Technical Analysis

Bet on ABC

Motilal Oswal | Updated on January 24, 2018 Published on January 04, 2015

BL05_BSE1   -  PTI

After 30 per cent-plus returns in 2014, Indian equities appear set for another good run in 2015. The market rally in 2014, which took off after the thumping mandate to the BJP in May, was largely hope-driven.

Now, with inflation tamed and interest rate cuts about to follow, Corporate India should actually see its fortunes reviving. The resultant earnings-driven rally could be far stronger. However, in the next two-three months, the markets could witness sharp volatility.

In February, the new BJP-led government will be presenting its first full-fledged budget and expectations are high.

Inflation and rate cuts

Inflation has wound down rapidly in the last six months, driven largely by sharper-than-anticipated decline in global commodity prices including crude oil. Though the rupee depreciation has moderated the impact, even in rupee terms, global commodity prices are now at three-year-ago levels. Wholesale inflation has declined to near-zero and retail inflation could fall to a decadal low in 2015.

The most direct benefit of low inflation would be interest rate cuts. Due to continued tight monetary policy and rapid unwinding of inflation, real interest rates have already turned positive. Left unchanged, the real rates of interest would zoom to historically high levels.

A 150-250 bps cut may be necessary over the next 12 months to bring real rates closer to the RBI’s indicative level of 1.5 per cent.

A critical problem associated with high real rates of interest is that real lending rates have reached unsustainable levels — higher than the GDP growth rate. This would be accentuated in 2015 if rates are left untouched, creating a deflationary bias.

Bridging the gap

Also, the interest rate gap vis-à-vis the US is at historical highs. A rate cut is imperative to narrow the existing arbitrage opportunities.

The twin benefits of low inflation and declining interest rates would favourably impact the profitability of domestic-market-facing manufacturing companies. The sharp correction in the prices of crude oil, coal, iron ore and palm oil would mean lower costs.

Also, finance costs would decline with lower interest rates. As a result, profit margins should improve. Low inflation should also bring stability to the rupee. But, the RBI is likely to proactively lend a bias for steady rupee depreciation to ensure export competitiveness and ward off future exchange rate volatility. This should support the profit margins of global facing sectors such as IT services and pharma.

While the unfolding macroeconomic scenario brings positive tidings for a broad range of businesses, a few select companies from ABC sectors — auto, banking and cement — would be worth investing.

Also, IT and oil marketing companies could be considered. Just buy right and sit tight for sustained wealth creation.

The writer is CMD, Motilal Oswal Financial Services

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Published on January 04, 2015
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