It has been a challenging period for investors in equity, as the broad indices have remained flat for almost four years now. However, investors must keep in mind that equities have delivered decent returns over a longer period, and thus, they should maintain the discipline of asset allocation. In fact, the volatility induced mainly by global factors is offering investors an opportunity to participate in the structural growth story of India.

While markets swing to the changing moods of investors most of the times, they tend to track performance against expectations. At the beginning of the year, there were expectations that the government would take action to revive the slowdown in the investment cycle and that inflation would cool down by the middle of the year. However, as the year progressed, things kept deteriorating on the macro, policy and execution front.

While the consumption leg of the economy maintained its momentum, investments failed to take off. The latent demand growth has displayed resilience during the adverse periods of high inflation and even higher interest rates (thanks to the policy choice of inflation control over growth sustenance). The demand growth though, is showing enough stress as we come close to the end of the year, post a relatively sluggish festive season.

We are entering the new year with more apprehensions. Almost each of the macro and micro variables (GDP growth, IIP, inflation, credit growth, currency and the global macroeconomic situation) is at the tip-off. Equities investors – both local and global – seek growth sustenance, policy predictability and a favourable currency bias. Each of these pegs is under a scanner as the new year sets in, almost forcing India down from its pole position in terms of global attractiveness.

2012 would also subject the global financial markets to an acid test of their existing ecosystems. The impending situation in Europe (the nature of outcome of which is as uncertain as it could be) would be a natural undercurrent to money movement across asset classes, and India cannot remain aloof to the developments.

Corporate India seems reluctant to commit new capital locally. Most of the capex has either been stalled, delayed or suspended. Rising wage costs, burgeoning interest payments (adverse currency in case of ECBs) and high energy costs have contributed to higher operative structures. Corporate earning expectations have been downgraded, and may reach their highest decibel in the next two quarters.[PAGE BREAK]

The economy cannot afford the continuation of sticky inflation, rising interest rates and a weaker currency. While demand is an addressable issue with marginal stretch from the policy side, the governance needs to step up its response to the glaring supply gap on most of the input parameters.

The government’s response to a slowing economy amidst mounting macro challenges and a tough external environment is quite critical, and we hope that the political class will rise to the occasion and not derail the structural India story. We believe that in the backdrop of impending state elections, a directional reversal in policy making would be subject to a test of political will, and this is critical for change in the market sentiment. The other important driver for the market would be the trajectory of inflation and interest rates. One can expect the RBI to soften its stance on interest rates, as India Inc. struggles on account of the simultaneous developments of slower growth, higher costs and a weaker currency.

The world of investment is very fascinating, and events and perceptions do change here. In an uncertain global environment, India stands out due to its relative attractive position in terms of opportunities. The underlying promise of the structural India story, with a compulsive balance on investments (supply constraints), consumption (demographics, low penetration and under-leverage) and export competitiveness remains unquestionable in a world dealing with deflation and anaemic growth. In the coming months, the India story would be subject to further scrutiny in terms of its character, depth, policy commitment and longevity.

One should not write off a black swan – in this case, the synchronised occurrence of favourable events such as softened interest rates, global commodities and a reversal of the currency slide (they all have high interlinks). Unlike the last cycle, any such event would be a derivative of global events rather than any positive surprise from within.

In today’s pain lies tomorrow’s gain. We expect this period to offer a good opportunity to investors to participate in India’s long-term story. Investors should focus on bottom-up stock picking, with a selection bias towards quality, a competitive edge and emerging high growth businesses.
At times like these, it is important to hold tight onto core beliefs of investment in terms of quality (business, management and cash flows), prudence (on cash utilisation) and agility (in terms of timing and allocation). The investment strategies in such a scenario would be –

a.  Enhance the defensive part of the portfolio with corporates that offer –

• Franchise value
• Consumption compulsion (say, healthcare)
• Early-stage penetration opportunities

b.  Play the input energy basket of oil, gas and coal as an additional hedge to an energy-starved economy

c.  Concentrate on pure asset plays that have come closer to distress value, and use cash prudently to seize opportunities in volatility

d.  Tactical bets on interest rates sensitives to benefit from an impending policy response

- Navneet Munot, Chief Investment Officer, SBI Funds Management