Watch Out For Volatility

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The Indian markets are fairly valued at around 21,000 levels and so to that extent the upsides would come in from a view on the rupee, enhanced liquidity flows due to QE2, and positive surprises in earnings. However, it is pertinent to note that India offers one of the most buoyant economies within the emerging markets and global fund managers probably have no choice but to go overweight. Also, the real story in India is in the mid-cap space where FII participation is low, and to that extent we would see a very robust market scenario over the next two years as the economic cycles become more robust and currencies stabilise.

The initial evidence on the results is not bad and we would not be surprised if revenue growth on a YOY basis for Sensex registers at around 20-22 per cent. Profitability however may not possibly grow beyond the mid-teens and possibly could register declines in cement, telecom, and auto. The key piece trigger for the Indian markets is likely to be the stance of the Federal Reserve on liquidity – any positive developments in the form of a second package for support may immediately trigger a race for emerging market assets and commodities and induce more FII flows through all kinds of channels into India. Q2 results of course remain a key element in deciding the extent of such flows. Inflation is expected to start moving down especially as the rupee remains strong and agricultural growth starts showing up.

The government and monetary authorities would also act if food inflation does not subside, especially via allowing interest rates to rise to some extent and reducing the negative real carry on cash. The global markets are likely to continue to remain extremely volatile and it is possible that commodities, both base and precious, register gains, more because of liquidity and less because of fundamentals.

The key dilemma now for the markets is the trajectory of the USD – which at the current moment remains unnervingly unclear. Metals, consumer goods, financials, oil and gas, and capital goods should do better than expectations as domestic growth drivers remain strong. Retail investors should continue to book profits at regular intervals and have a limited but good quality exposure to mid-caps in their portfolios. There are a wide variety of options available for diversification and it is probably time for clients to revisit their investments and move to cash and gold ETFs, at least to 25-30 per cent of their portfolios. We believe that the markets are ripe for a brief period of sharp volatility before they resume their journey upwards and investors should look at their risk appetite before deciding how to participate.