elections in April 2014, state assembly elections will be held in Chhattisgarh, Rajasthan, Madhya Pradesh and Delhi and the outcomes of these elections is important to gauge the response to Narendra Modi’s elevation as the BJP’s prime ministerial candidate. The opinion polls of the four state elections show that BJP is set to win 3 of the 4 election bound states. The results of all the four state elections will be announced on 8 December 2013, which seems to be an important event from a stock market perspective. Market will factor the outcomes of the elections and any deviation from the expectation would have an adverse effect on the stock market. Of these four states, Rajasthan is the state that will be a litmus test of the pro BJP sentiment. If on 8 December 2013, it becomes clear that the BJP wins Chhattisgarh, MP as well as Rajasthan then the market is likely to factor in BJP’s victory in General Election. Though there are many slip in between the lip and the cup and predicating a concert election outcome is impossible. Only probabilities can be assign to the outcomes. 

Opinion polls of four state elections

The momentum of the Indian stock market would sustain for prolonged period if the 2014 election outcomes comes in line with the expectation. The 2014 General election could act as a key catalyst for Indian economy as the economy is facing of number macroeconomic challenges following with slowing growth, rising inflation, lack of policy reforms and large number of stalled projects. A strong, sustainable and pro active government in the Central would improve the macro factors of the country and also resume the investment cycle which as of now remains sluggish. Implementation of reforms at different levels would regain the investors’ confidence and thus boost economic growth of the country. Whilst it is expected that India would attract more foreign investments and the stock market could witness more inflows from abroad, which could drive the index to a newer orbit altogether.