outlook 2013

Outlook for 2013

Period of uncertainties and mixed cues....miles to go for bullish confidence

Little bandwidth for financial/monetary support to spur growth

The set up of gloom and doom in the Global economy since 2009 is diluted but cues do not signal early turnaround for better! The authorities in the developed western economies have done their best to prevent global economic crisis through very accommodative financial and monetary regime; huge amount of money has been pumped into the system to maintain excess liquidity in the financial market while keeping interest rates at near zero levels to encourage investment and consumption. More importantly, the political system and monetary authorities are seen together with the Government to arrest downside risks on the economy and to get it back on track to the pre 2009 period. The asset markets in the Western economies have recovered sharply from the low of 2009 but way to go to scale the highs of 2007-2008. It would need quick turnaround in growth momentum while managing the side effects from severe pressure on fiscal deficit and public productive expenditure. The Government exchequer is already dried up to prevent financial and sovereign crisis and now find it difficult to make both ends meet. There is severe pressure on growth across US, UK, and the Euro zone exerting strain on fiscal health; measures are already on to cut costs (and public expenditure) and increase revenues through tax hikes. The agenda is to tax the “rich” (and affordable) without causing hurt to the middle/lower income class. Having come a long way since pre 2008 golden era, it will be prudent to assume that the worst is behind but the best is distant away given the longer lag time for recovery. Investors have moved into “risk-on” mode with shift in appetite from developed economies to emerging markets. There is no incentive to stay in cash or in low yield sovereign assets when downside risks on the western economies are significantly diluted. The resultant flow of liquidity into emerging markets will complement growth momentum in the western markets. Over all, there is nothing to fear but need patience to allow gradual improvement into 2007-2008 levels and thereafter to build bullish momentum. There is confirmation from the monetary authorities of Western economies to maintain very accommodative monetary policy till 2015 to support growth, investments and consumption.

The India story is unique and peculiar. While emerging markets have maintained their financial and monetary system in pro-growth stance since 2009, Indian economy shifted into anti-inflation stance through high interest rates and deficit system liquidity. Since then, macroeconomic fundamentals have turned worse with severe pressure on growth momentum (down below 5.5%) and high fiscal deficit (up above 5.5%). To make things worse, external dynamics (through high commodity prices, reduced exports and weak rupee) put pressure on current account deficit (up above 3.5%) and fuel subsidy (up from 1.2% to 2.5% of GDP despite regular fuel price hikes). Over all, the positive impact on inflation from tight monetary policy was significantly diluted by high twin deficits and supply side bottlenecks from low investments and poor demand for credit. The conflicts in growth-inflation dynamics pushed the system into “drift” mode with hope of “manna from the blue” for resolution management. The concerns are from (a) lack of co-ordinated efforts from political system, the monetary authority and the Government, raising concerns on policy paralysis, fiscal consolidation and growth; (b) absence of credible plans to protect economic interest from commodity price risks and lower external demand for India’s goods and services; (c) inability to provide resolutions to structural current account deficit issue, adding to pressure on exchange rate and (d) lack of vision to ramp up domestic capacity. Indian economy is the worst hit despite limited “globalisation” and it would need serious efforts to provide resolutions (to these concerns) to protect Indian economy from adverse external forces. Till then, macroeconomic fundamentals of the Indian economy will stay volatile and out of control being at the extreme ends, either very bullish or extremely weak.

Equity market

2012 was good for equity assets despite weak economic fundamentals. The triggers for bullish momentum was excess liquidity (and near zero interest rates) in western markets, limited downside risks and resultant shift to “risk-on” mode. The beneficiaries were the emerging markets (and off-shore investors). Indian stock indices posted gain of over 26% while DJIA was up by meagre 5.9%. The participation from domestic investors was limited while FIIs rode the rally really well pumping in over $24 billion in 2012. Most sectors including BFSI, Consumer Durables, FMCG, Health Care, Auto and Capital Goods outperformed the index while the worst hit was IT and Technology sectors.

