January 2011 Equity Newsletter: Fund managers good at stock picking will succeed
Headwinds or tailwinds?
Stock pickers will be the best performers given that headwinds look to be stronger than tailwinds for equity markets. In terms of schemes that are focused on a few stocks, do not hug benchmarks. Schemes having good fund managers, will be the funds to invest in. The broad market is not likely to do too well in this current equity environment and large, diversified funds which typically hug indices will struggle to perform. Investors looking for large caps may as well invest in index funds that carry lower costs.
There will be pockets that will do well in this current market environment. The policy as well as political risk is high at present and it will be wise to invest in stocks/sectors that are not policy dependent. Technology and pharma stocks to a certain extent come to the fore while consumer durable stocks operating in a stable margin environment will be better off than the consumer sector as a whole, which is extremely competitive. Good technology and pharma funds that have dedicated fund managers will be good picks.
Equity markets face both headwinds and tailwinds, and the market direction will depend on the strength of one over the other. The headwinds are in the form of inflation, high structural fiscal deficit, lack of domestic liquidity and politics. The tailwinds are in the form of high global liquidity, improving global economic outlook and strong domestic consumption. China can be a headwind and tailwind- headwind if the economy falls under its own weight, tailwind if policymakers can bring the economy on to an even keel. At this juncture, headwinds look to be stronger than tailwinds with China tilting the balance towards headwinds.
Inflation is proving to be a bugbear for domestic policy makers. Primary articles inflation is at over 17 per cent levels and is looking to remain sticky at higher levels on the back of rising food prices. The fuel price index is understated to the extent of subsidies and if subsidies are removed, inflation expectations will trend higher. The government’s finances which were looking better on the back of windfall gains are now starting to show strain of subsidies (oil subsidies have grown to Rs 65,000 crore from budgeted Rs 3500 crore). Government spending is not looking to come down with government committed to higher pay for its employees and higher MSP (Minimum Support Price) for crops. The liquidity in the system has turned from positive to negative with liquidity drawdown at over Rs 2,00,000 crore in the last nine months of this fiscal. Political risk is increasing with the government facing disruptions to its functioning on 2G scams and other corruption issues. There is a threat of mid-term polls if the parliament does not function properly.
The printing of money by the US Federal Reserve (Fed) and the European Central Bank (ECB) amidst record low interest rates is flooding the market with primary liquidity. The liquidity is going into risky assets and India is seeing a fair share of this liquidity. FII flows are forecast to equal 2010 flows of over USD 25billion. Global economic prospects look brighter in the form of improved consumer and business confidence in the developed world, better manufacturing numbers in the US and Germany, good retail sales growth and rising trade volumes. The economic performance is reflected in market indices which are at two year highs in countries like the US, Germany and UK. Domestic consumption is holding on with consumer durables showing growth of 24.4 per cent in the April-November 2010 period against 18.6 per cent seen in the same period last year.
China is tightening its monetary policy to rein in inflation which has crossed 5 per cent levels. The government is committed to curbing property bubbles as well as bringing down inflation and this could have repercussions on global economic outlook. China is determining world growth trends through its stature as the world’s largest consumer and manufacturer.
At this point of time there appears to be more headwinds than tailwinds. However, if liquidity continues to surge, China is able to bring in a soft landing and India is able to ward off inflation, tailwinds could gain ground.