Indian markets: 2011, a year to forget and hope for better into 2012
Indian markets performed to the worst in 2011; all asset markets were down and out. Stock market was down by over 25%; rupee exchange rate down by over 18%; fixed income market down by over 20% and Cash has been the king. In the meanwhile, US markets have been relatively stable with DJIA up by over 5% (flat S&P 500); USD Index up by over 1% and Gold up by over 10%. The Indian markets (across all asset classes) was the worst performer in Global markets; thus diluting global investor appetite on Indian economy. It goes to prove that the Euro zone crisis (since July 2011) has hit the Indian economy very hard while the US and other emerging markets have been able to withstand to the pressure. The reason for this is obvious – poor macroeconomic fundamentals of the Indian economy. During this period, Indian economy was struggling with all sorts of economic woes such as low growth; high inflation; tight liquidity; high interest rates; weak currency; widening trade gap and high fiscal deficit. There is no one-shot solution to address these economic woes while being dependent on external capital; liquidity and consumer demand, hence the struggle for the Indian economy and markets. Why Indian economy got into this kind of “trap” while other emerging economies heavily dependent on exports could manage to survive? This should be a good case study for introspection.
What is in store for 2012? While it cannot go much worse than this, there are no turnaround signals. It is possible that the worst is not yet sighted but firmly believe it is not far away. The signals from external sector are mixed. The US economy is showing signs of improvement. The growth momentum in the US is supported by low inflation; easy liquidity and low interest rates. The “worry” is from the Euro zone. Despite deriving comfort from provision of liquidity (by ECB/IMF) into Euro zone financial system; ability to address fiscal issues is in doubt. The worsening fiscal position in the Euro zone and high cost of liquidity (despite near zero policy rates) will keep the growth momentum under pressure for long time. The fear of disintegration of the Euro zone is still valid. The domestic factors, on the other hand exhibit signs of optimism. The confirmation on downtrend in headline inflation and significant pressure on growth would result in availability of adequate system liquidity at low cost. This monetary stance would be required to maintain GDP growth momentum at 6.5-7.0% (and avoid slippage into 6%) while providing stability in headline inflation around 6.5%. However, other issues of fiscal/trade deficit and weak currency will stay valid into 2013. Over all, we are entering into 2012 with mixed signals but with signs of optimism. The first half of 2012 will provide good opportunity for investors for decent returns by end of the year. The investment strategy of “cash is king” in 2011 is now shifted to “borrow and invest” for 2012.
Currency market:
RBI’s measures (and actions) in its efforts to arrest extended rupee weakness has provided stability in USD/INR at 52-54. The initial rally in rupee found solid resistance at 52.20 for push back into 53.49 and now in consolidation mode around 53 (within 52.50-53.50). The strategy for exporters to sell March 2012 dollars at 54.25-54.75 has worked well as March 2012 dollars has retraced sharply from the high of around 54.50 to below 53.75. The outlook for 2012 is mixed for rupee. The fundamental issues continue to remain valid. The trade gap will be under pressure not being met with adequate capital flows. However, the forward market is expected to stay neutral; thus releasing the pressure on spot market. Given these mixed signals, rupee direction will be guided by the behaviour of USD across major currencies. USD Index is now in consolidation mode at 79.50-80.50 but looks set for extended gains over 81.30 into 83.50 ahead of 88.75. This expectation builds a strong case for extended rupee weakness into 56-58 during 2012. On the other hand, it is very difficult for rupee to extend its rally beyond 52-51. This level is considered as fair value for rupee in REER terms which could trigger RBI into dollar buy mode with twin objective to build dollar reserves and to pump in rupee liquidity into the system. Taking all these together, it would be in order to look for consolidation in 2012 at 52-56 with overshoot limited to 51-58. However, it is matter of time before rupee settles into consolidation mode around 51-53 when external sector gets back on track. Let us now watch 52-55 in the first half of 2012. The strategy for importers is to buy up 1-3M dollars on spot gains into 52.50-52.00 and to cover 3-6M dollars on extended rupee gains into 51.50-51.00. On the other hand, exporters can sell 1-3M dollars on spot weakness into 53.50-54.00 and to cover 3-6M dollar receivables on extended weakness into 54.50-55.00. It is also a great opportunity to shift long term (3/5/7/10 years) rupee liability to dollar liability as rupee is close to its long term “low” and not expected to extend weakness beyond 56-58 in worst case scenario; gradual reversal from there into 51-53 will turn out to be good cost effective strategy for borrowers.
