Pan-Asia: 2010 Outlook – CITIGROUP
2010: Back to Stock Picking
27 November 2009
Aditya Narain
+91-22-6631-
aditya.narain@
Tirthankar Patnaik
+91-22-6631-
tirthankar.patnaik @citi.com
Economic Cruise—Watch Out for the 'Rate-Berg'
Market outlook — We believe
back, and is fairly broad-based, b) Policy measures are beginning to come
through, c) The fiscal shows signs of stabilising, and the Government
appears cognizant of the risks on hand, and d) The RBI has signalled the
exit from easy monetary policy. While this mix will support stronger and
steadier growth, the unwinding of fiscal and monetary risks will likely hold
back a retracement to peak growth levels or to aggressive valuations. We see
the market settling at long-term average valuations – for a Sensex range of
15,000-16,000 – before it commences on a sharper growth trajectory.
Key positive themes for 2010 — a) Rising and broad-based urban
consumption, b) Government-driven rural and social sector thrust, c)
Investment momentum, and d) Government policy aggression: Divestment,
and quicker implementation.
Key negative themes for 2010 — a) Rising interest rates, regulator-driven,
on account of rising inflation risks, b) Increased Government borrowing
squeezing liquidity and constraining fiscal spend, and c) Monsoon impact on
agri and related parts of the economy being more severe than has been
factored in.
Sector winners — We would be a little more defensive: a) IT – we expect a
demand pick-up, b) Pharma – defensive, business in decent shape, c) Autos
and retail – catch the urban consumption pick-up, d) Energy sector –
refiners & gas, and e) Telecoms – The bad news is largely in.
Sector losers — Interest rate cyclicals: a) Banks and financial services, b)
Real estate, and c) Materials (cement). The penny still needs to drop – and
when it does, that's the time to catch it.
Is it a platform, or a springboard, for growth? −
deep – and it has come out pretty strong, clearly suggesting that it caught a
chill rather than a flu. So, is the patient still convalescing, or is it out of bed
and pumping iron? We believe the patient is up and about, but that it has not
yet regained full vigour.
Risk appetite is a little dimmed, fiscal flexibility is a little reduced, and interest
rates are only going in one direction. Still,
for growth—the risk is that the market's expectations for the pace of that
growth will be disappointed.
The investment cycle has stabilized – the capital market cycle has helped and
will remain a key driver. Urban consumption has kicked in with a vengeance,
but rural remains a risk because of the monsoon. And while hopes are high
(perhaps too high), the data remains weak and is in need of an uplift from
more decisive Government action – such as divesting state-owned assets, and
in a determined and speedy fashion.
In short, there's a fair amount of good happening in the economy – the pick-up
is relatively broad-based and balanced and, unlike in 2007, the recovery
should be reasonable rather than breakneck (and thus more sustainable)
It does not come free − But the rapid return to reasonable growth has come at
a cost – the fiscal deficit has jumped on an already high leverage that the
Government carries, and easy money raises the spectre of inflation (13% only
18 months ago). These factors, individually and collectively, betoken higher
interest rates, possibly ahead of peer nations. Equity markets are undoubtedly
pricing in some of this overhang – and the risks to the still-stabilising economic
recovery – but we probably won't know how accurately until early to mid 2010.
Leading into 2010, we would be a little defensive in constructing a portfolio –
not too squeamish, mind, but prepared to keep some powder dry until the rate
and fiscal risks play out. That opportunity should present itself in the first half
of 2010, in our view. A re-run of 2009 is not likely, however − the upcoming
opportunity will be more nuanced and the gains will be smaller. But it will be
an opportunity nonetheless, and it will be worth waiting for any near-term falls
to maximize the returns. In any case, on a longer return horizon, the economic
revival would overwhelm near-term rate risks.
Buy what sells − We expect demand in
but that it will be harder to find than in the booming 2003-2008 years. And we
believe the market will be prepared to pay for it (and that businesses will make
profits on it – unlike in 2003-08). So, the themes we believe will play out are:
a) Urban consumption – the fear is gone, lifestyle upgrades are unlikely to be
reversed (for the most part), and hey, the job market appears to have opened
up, too, and b) IT services demand – the World's corporates have not invested
for a few years: the ones who have survived, and there are many, would emerge
from their shells and get on with life, resulting in more aggressive outsourcing.
We also believe the Government will continue to invest into the rural and social
sectors – some will be in the form of handouts, but there should be enough
physical investment and infrastructure creation to provide a sustained
opportunity for investment, monsoon risks notwithstanding.
Sell what borrows − We believe the rate risk is being underestimated – not
necessarily in its possible impact (which we think will be only moderate for the
real world) but by recent sector performance, in which rate-cyclicals have
moved up (as if rising rates drive up stock prices, rather than push them
down). This outperformance of the banks (most clearly) and real-estate
developers (to a lesser extent) will be the very reason for their
underperformance in the more immediate term, in our view.
-Citigroup Global Markets
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