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RBS Private Banking India has released a report wherein it expects the RBI to cut rates by 50 bps and expects the market to touch 5,700 by year-end and finds Indian equities undervalued
Investors can look forward to Indian equities outperforming in the second half of 2012 on the back of an expected change in policy stance, RBS Private Banking India said in its Mid-Year India Outlook 2012 report released today. RBS, like Morgan Stanley, is also bullish on India’s prospects, and expects the National Stock Exchange’s (NSE) Nifty index to hit the 5,700 mark by December 2012. So, is there a bull market on the cards, despite considerable headwinds? What can investors expect?
According to the report, RBS values equities at 12.8 times one-year forward earnings, which is less than the ten-year historical average of 13.8. The global investment bank has assumed 15% earnings growth over two years. Likewise, on a price-to-book basis, Indian equities are trading at 2.1 times against the ten-year historical average of 2.8 times. RBS advises investors to “maintain their allocations close to recommended levels rather than sit on the sidelines.”
The bank has recommended high dividend yield stocks in this kind of environment and cites that equities are discounting at 16% on the dividend yield basis. In addition to high dividend yield stocks, it has come up with a 15-stock basket themed “Indian Olympians” based on certain criteria such as high profit, ROE, ROCE, etc. However, it is not known what the exact composition is. Sector-wise, it prefers “interest-rate sensitive” sectors such as financials, consumer discretionary, automotive, healthcare and IT companies. It is negative on telecoms and consumer staples. Over and above this, it has preferred large caps over mid-caps.
The trigger for interest-rate sensitive securities to outperform is interest rates. The investment bank expects the Reserve Bank of India (RBI) to cut rates by 50 basis points. RBS chief investment officer Rajesh Cheruvu said, “We believe that prevailing macro conditions make strong fiscal action more effective than early monetary action. Going forward, lower commodity prices should ease headline inflation, and weakened domestic gold demand will support the current account and in turn aid the currency and inflation.” RBS also thinks that the government could partially deregulate diesel and liquefied petroleum gas prices.
Apart from equities, the investment bank prefers corporate bonds over government bonds as the latter has already run up considerably while corporate bonds have remained sticky. Also, it expects a spread compression between corporate bonds and government securities, and recommends high quality names. Again, specific names of were not given.
Rupee-wise, RBS has forecast the rupee to strengthen to 52 per dollar. The Indian rupee has depreciated by 8% this year. However, the appreciation of the rupee is contingent on strengthening of the capital account, and this would mean easing of macro-economic conditions such as fiscal deficit, reduced gold imports leading to reduced current account deficit, falling oil prices and initiation of reforms processes. Reforms process would be contingent upon the government’s ability to implement the land acquisition bill, mining regulations, authority for accountability in the civil administration and progress on the Goods and Service Tax (GST) and Direct Tax Code (DTC) towards implementation in 2014.
On a global scale, the bank expects policy action from China and other emerging markets, including India, to “support growth over the next few months”. Prateek Pant, director, Products and Services, RBS Private Banking said “Europe holds the key to the performance of financial markets for the coming half of the year. We believe that flare-ups in the Eurozone will continue, but would be met by policy response. Although financial markets are expected to remain volatile, coordinated policy action in the Eurozone, combined with domestic policy progress should see Indian equities continue to outperform in the second-half.”
If all of this does not pan out, RBS sees the Nifty going down to 4,900 levels, if the US growth slows further, the size and form of QE3 disappoints, domestic issues like policy paralysis continues and monsoon fails to pick up.