The undertone into 2013 is bullish for Equity assets. DJIA will get its focus at 2007-2008 high of 13279/14198 while NIFTY will sets its target at 2008 high of 6357 (and SENSEX at 21206) and beyond. While FII interest will stay intact, bullish momentum will be from participation by domestic institutional (and retail) investors. The shift into interest rate reversal cycle will improve macroeconomic fundamentals; FY14 GDP growth momentum into higher end of 5.5-6.5%, fiscal deficit into lower end of 5.0-6.0% and headline WPI inflation into lower end of 6.5-7.5% tolerance zones. There is huge upside potential for the Indian economy if the Government could address reforms relating to capacity expansion in core sectors including infrastructure, commodities, agriculture, manufacturing etc. The only risk factor at this stage is the political risk and lack of political consensus on reforms. The intra-2013 target for NIFTY is at 6338-6357 (and SENSEX at 21108-21206); any intra-year reversal should stay above 5625-5425 (and SENSEX above 18550-17900). If FIIs continue to stay invested into 2014, new highs will be on cards for NIFTY at 6750/7000/7250 (SENSEX at 22500/23400/24100). The icing on the cake will be on establishment of bearish trend in commodity assets (Crude Oil and Gold) to cut conflicts in growth-inflation dynamics. The trading range for NIFTY in 2013 is seen at 5625-6750/7000 with bias into higher end. 

Currency market

Rupee has been the worst performer in 2012 posting intra-year loss of 18% (against 7% loss in the USD Index). However, Rupee is marginally down by 3% on yearly closing basis against 0.6% loss in the USD Index. So, while dollar was weak against most global currencies, it maintained firm grip on the rupee. What is the problem? There is no solution to the impact on Current Account Deficit (CAD) from higher commodity prices. BRENT Crude is up from $36 and Gold is up from $ 680 since 2008. The CAD of $18-20 Billion a month cannot be bridged through sustained monthly inflows of similar amount into debt/capital market. The other major risk factor is the high dependence on short term/hot money inflows from FIIs/shift of short term rupee debt into foreign currency by Indian companies. It is critical to maintain the forward market in supply-driven mode to remove pressure on rupee. It is important to establish short/medium term bullish trend for rupee to “lead” supplies from exporters (in fear of sustained rupee appreciation) and “lag” demand from importers (in greed to buy weak dollar at later date). Till rupee bullish sentiment is not established, there is risk of rupee weakness into 55.88/56.43/57.32 (lows seen in 2012). On the other hand, it would need sharp reversal in commodity prices (to cut CAD) to extend rupee gains beyond 2012 high of 51.35/48.60. Given the current market dynamics (and expectation in 2013), worst case for rupee is seen at 55.88-56.43 and it would be good for RBI to arrest rupee gains beyond 51.35 to retain export competitiveness and to ramp up dollar reserves. RBI is seen in weak wicket holding less than $300 Billion of reserves in its balance sheet and do not have “fire power” to prevent excessive weakness on rupee. Taking all these together, 2013 range for USD/INR is seen at 51-56; break either-way will be seen as excessive. If the Government could work on reducing the dependence on essential imports, cut non-essential imports and boost exports, resultant bullish sentiment will extend rupee gains into 48.60 in 2014. It will be good for exporters to cover 3M exports at/above 56.00, 12M exports at/above 58.50 and over 1Y exports above 60.00. On the other hand, importers can absorb intra-month rally in rupee to cover 15-30 day dollar payables and extend coverage to 1-3 months on excessive rally if seen unsustainable.

USD Index is expected to retain its bearish undertone on general “risk-on” investor sentiment with immediate focus on 2012 lows at 78.60/78.10. Having said this, Euro zone continues to stay vulnerable to downside risks with less potential to deliver surprise bullish factors. On the other hand, resolution to fiscal cliff in the US and signs of growth potential will limit dollar weakness against major currencies; intra-year range for the USD Index is expected to be at 78.00-81.50 while any surprise package from the Euro zone will trigger break-down in the index into 74.50-76.00. In the meanwhile EUR/USD posted strong intra-2012 recovery from 1.2040 into 1.3486 and looks bullish to take out 1.3486 for 1.38-1.43 while 1.27 stays firm to set up intra-2013 trading range of 1.27-1.38/1.43. Importers can look to cover short term Euro payables at 1.3150-1.2700 while it may be prudent to cover medium/long term receivables at 1.38-1.43.

