What's in store for the investors in the New Year?

The Vidya Balan starrer “The Dirty Picture” released at a very appropriate time. Though the movie has been a hit, 2011 has indeed been a Dirty Picture for Corporate India, stock markets and the rupee.

At the start of the year the Sensex was at 20000 levels. There were fears around Greece and other European nations. The first half was expected to be tough but the second half was thought of a recovery phase. However the second half was even worse.

The Reserve Bank of India (RBI) continued to hike key policy rates (from 6.25% in Dec 2010 to 8.50% currently) in a bid to curb inflation. By doing so, it made the capital expensive, hitting industrial and overall economic growth. However, RBI kept its key policy rates unchanged during its December 2011 review.

The falling IIP along with rising cost of raw materials and a perception of policy paralysis among stakeholders made 2011 a year that India would like to put behind. The year witnessed BSE Sensex making new lows, gold at historic highs and INR falling to record lows.

In addition to rate hikes following is the overview of the top financial stories of the year.

IIP data into negative territory for the first time since 2009:

IIP nos kept falling through out the year, it nose-dived to negative 5.1% in October 2011 on the back of falling consumer demand and declining corporate investments.

INR at all-time low:

INR fell to a record low of 54.17 per USD breaching the 54 level first time in history on sustained foreign capital outflows and dollars gains against the euro and other rivals overseas. It has fallen by 16% since the beginning of the year, the worst performance among the Asian currency. A weakening INR is also eating into the gains of falling international commodity prices adding to inflationary pressure.
 

Sensex falls to 28 month low:

In a departure from big gains in the past two years, Sensex witnessed 23% fall till 29th Dec 2011 as risk aversion deepened globally coupled with absence of policy initiatives to revive slowing domestic growth. FIIs the main drivers of the market, turned negative on Indian equities this year after having injected a record USD 29.36 bn in 2010, pulled out USD 318 mn in 2011.

Gold price touches record high:

Continuing their record-breaking spree, gold and silver galloped to all time highs in 2011 (from USD 1400 levels in 2010 to USD 1900 levels in September 2011) on strong demand in times of economic turmoil and rising inflation. Nervous investors preferred to park their funds in gold as a safe investment instead of risky assets like equities. Internationally gold prices have seen correction from its all time  highs. However, falling INR has acted as a cushion for gold prices in India.

Downgrading of debt ratings:

Downgrading of debt ratings and the poor outlook of some European countries in May deepened investors concern. Later, an unprecedented downgrade of the US credit rating by S&P on 5th August led to turmoil in global markets, triggering fears of another recession in the world's biggest economy.

So what’s in store for 2012?

After making big moves over the past 18 months, RBI has decided to maintain a status quo for the time being in its December 2011 Monetary policy review meet. RBI has maintained the cash reserve ratio (CRR) at 6%. The repo rate (rate at which banks borrow from the RBI) was also kept unchanged at 8.5%. RBI however has clearly indicated that no further rate hikes are warranted. RBI also indicated that rate cuts would happen after an assessment of macroeconomic fundamentals.

The unresolved situation globally also hasn't helped matters much. A weak economy globally puts pressure on emerging market economies due to slowing export demand. In light of slower growth in these countries, central banks in Brazil, Indonesia, Thailand, etc have all cut interest rates. Being conservative as usual, the RBI has not followed its counterparts, opting instead for a mere pause in rate hikes.

On the fiscal ground, India being net importer country, the depreciation of the Indian Rupee (depreciated by around 18% since August 2011) is also posing a serious risk.

With so much uncertainty looming overhead, it's hard to predict what the next action step for the central bank will be. Inflation seems to be on a downward trajectory, but credit growth is seeing a slowdown. Downward pressure on the rupee is also making the situation difficult. If it persists, fuel inflation will be a bigger worry than just food inflation. We can cheer that RBI has conceded that slowing growth is a major concern, by pausing rates for the interim. Thus we can breathe easy for now, even if it is only for a short while. But, a formal assessment of inflation and growth numbers is still due in January 2012. We sure hope the New Year has good tidings for India Inc.

The worry that still persists is the health of Euro-zone countries. It is perceived that Euro zone crisis may not stop with Greece and Italy, since Fitch downgraded Portugal's rating to 'BB+' (from 'BBB-') a non investment grade. Similarly, S&P downgraded Belgium to 'AA' (from 'AA+') it is making investors believe that contagion effect is indeed spreading across the Euro Zone that could prove a serious threat to world economy.

In coming times, the rating agencies – S&P, Moody and Fitch have warned that all 17 Euro zone nations could face a risk of rating downgrade, including those of France and Germany who have so far enjoyed the prime rating of 'AAA+'.

Considering all, let's take a look at each asset class and explore the opportunities and threats:

Equity:

Going forward we think that global economic news disseminating from the developed economies - especially the Euro zone would continue to drive the sentiments in the Indian equity markets. Looking at the global scenario and economic data, we believe in the short term, the equity market will be bearish.  Though the net sales by FIIs has been only approximately 1700 crores, the situation could get worse if selling intensifies.

Valuations today are much better for equity investments (however they could get better), investments made during such times will return abnormal returns in the next few years but one could see red in the short term.

Keep a guarded approach, going extremely slow in making one time investments in equity and invest primarily through SIPs and DIPs (one time investments on days when the market falls). This has been one of the best strategies to capitalize on the current market volatility.

