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WF : Does this liquidity driven rally have support from improving domestic fundamentals?
Jayesh : The year 2012 started on an unprecedented note with equities posting best gains of January in the last 18 years and currency also appreciating on the back on high global inflows. Fundamental factors, both global and domestic, appear to be improving, although one does not know their sustainability. For instance, there are signs that the much talked about policy paralysis in the government seems to be ending. Also, RBI's intervention in the forex markets has ensured that the rupee rebounds back to more logical levels, also helped by portfolio inflows. More importantly inflation trajectory has started to reverse its course. Corporate results and subsequent commentary suggest bottoming out of margins and improving operating environment for the coming months. On the negative side, crude oil which was our principal concern, has spiraled up to USD 120-130 and reports suggest it could remain in this range for some time on account of Iran embargo stalemate. The negative impact for the high cost of crude is likely to be felt in coming quarters. Also domestic politics and election results in UP are likely to play a key role in determining policy action going forward. Domestic liquidity situation is at an unprecedented high negative level, keeping short term interest rates high in spite of slow growth.
With the twin large deficits, fiscal and trade, capital is moving out of the country. Equity markets are factoring in lot of positive events to occur such as rate cut by RBI, state elections results in favor of ruling coalition and most importantly forthcoming budget, government containing spending and enacting policy action to kick start growth in the economy. Hence one has to await the events in the next few weeks to ascertain if this rally can sustain or otherwise
WF : Some analysts worry that the rally has been led mostly by laggards of 2011 and not really by the best quality names - and is therefore a little suspect. Is this a valid concern?
Jayesh : Yes, the laggards are beaten down and oversold in bear markets to such an extent that they witness a sharper bounce back whenever there is a turnaround or otherwise. However, this phenomenon has been witnessed across emerging markets as well. The EM countries which were the worst performers last year, such as India, are the top performers this year to date.
WF : What is your overall Indian equity market outlook for 2012? Are we in a bull market or do you see a continuation of a range bound market this year?
Jayesh : Opinion is divided whether we are at the start of a new bull run or the current rally is a proverbial 'dead cat bounce' that one often experiences in bear market rallies. It is still unclear whether there is a sustainable change in global and domestics factors to favor equities from a medium to long term. Equities have historically been lead indicators of change in economic growth momentum; we would hope that the current momentum is also indicative of such a trend. The events in the next few weeks, such as budget, election results, etc. could very well be the key deciding factors for the next 12 months market performance.
WF : Oil in specific and commodities in general are rising - which is not a happy situation for the Indian economy. What is your view on commodity price trends for this year?
Jayesh : Commodities and Equities have behaved in similar manner over the last couple of years based on the 'risk-on' trade flows seen globally. India is in a peculiar scenario wherein higher commodity prices particularly oil impact the current account and fiscal deficits for the country and high volatility in commodity prices lead to lower corporate profitability in the short to medium term depending on the prevailing demand environment. Key monitor able for outlook on commodities is growth outlook on China, which is the largest producer and consumer of commodities. We would think that China's investment to GDP ratio is at a historic unsustainable high of near 50% and would see a slowdown leading to softer commodity prices in the next 5-7 years.
WF : Can we now say that the big event risk in Euro zone is behind us? What is your view on global equity markets for this year?
Jayesh : Events in Euro zone have averted a liquidity crisis for the banking system and technical default by Greece, which otherwise could have impacted global markets. Latest increase in LTRO and aggressive austerity promises by Greece have yielded some comfort for the medium term risk but there are impending elections in many of these over leveraged economies which would test popular support for such a package and we continue to monitor the outcome of such events. Data from US continues to be strong with 4Q GDP growth in-line with expectations and upbeat consumer sentiment in the year of presidential elections. US markets could surprise by a big up move in the year because of stronger than expected growth rates from the economy.
WF : How are you currently positioning your ACE fund in terms of market cap biases as well as sectoral biases?
Jayesh : A.C.E. fund is currently positioned predominantly with a large cap bias with being overweight in pharmaceuticals, software services and consumer discretionary products. Our large allocation is to companies with stable and predictable business models, strong visibility and balance sheet. While we have not made significant changes in the portfolio during the last few weeks, we are watching the recent events closely to see if there are early signs of significant improvement in medium term outlook for equities. Mid-cap allocation to the portfolio is moderate at 13-15% levels. However, as economic growth momentum picks up, there is a good possibility that the allocation to mid-caps and domestic cyclical sectors would see a change.
WF : What are the key risks that you would be watchful about in the Indian equity market?
Jayesh : Today, the key risk to the India growth story is government inertia on reforms agenda. Markets are keenly watching government action on key policy issues like coal allocation to power companies, resolution of telecom sector spectrum issues, award and implementation of key infrastructure projects, FDI policies in capital-starved sectors of the economy like retail and insurance. Post the ongoing state elections, markets are expecting a firm budget with control on subsidies and expenditure, which would lead to lower government borrowing for the next fiscal, and implementation of policy reforms to aid Indian economic growth from the current levels of 7%. Other key risk which has been highlighted many times is the sharp run-up in commodity prices particularly oil prices as they lead to inflationary spiral impacting corporate profitability in the short to medium term apart from increasing the current account and fiscal deficits which leads to crowding out effect and high interest rates for the economy.
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