Since the last update, EUR/USD has moved end-to-end of set sell zone at 1.3150-1.3250 (high of 1.3197) and buy zone at 1.2950-1.2850 (low of 1.2850). Over all, EUR/USD has now completed end-to-end of set short term range of 1.2850-1.4150. The outlook for EUR is weak given the risk of possible disintegration of the Euro zone and improved economic performance in the US. The objectives into 2012 are at 1.2625-1.2575 ahead of 1.20-1.1850 while 1.3000-1.3150 stays firm. Let us now set our focus at short/medium term range play at 1.1850-1.3150 with bias for gradual move into lower end.
USD/JPY lost steam at strong resistance of 78.25 (high of 78.22) and now finding support above 76.50-76.25 support zone. JPY has outperformed USD with gain of over 5% in 2011. This trend is there to stay till Japanese exporters put pressure on BOJ to arrest run-away gains in JPY. Else, the risk of move below historic low of 75.55 is not ruled out. Till fresh clues emerge, it is fair to assume that USD/JPY would hold above 75.50 for push back into 80.00. It is good for companies to consider shifting USD liability to JPY on extended move below 75.50.
Fixed Income/Bond/OIS market:
The shift into interest rate reversal cycle in 2012 will be good for Bond market and rupee borrowers. However, momentum to the reversal process is not clear. While severe growth pressures call for sharp downturn; worry on inflation is not expected to get out of the way soon. RBI would need to shift into balanced approach soon to guide stability in growth and inflation around 6.5-7.0% in 2012. The system is already operating at higher end of LAF corridor. RBI can afford to guide 1% downward shift in rate curve without effecting rate cuts; through infusion of sufficient liquidity into the system. This would mean CRR requirements to be cut down from current 6% to 3-4% by end of 2012. The expectation is for reversal in operative policy rate from current 8.5% to 7.0% in 2012 either through 1.5% rate cut (retaining operative policy rate at higher end) or 0.5% rate cut (and infusion of rupee liquidity through combination of CRR cuts and OMO operations). Given the huge pipe-line demand for funds from the Government, supply of bonds by RBI will be high throughout 2012. The reversal of monetary policy stance could well begin soon by 24th January monetary policy. The rate/yield curve will witness sharp downward shift in the shorter end (1-365 days) with normalisation in the medium to longer end (beyond 5 years) of the curve. The inverted curve should shape into a marginal upward sloping curve during 2012. The final pit stop for this move is for overnight MIBOR around 7% and 364D T-bill yield around 7.5%. This expectation should guide 1Y CD rate into 8.5 by end of 2012. Strategy for short term investors is to stay invested in 1Y Bank deposits/CDs/T-bills.
Since last update, 10Y bond yield has moved end-to-end of set buy zone at 8.50-8.60% and sell zone of 8.35-8.25% and now in consolidation mode around 8.35%. Despite huge supply side issues, Bond market is expected to stay in bullish mode driven by pipe-line rate cuts; CRR cuts and OMO operations. Government is also expected to do its best to cut its dependence on market to manage its fiscal deficit. The improvement in macroeconomic dynamics would help the Government in its efforts to manage its fiscal deficit around 4.5% of GDP for FY13. The range for 10Y bond yield in 2012 is expected to be at 7.75-8.5%. The bias is for move into 7.90-7.75% while 1Y T-bill yield find support around 7.50%; thus building tenor spread of 25-40 bps between 1-10 years. The risk factor to this expectation is from higher commodity prices and weak rupee which could delay the rate reversal process while shift to pro-growth monetary stance will absorb weakness.
The moves in OIS market were perfect to the script. 1Y rate traded end-to-end of 7.65-7.85% while 5Y rate traded end-to-end of set pay zone at 6.90-6.80% and receive zone of 7.10-7.20%. OIS rates have more or less factored the bullish expectations in the bond market; hence consolidation in 2012 may be in order. Let us watch 7.50-7.85% in 1Y and 6.80-7.15% in 5Y with bias for gradual move into lower end. Strategy is to play end-to-end of these ranges as test/break either-way is not expected to sustain.
NIFTY
Since last update, NIFTY has traded end-to-end of buy zone at 4550-4525 (low of 4531) and sell zone of 4750-4850 (high of 4782). The year 2011 has been bad for NIFTY having lost more than 25% driven by weak domestic and global cues. The year 2012 will definitely be better with signs of improvement in the domestic sector and the US economy leading the recovery in the developed economies. Having said these, the market is expected to stay in downtrend till April-June 2012 before setting up the reversal process. The downside objective may not be beyond 4350-4150 with reversal target at 5150-5350 before end of 2012. It is good for strategic investors to buy in 3 lots; one each around 4550/4350/4150 for 5150-5350. Factors guiding this move will be pro-growth monetary stance; easy liquidity and low interest rates while momentum will be provided by improved investor sentiment from foreign investors.
Moses Harding
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