USD/JPY was volatile in 2012 trading back-and-forth within 76-86; cues into 2013 are mixed. The QE kind of financial support by BOJ will retain bearish undertone on JPY into 2013, seen good for Japanese exports and the economy. The rally in USD/JPY can extend to 2010 high of 94.98 while 80-83 stays firm to set up intra-year trading range of 80/83-92/95. It is good to cover JPY exports at 80-83 while prudent to cover JPY liabilities at 92-95.

Interest rate market

Bond market was rather steady in 2012; 10Y Bond yield traded end-to-end of 8.0-8.25% (low of 7.97 and high of 8.28) before yearly close around 8.10%. The end-to-end move was largely triggered by bullish momentum into policy (on rate cut expectation) and bearish momentum post policy on non-delivery of expectation. Now, there is better clarity into 2013; reversal into rate cut cycle is matter of months not beyond January-March 2013 but extent of rate cut is not clear at this stage. While there is consensus on 50 bps rate cut, beyond there is dependent on sharp reversal in headline WPI (and retail) inflation print. RBI will have close track on real interest rate to arrest diversion of house hold savings into Gold and real estate. Other factors that would influence price action in 2013 are (a) timing of shift of system liquidity from deficit to surplus; (b) extent of fiscal deficit and market borrowing for FY14 and (c) timing of cut in HTM retention limit at par with SLR. While there is clarity on strong (and rock-solid) support for 10Y Bond at 8.15-8.25%, what is not clear is the best case scenario beyond 8.0-7.97% which can extend to 7.65% till operative policy rate is administered at higher end of LAF corridor. It would be very bullish for Bond market on shift of overnight rate into lower end of LAF corridor to extend bullish rally into 7.25-7.0%. The strategy is to stay invested in 10Y Bond yield at 8.10-8.25% for minimum 50 bps intra-year rally.

OIS rates will stay soft into 2013 but extent of reversal from 7.67-7.70% (1Y) and 7.17-7.20% (5Y) is not clear. The average overnight MIBOR for 2013 is expected to be between 7.0-7.50% taking into account shift of policy rate from higher end to lower end of LAF corridor during second half of 2013 (assuming LAF corridor at 6.50-7.50% on shift into FY14). On shift into growth supportive monetary stance, it may not provide desired impact if system liquidity is in deficit mode but how this would be achieved is not clear. Taking all these together, 1Y OIS rate can extend to 6.65-7.15% by end of 2013. On the other hand, 5Y OIS rate will find strong resistance at 7.17-7.20% on cut in “carry” post rate cut action. But shift of operating policy rate from higher end to lower end of LAF corridor will squeeze the 1X5 negative spread to par, thus providing strong support at 6.85-7.0%. Given these factors in play, 2013 range is seen at 6.65/7.15-7.70% (1Y) and 6.85/7.0-7.20% (5Y) with bias into lower end. The strategy is to stay “received” for this move but not considered prudent to stay received in 5Y at 6.85-7.0%.

Commodity market

Gold was relatively steady in 2012; intra-year rally from 1527 to 1795 met with strong resistance for close around 1660. There are signs of short/medium term trend reversal post sharp correction from 2011 high of 1920, unable to retain strong 3 year rally from 680.80 since October 2008. Gold has now lost its traction with USD Index losing its safe-haven/risk-off status. There is little appetite from risk-on investors at current high valuation. The intra-year objective is now at 1525 (ahead of 1450-1300) while 1725-1800 stays firm. The trading range for Gold in 2013 is seen at 1450/1525-1725/1800 with bias into lower end.

NYMEX Crude after sharp rally from 32.40 (December 2008) to 114.83 (April 2011) was in consolidation mode in 2012 at 77.28-110.55 for close around 90. The expectation of sharp rally post QE3 did not materialise exhibiting signs of set up of bearish trend into short/medium term. The demand for imported energy (and dependence on Crude) is on decline. Crude Oil price needs to stabilise at a fair value considered good for the global economy and oil producers. There is high possibility of extension of bearish momentum below 2011-2012 low of 77.28/74.95 into 64.00 while 95-100 stays firm. The trading range for NYMEX Crude in 2013 is seen at 65/75-95/100 with bias into lower end.

Wish you have a very profitable 2013...........................Moses Harding