Avoid the global noise, decouple from economic markets to play

Over the last few months, there has been lot of noise around various global events that made headlines, and have impacted stock markets in India. At some levels, it has been the crisis in Greece; at another, the potential hike in interest rates by the US Federal Reserve; and now the latest is the depreciation of the Yuan by the Chinese. All these events were predicted to lead to doomsday, but no such thing happened. The key now, is to evaluate what lies ahead.

Over the last few days, I have clearly come to believe that we are now at a stage where decoupling of markets is likely to play out significantly over the next few years. Most markets are coupled with each other at times of extremities, where there is a huge euphoria or huge despair. However, at times, when we are somewhere in between, is the time when decoupling can play out, especially when the economic outlook differs so widely across countries.

In the Indian context, we are at the inflexion point of growth revival today. Economic growth is likely to revive sharply, GST or not. If we get GST early ie, in 2016, it might just aid economic growth but it will not generate economic growth as is widely believed. Economic revival in India is a given today. It is going to be driven by factors such as:

-- Low and controlled inflation which will be driven by extremely low commodity prices. Crude prices, for example, have corrected by nearly 60% over the last one year, thus giving a push of nearly Rs 4 lakh crore via savings on crude imports on a 12-month run rate basis. Companies are reporting record margins despite poor capacity utilization. As growth picks up, the operating leverage will come into play, and inflation is unlikely to come back soon. Even on food prices, moderate MSP increases and small steps towards improving productivity and wastage will help in the short run. Over the long run, further supply side measures will be required.

-- Strong government finances reflected in the recent numbers -- indirect tax collection went up by 39% in July. This combined with reduced subsidies will aid government finances, help them push capital expenditure and reduce crowding out from the markets and help bring down interest rates.

-- Improved investments reflected in much greater enquiries with companies, better execution as well as a revival in pent up demand. A turn around in demand can be seen in the commercial vehicle segment, where sales are growing at nearly 25%. Various public sector units are also pushing for greater investments as their cash flows improve. For example, railways may make huge savings as diesel prices have come down. That, accompanied by reduced leakages, will boost capital expenditure. Similarly, oil PSUs are seeing huge improvement in cash flows which can go into investments.

-- PSU banks' recapitalization, combined with promises of greater autonomy and less interference, can drive a value creation cycle and also provide much-needed growth capital in the economy. Some measures on this front have been announced by the government in the form of the seven-pronged reform agenda; more might follow.

-- Large funds flow into equity is likely to continue from domestic investors driven by lower interest rates on fixed income, non-performance of gold as an investment, and a likely stagnation in the performance of real estate.

Besides this, the bogey of Yuan depreciation needs to be understood properly. Since the end of the last boom in 2007, the Yuan has appreciated by 20% and the rupee has depreciated by 60% against the US dollar. Currently, while the Yuan has been devalued by 3%, the Indian unit has fallen only 2%. This noise should be totally ignored.

Another huge noise that needs ignoring is the expectations of a hike in interest rates by the US Federal Reserve. As the Fed hikes rates, whenever it does, we will see a huge capital flow into growth assets as this move will be driven by confidence in economic recovery. Fed's fears are similar to those at the time when it going to stop bond buying and people had predicted doomsday.

India as an economy and a market is likely to see significant decoupling, not only from the major emerging markets, but also from global equities over the next 3-4 years. This doesn't mean that the effects of a huge short-term sell-off globally will not impact India. That will always happen, however, the economy is now in a sweet spot with most of the negatives behind us, and the likelihood of positive surprises much greater than negatives over this time period.

2003-2007 saw huge decoupling where the performance of major markets differed widely. Since the beginning of early 2003 till the bottom in March 2009, the world index moved down by 17%, while Indian markets were up 240% and the MSCI EM Index was up 166%.

The outperformance really took off after the fall of May 2004. At the beginning of the BRICS rally in 2003, equity markets constituted just around 2-3% of world market capitalization. As of now, they are at around 20%. Over the next two decades, this will move towards at least 50%, if not more.

Decoupling Phase II is around the corner. Choose to play it or miss it.

Sandip Sabharwal is a fund manager who runs an investment advisory company. He can be reached at his website.