Risk-reward in favour of buying equities

Last Updated: Mon, Nov 05, 2012 04:27 hrs

Even with the benchmark equity indices moving up over 20 per cent so far this year and even with India being one of the best performing equity markets globally, there appears little cheer as far as investor sentiment is concerned. Sentiment remains jittery. Scepticism is widespread regarding the sustainability of this upmove. Mutual fund outflows are abundant as retail investors continue to view equities as the least preferred investment. Globally, investors are still underweight on Indian equities. Sure, there are plenty of risks out there but this excessive focus on risks, in our view, is conducive for markets, as equities usually love climbing walls of worry and the best returns are generated when intuition dictates otherwise.

Alongside the sentiment picture, technicals continue to be supportive for a move higher as well. The markets had broken out from a multi-month down channel in the early part of this year and have broadly had better times since then. On the Nifty, 5,450-5,530 range should be a strong base on a medium term basis and any downsides should be limited to those levels implying limited pain from the current levels. Meanwhile, the Defty has broken out from a multi-month trendline (see chart) that had defined its downtrend over the last two years. The Defty is the dollar-denominated Nifty and more accurately captures Indian equity moves from a foreign investor's perspective. This breakout suggests the downtrend in Indian equities has been negated even from the foreign investor's perspective and bodes well for the future outlook of Indian equities.

Recent sectoral performance trends underscore the bullish outlook, too - cyclical sectors such as autos, capital goods and banks have started to outperform defensives like fast-moving consumer goods and pharma. This usually is a positive reflection on the market's strength. Also, the Nifty's historical volatility is near multi-year lows suggesting we have already seen significant congestion and a decisive move should soon ensue. For the several reasons highlighted so far we remain of the view that this congestion should be resolved to the upside.

Finally, fundamentals have begun to improve at the margin, aligning well with the sentiment and technical sides of the market to complete the jigsaw. The recent break from the policy paralysis, along with our view that corporate financials are bottoming and that the qualified institutional placement (QIP) market should open soon, helping to de-stress corporate India's balance sheets, will all act to strengthen the fundamental picture. With reasonable valuations at the market level and with the valuations premium of defensives versus cyclicals at a decadal high, indicating extreme pessimism, there seems good reason to believe the risk-reward is significantly in favour of buying Indian equities. In addition, a global bear market in commodities, now becoming likelier, can provide a significant tailwind for Indian stocks.

To sum up, we maintain our constructive outlook on Indian equities. Intermittent jitters, which in the immediate short term can be caused by the US presidential elections, for example, should be used as opportunities to add to long exposure.

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