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Alpha Edge, March 2017 - The tide is turning

As the markets and their valuations reach higher, so does the prospect of uncertainty. The difference this time could be the prospect of facing a faster pace of improvement in underlying factors. Investors are bracing for just such a prospect in the U.S and in India. No wonder the markets are reaching at all time or recent highs, quickly discounting the positives. Nifty’s continued from its rally of Jan 2017 and came to kissing distance of all-time highs during Feb 2017, bolstered by better than expected set of results for the December quarter, strong domestic flows and re-rating of heavy weights like Reliance Industries.

Globally, all eyes were on Donald Trump’s speech to Congress as the markets wanted to take cues regarding his plans and its implications. The speech was noticeably not as strident on illegal immigrants as earlier, alleviating the world’s anxiety for the upheaval it portends. His speech was still high on promises especially massive tax cuts, higher infrastructure spending etc. However, it was short on specifics on how he intends to achieve them. World over, shorter term growth indicators are showing some signs of improvement coinciding with rising political uncertainty in Europe and rising inflationary pressures in most of the economies which are at their long term inflation targets. This could play spoil sport to equities if bond yields firm up even further. Soon, central bankers may take cues from the US and start to taper their loose monetary policies.

From a domestic stand point, Indian GDP surprised on the upside for the final quarter of 2016, growing at the rate of 7% year-on-year. Our estimates on the impact of demonitisation while mildly negative, the analysis of the recent GDP numbers indicate that even that seems like an over-estimation. The unveiled numbers have certainly stumped many economists and market participants who set their lower expectations, based on lower IIP in December and falling CPI, indicating fall in economic activity for December. The only explanation could be that the initial GDP numbers do not capture the informal economy to the extent required, which has been admitted by CSO. To get a true sense, we will have to wait for the revised numbers for December 2016 or try and gauge any residual impact, through a couple of quarters going forward. The attention now goes back to the reform agenda and implementation of key initiatives like GST, so that India can realize its full growth potential.    

Indian equity markets saw a decent earnings season on the back of the December quarter notwithstanding impact of demonitisation. It occurs that, had demonetisation not happened, the numbers would have been much stronger, confirming the underlying revival in the economy that was palpable earlier and one which will re-emerge stronger in a quarters time. The markets seem to have temporarily gone ahead of itself, amidst continuous decline in consensus forecasted earnings. This has resulted in valuations expanding and reaching to levels, where hardly any margin of error is left, once again. We expect heightened volatility in March against the backdrop of two events –The UP election results and Fed rate hike. Hence, from a short term perspective, risk reward ratio is not completely in favour of equities. Even though the valuations have run ahead, the underlying fundamentals seem to be improving. The way to go about it is to stagger fresh investments, as markets will give enough opportunities to invest throughout the year. A technical view remains that should the 9100 levels on Nifty get taken out, there is a probability of markets melting up all the way to 10,500.

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