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‘A Statistical Recovery’

Where does reality reside as the ‘recovery’ from recession happens?

The global economy seems to be bouncing out of recession much faster than most people expected. This recovery is driven by a massive policy stimulus, which has been extremely synchronized and powerful. The fall in output, capacity utilization and employment was so severe in 2008 that base effect and marginal improvement put together can produce a strong recovery but, one should look at it more as a ‘statistical recovery’.

Expectations last month were that the economic data would surprise on the upside over the next few months, but markets can’t ignore the fundamental longer term issues. ‘Cash for clunkers’ scheme used recently in the US, tax incentives or government spending cannot be the drivers for long-term sustainable growth of any economy. If financial markets are any indication, then the uncertainty over future outcome continues. While equity markets are pricing in continuity of the recovery process and earnings upgrades, low bond yields despite massive government borrowing reflect a gloomy scenario with deflation as a bigger threat. The Chinese stock market has witnessed a correction of over 20 per cent from its peak on concerns over massive credit growth leading to a speculative bubble in asset prices.

The Indian equity market has been in a consolidation zone with short-term movements driven by global cues. Given the uncertainty and lack of direction on the global front, the focus at SBI Mutual Fund is more on bottom up stock picking with a long-term approach rather than taking larger macro calls. While a higher volatility in the near term cannot be ruled out, the longer term outlook is positive given the improved economic scenario, continuity of earnings upgrade for FY11 and incremental economic reforms including divestments. Also, expectations are that capital flows will remain buoyant as investors use every dip in the market to increase exposure to India. A focus on stock selection and sticking to high conviction ideas would be the best way to generate alpha. Media and entertainment, agri-inputs, beverages, renewable energy, packaged food, travel, logistics, healthcare, organized retail, and education are examples of businesses where there is a massive growth potential and companies that can successfully scale up to take advantage of these opportunities can generate huge wealth for investors.

On the fixed income front, while the short term yields remain depressed due to abundant liquidity, G-sec and bond yields have moved up. 10-year G-sec yield has moved up from 7.05 per cent to 7.45 per cent over the last one month. Corporate bond yields have also moved up though spreads have contracted a bit. During this period the 10-year US treasury has come down from 3.80 per cent to 3.40 per cent. India is one of the few markets where bond yields have seen a sharp up move. The market is finding it difficult to absorb the large government borrowing and the RBI is not giving strong signals to rein in the rise in yields. Undoubtedly, one needs to worry about the underlying inflationary pressures (while WPI is in negative territory, CPI is in double digit) and the large government borrowing of both the centre as well as states.

Having said that, there are still interesting opportunities at the medium end of the G-sec and corporate curve. There is too much gloom in the bond market now with a near consensus view that rates would go much higher in a short period. As markets become more fearful, being a contrarian may offer a good pay off. Investors should consider income, gilt and short term funds depending on their risk appetite and horizon.

Navneet Munot,
Chief Investment Officer,
SBI Funds Management

NOTE: The views expressed here are the author’s and not necessarily those of Value Research.