Where Angels Fear to Trade

The first shock of the year has already registered. On January 7, the BSE Sensex fell 554.50 points - or 2.2 per cent - to touch 24,851.83, its steepest drop in the past three months. Indeed, stock markets around the world followed suit, all due to China devaluing its currency by 0.51 per cent to 6.5646 against the US dollar earlier in the day - its lowest levels since March 2011. But to many market watchers, it came as no surprise. "Equity markets in India are expected to be volatile for global reasons," says Sankaran Naren, Chief Investment Officer, ICICI Prudential Mutual Fund. "For investors, hybrid funds would be the best way to tackle the situation for the next six months."

The Chinese Yuan appreciated significantly in the past four years relative to many of its trading partners' currencies, rendering Chinese exports less competitive than before in an economy much focused on exports. To beat this trend, the Yuan was devalued in August last year and has now been devalued again. There is every chance of further devaluation in coming months. This could impact several segments of domestic industry in India - tyres, tiles, steel and more - if Chinese offerings become cheaper than local goods. "What China does will have a huge bearing on India, putting pressure on the current account deficit and the rupee," says Saurabh Mukherjea, CEO-Institutional Equities, Ambit Capital. China is making structural changes to its economy to shift focus and become a domestic consumption-led economy. However, until that process is complete, to keep its exports competitive, its currency is likely to be forcibly depreciated.

The difficulties of the Chinese economy, however, are not the only global threats. "There is need for caution not just because of China, but also due to the likelihood of oil exporting countries selling off their investments, as well as concerns of war in West Asia," says Naren. The drop in crude oil prices, beginning roughly around the time the National Democratic Alliance (NDA) government took charge, has been a very lucky break for India, saving it around $70-80 billion, but it has also shaken the economies of the oil producing countries, some of which have gone from healthy surpluses to staring at deficits. They could well sell off part of their global equity holdings to reduce debt, which in turn would put pressure on Indian equities. As for war, the depredations of the Islamic State (ISIS) and the growing standoff between Saudi Arabia and Iran make it a distinct possibility.

"In the first half of 2016, there are known (unknowns) and unknown unknowns," says Uday Kotak, Executive Vice Chairman and Managing Director, Kotak Mahindra Bank. "I've entered 2016 with a conservative mindset." Kotak feels a combination of things could go wrong in the first half of 2016 due to developments in the US, China and oil producing nations. For instance, with US corporate bond spreads increasing, he feels there could be a credit accident globally or in large companies.

Domestic Issues

2015 was not a particularly happy year for the bourses in India. The euphoria of 2014, with the swearing in of the new NDA government, having faded, the Chinese devaluation, a sub-normal monsoon and indifferent corporate earnings took their toll. On December 31, the Sensex closed at 26,117 points, 5 per cent below its level exactly a year ago. The first months of 2016, too, are likely to be uncertain, but many experts feel the dangers are only for the short term. "Looking forward five years, it is a great time to be in India and build businesses," says Kotak. "The countries I would really bet on are US and India."

Prateek Agrawal, Head of Business and CIO, ASK Investment Managers, agrees about India. "December 2015 quarter results are likely to be the worst, after which corporate performance will improve. I expect the second quarter of 2016/17 to be a bumper one. All this will give a fillip to the market. Global developments will not matter all that much if there is strong domestic corporate growth."

Ambit Capital's Mukherjea, however, remains sceptical. "The earnings growth of large-cap companies is likely to remain weak over the next couple of years," he says. "The benchmark indices are likely to remain under pressure. Our Sensex estimate by the end of 2016/17 is around 29,000." Much will depend on the policies pursued by the government and the Reserve Bank of India, as well as the adoption of advanced technology. "We like companies which have consistently expanded whilst maintaining balance sheet discipline," he adds. Kotak too worries about the balance sheet discipline. "The high debt of many Indian companies is a concern," he says. "They have to bring down debt. In an environment where wholesale price index (WPI) is negative, high leverage is dangerous."

Uday Kotak, Executive Vice Chairman & Managing Director, Kotak Mahindra Bank

One important silver lining for the equity markets is the growth of mutual funds, especially the rise in the number of retail investors using systematic investment plans (SIPs). The average monthly inflow into mutual funds through the SIP route in recent months has been around Rs 2,500 crore. Mutual funds were the unsung heroes of the equity market in 2015 and the same is expected this year.

As is the case every year, the forthcoming Budget will impact the market, with the extent of government spending playing a key role in reviving sectors such as infrastructure. The implementation (or otherwise) of further reforms, especially the passing of key reform bills including the Goods and Services Tax bill, will also make a big difference. The monsoon too will be crucial - after two consecutive years of below average rains that badly affected rural spending, it is hoped that the Gods will be benevolent in 2016.