Outlook for the month of March

• Markets not showing any signs of resilience and lacks sanguineness.
• Expect 15-20% earnings growth this fiscal year.
• Valuation multiple may come down a little bit by the year end.

• Concerns:

1. High crude oil price
2. Foreign flows
3. Inflation

• Beginning of 2010, we had rising inflation, so central bank had done much work on rates, the current a/c deficit was widening. Now in 2011, it is likely that current a/c deficit will narrow. Across Asia, no central bank has worked so extensively as ours. So, the rates are almost normal and inflation has peaked out well.

• The tricky thing is, what is happening in the world- at the one end of the spectrum you have Europe still struggling with its debt problems and at the other end you have US surprisingly achieved a lot in the last 2 months. QE 2 happened and got some consensus on the tax breaks, for which now on the street arguing for higher US growth.

• This will lead to rise in commodity prices, which could create an issue for India. How?

US growth rates accelerates, crude oil prices rise and to that extent it does upset India’s macro balance.
If oil prices got to $110-120 per barrel then things looks a bit worrisome for India.

• India is trading at about 35% premium on the forward multiple to emerging markets. So, it is slightly on the richer side. So that multiple may come off a bit.

• Consider if a bull case, 30% upside if crude oil prices remain range-bound say, $80-100 per barrel.

• In 2011, focus may shift to developed world than emerging markets, so these countries will have to deal with inflation, because developed world export inflation into emerging markets. If one closely observes can say, “Developed stock markets respond to growth and emerging stock markets respond to rates”.

• But talking about India, it is actually quite nicely perched because, India has already done its work on rates.

• India attracted $29 billion in 2010 and now in 2011?

We will need lower flows because the current deficit is shrinking. For September data, it stood at 4% annualized, in terms of flows means, we need $50 billion to fill that hole. And definitely this deficit is going to reduce for 2011.

• In fact, 2 factors drove this deficit,

1. Negative real rates
2. High level of fiscal deficit

Now these 2 are receding, so a contraction in this deficit. And to that extent, savings rate in the economy will rise. So, the current a/c deficit will decline.If one excluding an assumption of a runaway crude oil price, probably flows will reduce from $50b to $35-40b
For 2010, these flows were largely in the form of FII, but this year, can expect a mix of FDI and FII

• A lot of people see inflation peaked out but the pace at which it will decline is not sure. This may become a wild card for the coming 6 months.

• Actually, there is a genuine problem with food, because of structural factors, less to do with cyclical factors. It is well known about India’s protein consumption, which is going up, so all the protein basket like milk, eggs, poultry, meat and soya bean are experiencing huge demand for this the prices of these items are elevated. And some of these items prices were anchored at higher levels. So, any shortage in particular food commodities will be leading to higher levels. So, this year we will see some base effect in terms of growth of inflation and interest rates rise. So to that extent, I do think that consumption will slow. A mix of growth in India will shift from consumption to investments.

• We have seen 2009- a great year, 2010- a tepid year, 2011- expecting a range bound

• Other indicators:

1. Credit growth:- need to assess whether banks are pulling back on credit
2. Fuel subsidy:-

• On financial companies?

A reason to under-performance, which was a star performer in 2010
1. These institutions were too bullish, so ownership levels had earlier reached record levels. So valuation got rich;

• On IT companies?

In 2010, there was a skepticism that developed markets struggling, will lead to domestic IT companies struggle. But it was so wrong because what happened was when developed markets struggled, companies in the developed world reacted by cutting cost very sharply and IT companies in India benefited. Going into 2011, the environment is actually looking better and the likelihood is that budgets will get marked up. So IT companies in India will continue to benefit.

• Sectors to watch:

1. Materials and energy

We can see a major shift from Financials and Consumers into global commodities and Industrials in 2011.

• Why Industrials?

There are triggers in place for a bigger CAPEX cycle, investors are highly skeptical about CAPEX cycle kicking in and Industrial stocks have been terrible outperformer except L&T.

• In 2010, investors have flocked to high RoE, high FCF and low-beta stocks and this will change in 2011.

• We need to keep in mind that there are not any domestic factors affecting the market on the downside. It is rather global. China has to work on rates. If they get it wrong, then it will hamper India's progress as well.

• Are we still in a bull market?

The basic tenet to say whether it is a bull market or a bear market, two things to consider:
1. Globally policy makers falter on inflation. Take US for example; inflation comes back much faster which causes yields to go up in America. It then creates a problem for US all over again. In that scenario, it becomes difficult for them to sustain quantitative easing with the fiscal deficit already high. It then creates a problem for US and spills over into the emerging markets.
2. Domestic policies may also go wrong.