Results season starts well

The low expectations result season has started off reasonably well with most of the companies reporting till date either beating or meeting expectations. Although it is early days yet, given the fact that we have gone into the results season with low expectations it augurs well for the markets.

The general observation from the results till date is that the IT sector companies have held up well on the face of increasing uncertainties in the macro environment and have reported results in line. The outlook for the profitability of these companies in the near term has improved significantly due to the sharp depreciation of the Indian Rupee. This should help earnings growth even for the next year. Demand will certainly see some impact in the year 2012, especially from the BFSI segment. However overall the current results season and commentary till date does provide downside protection to the stock prices of these companies.

The other key standout factor has been from the few results of the banks that have come out. The best part of the result of these companies has been that the Non Performing Assets seem to still be well under control. As such the apprehensions of a significant fall in asset quality does not seem to be playing out as of now. However given the fact that the actual impact of credit tightening is yet to fully play through and also the fact that the tightening has been severe over the last three months there is likely to be deterioration in asset quality going forward. The second thing has been that Public Sector Banks have not yet reported earnings and a greater stress is expected on that side of the banking universe. However overall given the fact that the interest rate cycle has peaked out and also the fact that the sector on an overall basis has underperformed the markets since November 2010 the downside for this sector also seems to be protected. However the preference will be for private sector banks with adequate capital adequacy and a lack of requirement for immediate fund raising.

A few results from Oil & Gas as well as Automobile companies also have come in line or better than expectations. However we are likely to see more results coming out over the next two weeks and it will be important to see if the current trend holds up or we see a deterioration going forward.

Overall my view from the result season is that given the fact that expectation are running low, an outperformance will be rewarded strongly however an underperformance might not be punished too much.

The Macro Scenario

The Macro scenario on the domestic side continues to be one of slowing growth. The Industrial Production figures released last week clearly indicate a broad based slowing down of growth. RBI in its statements of the last two meetings has been trying to justify their actions by a surgical examination of the data. On one instance they quoted strong durable and auto sales and in the other meeting they quoted strong growth ex of capital goods. However unfortunately for them they have run out of all these explanations this time as the slowdown is evenly spread out. As I pointed out in my last article the downside risks to inflation have increased with the sharp correction in global commodity prices. However the rupee weakness and the lag in increase of Fuel, Electricity and Fertilizer prices is keeping Year on Year reported inflation higher than what it would have been in a free pricing environment.

The other key macro development domestically has been the sudden announcement by the government about additional market borrowings which led the bond yields to shoot up by nearly 40 basis points. RBI and Government actions have now set up a vicious cycle. On one hand there is hardly any policy action to boost growth and investments. On the other hand continuous RBI tightening has led to slower growth which in turn has affected government revenue collections. Given the fact that most of the government expenditure is inflexible, falling revenues and increased borrowing costs will lead to a further deterioration in the Fiscal Deficit situation.

The only way out is to boost growth by greater reforms and policy actions. Although global slowdown and falling commodities will aid inflation in the short run, the long run solution lies in boosting supplies and inducing greater investment confidence. Although there is no risk to India’s long term growth prospects poor Macroeconomic Management is affecting prospects in the short run.

Globally the markets seem to have adjusted to the Euro zone situation and the news flow out of the US has actually been positive in terms of growth outlook. Results from US companies have either beaten or met expectations in a majority of cases. Macro data in terms of the unemployment, housing, manufacturing etc. also seems to be improving albeit slowly. This gives confidence to my view that the US will recover better than what most people expect and thus improve investor confidence in general.

Incremental downgrades in the Euro zone as well as policy flip flops have not been met with significant negative reactions. There is also some news flow on the possibility of the EPSF being used as a bank which can leverage itself by 3-5 times. Any such move could improve risk appetite significantly. These things should become clearer over the next two weeks.

Markets

The markets started the last quarter of the year in a state of pessimism and extreme risk aversion. There has been a huge flow out of equities into gold,cash, commodities and hedge funds. Moreover most hedge funds entered the quarter with very low net long positions and in a capital protection mode. If markets stabilize and the view of a durable bottom for the year gets established we could see strong flows coming back into risky assets this quarter. Given the fact that expectations are low and valuations are reasonable, the probability of a strong last quarter is very high.

The bottom seems to be well in place. The question is on the extent and pace of the up move. I would still go with the view of a 25% one year upside potential with an 8-10% downside possibility in the near term in case there is some unforeseen event risk.