Indian stock markets in anticipation

The last few months have been challenging for the Indian economy. The twin issues of high inflation and low industrial production continue to plague us. To compound this, the perception of a governance deficit and policy paralysis at the government level have made asset markets even more uncomfortable. The global ‘risk on–risk off’ trade, driven by the European sovereign debt crisis, the US unemployment situation, a slowdown in China and high oil and commodity prices added to volatility in the Indian markets.

While it is still a little early to believe that all these issue will sort themselves out quickly, there are initial indications that the situation is taking a turn for the better. Excessive pessimism at this stage is unwarranted. Indian equities have underperformed significantly this year, with returns of negative eight per cent and more. Markets seem to be pricing in lower growth, and this has led to valuations falling to reasonable, if not attractive, levels. For long-term investors in the insurance sector like us, markets have now begun to afford the opportunity to buy good stocks at moderate levels.

Inflation appears to be peaking, as food inflation has begun to ease and core inflation is flattening out. As the inflation outlook improves, the RBI is expected to end its monetary tightening cycle. Interest rates should, therefore, peak in the next few months. On the policy front, we are finally seeing signs of the government stirring back into action. The last few days have seen a flurry of policy initiatives on the retail FDI front, the GST front, clearances of a few coal blocks, the new mining bill, the land acquisition bill, etc. This increasing pace of policy reform could pleasantly surprise the market.

Low liquidity and muted expectations on the earnings growth side will preclude a full-blown bull rally at this stage. Markets will thus trade in a range for some time. Being overweight on defensive sectors like FMCG, pharmaceuticals and telecom for some more time may still be a good idea. With interest rates expected to peak, interest-rate sensitive sectors like banking and auto could be the ones to watch out for.

The long-term India story remains strong. Favourable demographics will drive domestic consumption for the next decade. We can expect a consumption boom across many sectors in the next few years, as household incomes increase. Increased social spending on education, health and poverty alleviation will also move the economy into a different trajectory. Higher spends and investment in infrastructure development will also be a key driver of growth in the economy. With China showing signs of slowing down, India could become a preferred destination for foreign investment.  In my view, this could be a good time for retail investors to begin increasing their exposure to equity.