Prof Amogh Notes #3

Market Musings..The Year 2012 for the Markets

Annus horribilis (year of horror) - is what most of us in financial markets would want to term year 2011. A year that started with lots of hopes eventually turned out to be one of the most turbulent periods for financial markets across the globe. So much so, that one was compelled to draw parallels to periods ranging from the '90s to the very recent 2008 financial crises.
  
 Worst part was India - which never originated the crises, actually bore the maximum brunt, with an ailing currency as also deteriorating growth prospects. The INR depreciated -15.87% in 2011, while the Sensex eroded in value by -24.64%. Also, the combined fiscal deficit of the state and center is likely to be around 10% for FY 12. None of these frankly were so clearly envisaged at the beginning of the year.
  
 So what really went wrong ?
  
 If 2008 crises was US led, then time the lead role was played by the Euro zone. Money flocks to safe haven in times of turbulence and hence it was no surprise to see the dollar reign supremacy in 2011 with a gain of 1.58% in the dollar index (most currencies depreciated in this period).The US 10yr treasury also returned around 17%. It was therefore natural to see INR depreciate in line with other currencies. This continued happen at a time when crude prices also remained reasonably steady. Infact, brent crude (which is relevant for India) rose almost 15% in CY 11. India is a net importer of crude and the depreciating rupee only aggravated the oil bill, leading to a widening of the Current account deficit (CAD). To add fuel to the fire, India's gold imports also remained robust. Further, for most part of the year inflation remained sticky (WPI averaged at around 9.59%) which led to monetary tightening by the RBI (interest rates hike by 225 bps in CY '11). The yield curve bear flattened in response to rate hike as well as tight liquidity conditions
  
 Have things changed since then?
  
 Not entirely - but early signs of hope do linger. Globally, the Euro does not seem to break off the marriage in a hurry, though differences still exist. The recent measure by ECB to extend 3yr loans to banks is some indication towards that. There is less bad news from the US, indicating more stable conditions there. Closer home, the recent domestic macro economic data do have a story to tell. The IIP has shown a negative growth of 5% over the last year. Food inflation has cooled off from peak levels, as also the WPI. Early signs of slowdown in consumption also have been visible alongside some stalling in the investment cycle.
  
 What to expect in 2012?
  
 While the idea is not to do a crystal ball gazing or put down a list of predictions to prove our astrology skills, we are trying to make a knowledgeable conjecture of what we feel could be in store for 2012
 - Policy rates to start easing from Q1 - FY 13 as the stance changes from "growth focus" to "inflation focus". CRR cut may be effected earlier to allow the system to breathe easy on liquidity. Recall that the system has been in the deficit mode for over 5 quarters now.
 - Inflation to ease off in the 1st half due to base effect and softening impact of primary articles. 2nd half could trend higher, albeit average for the year could still be lower
 - The "China effect" which saw rally in commodities could temper off if talks of China slowdown were actually to materialize
 - Gold to continue to display resilience in a market where uncertainties continue to exist. Headwinds may be faced from stronger dollar, but trend for 2012 remains higher.
 - Currency to continue to remain under pressure in near term, range bound for most part of the year
 - Some stocks have corrected more than the broader indices. Markets could remain range bound with attempts to seek valuation based buying this year. Remember current levels of index offer PE multiples at around the similar levels last seen in FY09.
 - Fixed income to offer opportunities across the yield spectrum. Short duration funds to be beneficiaries of the anticipated steepening in the yield curve (currently flat/inverted)
 - 10yr Gsec yield to hover in the band of 7.75% t0 8.25%. Intermittently, either end of bands could be breached in response to ad hoc news. OMOs by RBI and slow down in credit disbursements to anchor any sharp rise in yields
 - Equity markets to move sideways before some stimulus (read rate cuts) could change sentiment. Expect a trading range of 14500 - 18000 for the Sensex