How Do Banks Outperform unless they fudge NPAs from Real Estate and Shift Bond Losses to HTM Category?
Market is at fair value – Buy Undervalued, Under-owned and Unloved stocks (3Us): Our residual income for the Sensex implies an equity risk premium of 6% – around our top-down assumption – which means long-term valuations are at a fair level (relative to our view). At the sector and stock level, we are focused on the 3Us. Key sectors that pass the test are Materials and Utilities. The Consumer sector fails the test, as do financials.
Key Catalysts
Catalyst #1: Global risk appetite:
The global picture remains a critical factor for India equities even as the market has been showing signs of decoupling. APXJ/EM and China currently seem to have the most influence on Indian equities, with three-month return correlations at over 80% and 71%, respectively. However, too much risk appetite is not good given the commodity inflation it could bring into India as India negotiates its already high inflation over the coming 12 months. Catalyst #2: Growth indicators and corporate fundamentals: Earnings could be a key driver for short-term equity market performance. No doubt, earnings revision breadth has weakened in recent months, but it is still not at levels that tends to hurt stocks. India's corporate fundamentals remain very strong - earnings and ROE are both on the ascent and have seemingly decoupled from the rest of the world.Catalyst #3: Inflation: Inflation has been sticky over the past 12 months, driven by a slow supply-side response to a big recovery in demand helped by strong stimulus and a negative food supply shock. We expect both these factors to recede and hence inflation to decelerate in 2011. Indeed, the inflation peak may already be behind us. If inflation declines, as we expect, it could be positive for equity returns. Historical data shows that India's relative performance has been positive in three out of the four disinflation cycles of the past decade.
Catalyst #4: Sentiment: The recent correction has hurt sentiment. To that extent, the market looks a lot more healthy. We think this is just another average bull market correction. Key to prospective returns is that relative valuations are on the richer side and, hence, we expect moderation in index returns in the coming 12 months (in the low double digit zone from current levels). That said, we remain in a structural bull market so any dip will enhance returns and provide a great opportunity to buy equities.
Key Themes:
Theme #1: India's inflation is likely to decline: Inflation has been sticky over the past 12 months, driven by a slow supply-side response to a big recovery in demand helped by strong stimulus and a negative food supply shock. We expect both these factors to recede and hence inflation to decelerate in 2011. Indeed, the inflation peak may already be behind us. If inflation declines, as we expect, it could be positive for equity returns. Historical data shows that India's relative performance has been positive in three out of the four disinflation cycles of the past decade. Key sectors that do well during disinflationary cycles are industrials and financials. Technology tends to underperform. A corollary of declining inflation is that real rates are rising – this may not augur well for consumer stocks.
Theme #2: Surprise from the government: Expectations from the government appear tepid. There are three areas where the government can spring a surprise: a) Accelerate infrastructure spending further – key stocks to buy are Larsen & Toubro (Rs1,979), IVRCL (Rs129), and Nagarjuna (Rs141); b) FDI liberalization in retail – our favorite is Pantaloon (Rs367); and c) rein in fiscal deficit more aggressively – long bond yields decline – buy SBI (Rs2,811).
Theme #3: Hedging the risks: India's key risk is that it is pursuing growth assertively. Consequently, public spending is still at elevated levels, and the current account deficit is at record levels. India is joined at the hip to global financial markets, given that this deficit is funded by capital markets. India's best-case outcome is a "muddle through" world. The economy and the market may not tolerate extreme outcomes. A deep risk aversion event could cause India's growth to falter and markets to react adversely – Sun Pharma (Rs485) and Bharti (Rs358) are good hedges in this context. The flip side is that the world recovers and commodities do well – India could still falter. Our favorite to protect portfolios is Reliance Industries (Rs1058).
Theme #4: Macro in vogue – Focus on sector trades: At the end of last year, the influence of the market (read: macro) on stock returns was at an-all time high, with stock-specific, idiosyncratic factors taking a backseat – it was a clear signal to abandon macro over stock-picking. Through 2010, stock-picking has been in fashion. The evidence of how little influence macro has had on the behavior of stocks is in the correlation of returns from individual stocks (market effect) with the market, which has collapsed over the past 12 months. It is likely that macro effect rises now, and, to that extent, stock pickers may have to take a back seat in the coming months. The message is to focus on sector trades. Our sector positions are wider than at the start of 2010: We are overweight Industrials and Commodities and underweight Consumer Sectors.
Theme #5: Equities look more attractive than long bonds but not by a big margin: We think equities are likely to continue to beat long bonds in 2011, although the gap in performance may narrow compared to 2010. The likelihood is that long bond yields have peaked. State Bank of India (Rs2,811) is our favorite stock on this trade. The rest of the PSU banks space looks less attractive.
Theme #6: Buy capex proxies – demand and supply side supportive of capex trough: We expect a disciplined capex cycle in 2011 and believe that capex-related sectors, such as industrials, property and materials (most of these have underperformed in 2010 and are not favorites with the consensus), to do a lot better. Key stocks are DLF (Rs292), ACC (Rs1076) and Larsen and Toubro (Rs1979). Consequently, the Consumer Sector, which seems to be pricing in a lot of the prospective growth, could underperform.
Theme #7: "Growth" is policy: The significance of the Bihar election outcome should not be underestimated, as it reaffirms the evolving dynamics of "development" politics in India. Indeed, our conversations with policy makers reveal that "growth" is India's policy, and we think that growth could surprise on the upside. The government is taking risks with the external deficit to fulfill its target of 9-10% GDP growth. This policy entails strong rural support through high levels of government spending until private sector demand takes over fully. Two stocks that strike as beneficiaries of this growth environment and do not appear fully valued are Jain Irrigation (Rs211) and Exide (Rs167).
Theme #8: From cash flow generators to asset gatherers: 2010 was all about cash flow generators. Stocks of companies with long duration cash flows distinctly underperformed. This is all about a hesitant bull market that we are in. High beta, low ROE and low free cash flow have underperformed in 2010. We think that, as the bull market matures, it may shift its attention to longer duration cash flow companies. Again, a peaking 10-year bond yield may help. Our favorite stocks are Jaiprakash (Rs106), Reliance Infrastructure (Rs842), Adani Power (Rs130) and IRB (Rs226).
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
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1 comments:
Bottom for sensex at 18200. We are very close to the bottom
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