As the stock markets continue on their volatile movements over the last few months it is now important to sit back and evaluate the various factors impacting the markets and correlate from them the direction that the markets are likely to take going forward.
There are various factors at play today, There is the slowing global economy and the stress in the financial sector globally which has led to a squeeze on liquidity and credit flow. The germination of the same was the US subprime problem and has rapidly spread to other parts of the US economy and has also flown abroad through complex derivative products which have impacted financial institutions all over the world, more so in the US and Japan. Rapid interest rate cuts by the US Fed have limited the damage to some extent but seem to have created a US dollar carry trade which has led to a huge flow of money into commodities. This has inturn created strong inflationary pressures due to the increase in prices of commodities across the board from oil to agricommodities to metals. It has also flown through to secondary products made from primary commodities lately.
This has now created a dichotomy where central bankers across the world are faced with slowing growth and strong inflationary pressures. We believe that the central bankers will be more focused on controlling inflation at this stage and that is also reflected in the statements of the US Fed where they are indicating a steady policy going forward. European central banks are also holding steady and in the developing world we are either seeing a standstill policy or liquidity tightening measures being pursued as in most countries inflation has gone above the targeted levels.
We believe that a combination of slowing global growth and reduced liquidity flows will lead to a collapse of the commodity bubble going forward. We have already seen several agri commodities and base metals already correcting. However crude oil and steel are yet to see any significant correction. A correction in these commodities is now imminent.
As commodities correct they will lead to a reduction of inflationary pressures and we expect that inflation in India which is today at 8 percent plus should trend down to 5-6% over the next one year.
Domestically today we have a macro situation that does not look very healthy with a ballooning fiscal deficit situation, high inflation,increasing trade deficit and slowing growth. However on the micro front as we evaluate company results and the guidance given by companies across sectors is concerned the situation does not seem to be as grim. Most capital goods and construction companies have guided for a growth of 30-40%. Companies in the technology sector have guided for a growth of 20-25% and that guidance factored in rupee at Rs 39 levels. Given the way rupee has fallen over the last few months this guidance is likely to be exceeded. Pharmaceutical companies that were not doing well over the last few years are bouncing back strongly and are likely to grow at 20%. High steel and base metal prices are likely to see strong growth in commodity companies. FMCG is seeing a revival and growth in earnings is likely to be 15-20%. Telecom companies are likely to grow at 30% plus. Automobile and real estate sectors are likely to slow down but still grow earnings. Overall as it seems earnings are likely to see a 20-25% growth. Current market expectations are for a 10-15% earnings growth and the markets in their valuations are factoring in this slow growth. The stock markets are down nearly 30% from the peaks and the mid cap index is down over 40%.
Overall we believe this is the right time for long term investing and lot of the macro issues will get addressed over the next one year. Given strong earnings growth we believe that markets over the next one year are likely to deliver a return of 30-40%. Monsoons are first quarter corporate results are likely to trigger the upmove and the pace of the move will depend on various factors like the rate of change of inflation, commodity price movements as well as clarity on global economic growth. Valuations at around 15X 2009 earnings and 12-13X 2010 earnings are now reasonable. Irrespective of short term volatility or weakness the long term trend is very much intact and it is time to focus on long term upsides rather than short term downsides.
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