Realistic Optimism

Industrial production growth numbers have led some corners to doubt the pace of economic activity going forward. In contrast, we believe these statistical series are inherently volatile and cannot decisively indicate a change in trend. We focus on the RBI’s recent statement where it has indicated that the domestic economy is operating close to the trend growth rate, driven mainly by domestic factors. The normal monsoon has boosted the prospects of agricultural production, which should stimulate rural demand. Most industrial and service sector indicators also point towards sustained growth. As an economy emerges from a downturn, confidence improves both at the consumer and the business level. It is not surprising to expect rising discretionary spending in such a scenario. We have witnessed a similar phenomenon in the consumer space too with sectors such as automobiles, FMCG, etc.

It is expected that discretionary spending would continue to move higher and spread to other areas including consumer services like entertainment, travel and leisure, etc. Hence, we see a good demand for investment related goods (capital goods). If we add the government thrust on infrastructure and a large pool of savings available for financing investments, we get a potent economic machine capable of delivering growth for years to come. As the economic landscape world-wide is quite uncertain, we cannot rule out a few odd corrections induced by global macroeconomic volatility, it is not unlikely to reflect a fatal economic condition.It is also unlikely that global policymakers will let the worldwide financial system come dangerously close to instability since they have seen the impact of the late 2008 events in the US banking industry. Therefore, instead of looking for triggers that could spark the next rally, we focus on identifying companies with good business models and sustainable growth prospects. The BSE Sensex was moving in a 2500 point range for almost a year until 2½ months ago wherefrom it staged a strong rally on the back of the huge surge in liquidity from FIIs to reach the January 2008 levels.

Even after this, the index has returned close to 15% during the current calendar year, which is by no means extraordinary, but a reasonable return for 10 months. This rally and the recent success of the Coal India IPO have made a number of investors ask about the market’s prospects in the remaining period of the year. It makes us wonder how many of these investors were able to position themselves to gain exactly before the recent rally started. In our opinion, not only is it futile to predict the market’s move in the next 1½ months, it would be worse to invest on the basis of any such forecasts. We think market valuations are close to fair and not exorbitant. It is reasonable that investors could earn a hurdle rate of 15-20% or perhaps more through good actively managed funds. One must select a judicious mix of large, mid and small cap funds depending on one’s risk profile. However, our suggestion is to allocate incremental capital to equity markets at regular intervals to tide over the volatility.