Going against the tide may just pay off — buy equities

Equity markets are still 4% off from lows seen pre-budget with the sensex at 18,000 up from lows of 17,500 seen in February 2011.

The rupee has been steady in a Rs45 to Rs45.25 range against the US dollar, down from levels of `45.50 seen in February. Bond yields are 15bps off highs seen pre-budget with the well-traded bond, the 8.13% 2022 bond, trading at yields of 8.12% from levels of 8.25% seen in February 2011.

Credit spreads on Indian names have been steady with ICICI Bank CDS (credit default swaps) spreads hovering around the 235bps levels for the last couple of months. The markets are higher all round month on month despite a whole host of negatives plaguing the market at present. Have the negatives been discounted fully and have the market seen its lows in February or can it touch further lows? Optimists will tell you that markets have discounted all bad news, while pessimists will tell you markets have not discounted bad news. On a consensus basis, there does seem to be more pessimists than optimists, though the market seems to be more optimistic than pessimistic. So will the markets go up or down?

It is easy to be pessimistic with negatives all round. Middle East unrest leading to high oil prices (Brent at $115/bbl is at two and half year highs). Japan nuclear disaster threatening world economic growth. China raising rates to fight inflation. High inflation with WPI (wholesale price index) at 8.3% way above policymakers’ comfort levels. Prospects of rate hikes by the RBI given rising inflation expectations. Corruption scandals leading to worries on corporate governance. State elections increasing political risk. The budget for 2011-12 itself was more on optics than reality with utopian-like scenario of high growth, low inflation, low fiscal deficit and lower current account deficit. In times of rising oil prices, such scenarios are not possible.

There is reason to be optimistic too. A market sitting short with FIIs’ being net sellers of around $2 billion calendar year to date, US equities still showing positive returns year to date, strong manufacturing and export growth in the US and Germany (manufacturing growth in the US was up for the 19th consecutive month led by good export orders while Germany’s manufacturing growth touched a 15-year high), positive employment numbers in the US, soft landing hopes in China and central banks still keeping interest rates at all-time lows despite signs of rising inflation expectations. Global investors are in a mood to live with high oil prices (despite Middle East tensions raising the prospects of higher oil prices) and they are taking up equity indices higher. India being a significant underperformer with a 10% loss year to date against gains of 2% to 5% in other markets, may attract its share of attention as an underperformer.

On the domestic front too there are positives. Manufacturing growth for February was at 20-month highs while exports are continuing to do well at close to 30% growth for the April 2010-January 2011 period. Vehicle sales are robust with high double digit growth for February. Economic activity continues to be robust despite rising costs in the economy. The liquidity situation in the banking system, which was tight for almost eight months with banks borrowing from the RBI on a daily basis, looks to be turning. Government spending will ease liquidity with the government expected to spend Rs60,000 crore in March.

Deposit growth rates of banks have picked up with banks paying more for deposits. Deposit growth has grown by 16.4% as of February 25 against a growth rate of below 15% seen in the second half of the calendar year.

Who will come out better? The optimist or the pessimist? Sometimes it pays going against the tide, so do not watch TV, do not read newspapers do not log on to the net and switch off your phone and buy equities. It might just pay off.

email: arjun@arjunparthasarathy.com