The equity markets gained about 25 per cent in 2012 on positive global and domestic policy developments. The Sensex is above the psychological 20,000 point mark. Now, as growth and inflation stabilise, the thrust on policy reforms continues and global liquidity flows remain robust, the markets are likely to witness new-highs.
Macroeconomic fundamentals are showing early signs of stabilising, with the likely bottoming out of economic growth and moderation in headline WPI inflation. But, in the near term, risks such as high current account deficit (at record high of 5.4 per cent of gross domestic product or GDP) persist. Due to this, preserving our sovereign credit rating gains importance for attracting capital flows into the economy. Oil and gold imports remain high but non-oil and non-gold imports have also risen. This indicates that cheaper manufacturing imports are contributing to the widening trade deficit and so, some degree of rupee depreciation is also warranted to improve manufacturing competitiveness and revive exports.
As for the fiscal deficit, in the medium term, a high growth economy like India can take care of it on account of higher tax revenues from higher GDP growth. But, in the short term, the greater concern for the government is to continue attracting foreign capital and bring down domestic inflation and interest rates. So, I expect the upcoming Budget would focus on delivering a lower fiscal deficit, which could be a positive near-term trigger for the markets. Recently, the government has taken some unpopular but economically meaningful measures to narrow the fiscal deficit in order to revive investment and growth. In this backdrop, I am hopeful about policy rates easing, which could augur well for cyclical sectors.
I'm particularly bullish on private sector banks and four-wheeler automobile companies, among rate-sensitives. Private banks have strong capital adequacy and branch expansion plans that will help expand their market share consistently. They have also maintained better lending standards, which reflect in their superior asset quality vis-a-vis PSU banks. I'm overweight on automobiles as I expect interest rates on retail loans to be lower by about 100 basis points. Quality stocks in the capital goods space also are a decent bet, as they are currently trading at very cheap valuations and will benefit the most from an economic revival, though investors might need a slightly longer investment horizon.
Among defensives, the IT (especially large-caps) and pharma sectors still look decent to some extent. In pharma, though valuations have gone up, several Indian companies are likely to continue clocking healthy growth, as they still have lot of room to expand their global generics market. In metals, given my structural view that global metal prices may decline going forward, I am selective in my stock preferences, with a bias towards large-caps, which are going for big integrated domestic capacity expansions.
Overall, Indian companies have seen several quarters of margin compression, which in our view has now bottomed out. Corporate top line growth remains above 15 per cent, and as margins are at lows, at least 14-15 per cent growth in bottom line is conceivable in FY2014. So, Sensex earnings per share can end up at about Rs 1,400 in FY2014. At 16 PE valuations, the benchmark index can touch 22,500 levels in the next six to nine months.