Stay Invested in Equities

     Print Edition: April 2012

The slew of measures taken by the Reserve Bank of India (RBI) to ease volatility in currency markets like increased FII limits in Indian debt markets, liberalised foreign funding routes and restrictions in forward markets together with improved portfolio flows have caused sharp appreciation in Indian currency. Further, the cooling off of inflation combined with expectation of growth bottoming in December-2011 has enhanced optimism on Indian equities.

IMPROVING POLICY ACTION
We have started seeing some momentum in areas like environmental clearances for mining, fiscal incentives to reform state electricity boards to overcome payment issues with power utilities and notification on single-brand retailing. There has been some progress on GST and implementation of the direct taxes code.

However, big-ticket reforms like opening FDI in restricted sectors and rationalisation of subsidies will continue to be a distant reality in the absence of political mandate. With growth coming down from earlier highs and inflation tapering recently, we expect the RBI will start cutting rates from April.

We expect liquidity conditions to improve further from April but contingent to the currency trajectory, as rise in crude prices could trigger currency depreciation and compel the RBI to sell dollars and negate the effect on the rupee.

2012 WAY FORWARD
Going forward, with the domestic monetary easing round the corner, expected improvement in policy momentum combined with the revival in global risk appetite would help sustain portfolio flows into India. Currently, earning expectations appear very modest for March 2013 and March 2014.

With the improvement in the macro environment, we expect positive earning revisions from 2QCY12. Indian equities are trading at 13.2x valuations vs historical average of 13.8x earnings on 1Yr forward basis.

Against this backdrop, Indian equities appear attractively priced to generate superior returns in the remaining part of the year, with a target on Nifty ~6050 by December 2012 (13.8 multiple of 1Yr forward Nifty EPS). In the near term, market direction would be driven by portfolio flows and outcome of events like Monsoon outlook, French elections outcome and Euro Zone summit etc.

From portfolio positioning perspective, we like interest rate sensitives and IT, while telecom and energy are least preferred sectors for now. In the recent past, we have started cutting defensive positions in portfolios in favour of rate sensitives like banks and consumer discretionary.

In the above background we suggest investors stay invested in Indian equities to reap superior returns over medium to longer term perspective.

BE WATCHFUL OF RISKS
While we cannot completely forget the challenges witnessed in 2011, they could resurface and derail the process of global growth recovery. Euro zone debt crisis, fatigue in US growth and higher than expected slowdown in Chinese economy could spook the sentiment in the equity markets. Similarly, domestic inflationary risks could return with the volatility in global commodity prices and concatenate effects on trade and fiscal deficits.

RAJESH CHERUVU
Head of Investment Strategy, RBS Private Banking

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