On the positive side, interest rates should start coming down starting next financial year. Also, monsoon rains were 2% above average. A good monsoon season can typically boost rural farm incomes and have an impact on the wider economy through increased spending on consumer goods as well as reduced prices of food items. In addition, with developed world expected to slow down, we expect commodity prices to fall further in the next several months. These are all excellent triggers for the equity markets and at a certain point of time when Euro-zone worries slow down, these triggers will play a role in determining the direction of Indian equity markets.

Cash will be king in 2012 as a lot of asset classes could come under pressure in light of liquidity crunch and risk aversion.

Gold:

Gold prices have corrected from the record high of USD 1,924 an ounce in September 2011 to USD 1,570 an ounce on 14th December 2011 as investors sold to cover their losses elsewhere coupled with profit booking by fund managers near a year end. Since October 2011, gold has corrected by 15-20%, however the depreciation of Indian Rupee (depreciated by around 18% since August 2011) has helped the prices to remain firm in INR terms. We believe profit booking would still come in gold, however the depreciating Indian Rupee would act as a cushion to fall in prices globally.

Going forward gold prices would pave their path depending on how the global economic headwinds unfold. If downbeat global economic data is disseminated, along with inflation pressures persisting in the Emerging Market Economies, gold would continue its up-move. However, any intermediate positive newsflash may bring in a marginal correction in prices of gold. Hence, nothing has changed for gold and we believe it will continue to maintain its upward trend in the medium to long term. In fact, we believe that such corrective phases are opportune times to invest in gold and safeguard against global and domestic economic risk. But like paper money, gold is only worth what people believe it's worth. To sum up, investment in gold should be scaled up, to atleast 15% of the portfolio.

Real Estate:

The impact of slowdown has already been felt in the real estate market. Apart from demand slowdown, impact of rising cost of funds, increasing construction cost and delays in government approvals is worsening the already dismal condition of the sector. Like any other sector, the aforementioned factors clearly point towards a price correction in the real estate market. However, residential prices in most of the cities have either remained steady or increased marginally in the past few quarters. This implies that demand-supply conditions are not having any significant impact on the residential market prices in the short term and there are other factors at play which are having a greater influence on price.

Financial condition and holding capacity of real estate players are such factors which influence the price movement in the market to a great extent. To understand, we did quick numbers and found that since FY 08, revenues and profits have dropped by 19% and 70% respectively, despite property prices witnessing an increasing trend during the period. On the other hand, debt and interest outgo have increased by 1.5 and 2.3 times respectively, in the same period. The equity fund raising has almost dried up through stock markets. Further, over the last two years, developers have raised huge amount of debt and equity through private placements and other innovative manners, this option too now practically looks exhausted.

In FY 08, when the global economy was going through a recessionary period, the stress level of the sector was at its highest level and many developers were on the verge of defaulting on their debt payment. However, the Reserve Bank of India (RBI) had allowed banks to restructure the debts of these companies keeping in mind the recessionary condition of the economy and hence giving the much needed breather. But the possibility of this happening in the current scenario is very bleak and looking at the stress level of the industry, the road ahead for real estate industry looks bumpy.

Interestingly we have entered the phase where real estate companies are going to raise capital for project completion and debt repayment rather than for expansion plans.  However, some of them are launching new projects which are due in 2016-2018, so that money could be utilized for existing projects. We believe that till the time real estate players are able to raise additional long term funds in order to meet their short term obligations, residential prices will remain steady. However, there is always the possibility of some players who are not able to raise fresh funds easily will have to offer better deals to investors or will be forced to reduce prices in order to meet the short term cash flow requirement.

As mentioned in our last report, this could well turn out to be a great time for HNI's and Institutional investors to strike good deals with builders. Some of the institutional investors are striking debt deals with builders at a coupon of 20-24%.

Debt:

In spite of deregulation of saving bank interest rate, considering tight liquidity in the system, we continue to maintain that it is extremely important to keep short term money from saving and current account into liquid plus funds to earn higher post tax returns. Liquid plus funds are giving returns of around 7% (100-150% higher returns post tax than saving (currently 4-6%) and short term fixed deposits). If you are a fixed deposit investor, it makes sense to go with tax free bonds such as NHAI ,and PFC that are delivering a tax free return of 8.2-8.3%. However for shorter tenures ,good quality FMPs are a better option than FD's as they offer higher post tax returns. However, FMPs should be done for a period of 3 years as higher post-tax yields are locked in.  Short Term Bond Funds are excellent opportunities for a time horizon of 12 -18 months.

In short, the preferred debt investments are Liquid Plus funds for 3-6 months horizon, FMPs for 3 year horizon, and Short Term Income Funds for 12-18 months horizon.

Considering the recent pause by RBI, we believe interest rates are at elevated levels and almost nearing their peak makes longer tenor papers attractive. These are the excellent time for gradually taking exposure to long term government securities funds. As interest rates fall, investor gains capital appreciation on their investment along with the coupon payable by the issuer (In short there could be a 15-20%  return in such investments. However, there could be negative returns also because of interest rate volatility and hence suitable for aggressive investors). Investments in GILT funds, when yields on 10 year G-Sec are above 8.8-8.9%, could be a good investment option for 18-24 months (Since interest rate movements can be swift, we generally do not take GILT calls for trading gains).

In short 2012 can be a very interesting year to lock in deals in different asset classes.

Wish you and your family Merry Christmas & a very Happy, Healthy , Safe and Prosperous 2012.

Source: http://www.moneycontrol.com/news/mf-experts/whatsstore-forinvestorsthe-new-year_641850.html