Stay with 'the quality' on India stocks

India's jittery stock markets are likely to remain choppy for some time as the country continues to grapple with economic issues including slower growth, analysts say.

A view of the Delhi stock exchange in the old part of New Delhi on August 8, 2011. India's central bank said risks to the growth of Asia's third-largest economy were "limited" after the US credit downShow more

India's stock markets are likely to remain choppy for some time as the country continues to grapple with economic issues including slower growth, analysts say.

"Markets have become increasingly jittery of late, as investors grapple with the fact that data on growth momentum - both GDP and corporate revenue growth - remains very weak," said Nick Paulson-Ellis, the chief executive of Esprito Santo Securities in India.

GDP growth slipped to a decade low of 4.5 per cent in the third quarter of the current financial year, which ends this month.

"Until the indicators of a bottoming-out of growth and green shoots of recovery become clearer, markets are likely to be choppy," said Mr Paulson-Ellis. "And investors should be careful of expecting too many more reform rabbits up [the finance minister's] sleeve to offset disappointment in the actual fundamentals. "Against that backdrop we see no reason to change our mantra for the year: maintain a [high] 'quality' bias in portfolios and avoid trading down to second-tier names."

Measures taken by the government last September, including opening up the retail and aviation sectors to more foreign investment helped to boost stocks in the months following the announcements. But the benchmark Bombay Stock Exchange Sensex declined more than 5 per cent last month on weaker-than-expected corporate earnings.

Dhananjay Sinha at Emkay, a financial services company based in Mumbai, said challenges remained in India, including high leverage of corporations and banks and the country's gaping budget and current-account deficits.

"The steep run-up in benchmark indexes and feeble fundamentals is a paradox attributable to compression in global risks induced by excess global liquidity, which can be volatile," Mr Sinha said. "Domestic announcements have been riding on the global liquidity spill over. We believe the market may be currently pricing significant exuberance or very strong rebound versus our expectation of a modest recovery.

"We remain conservative as we believe the inflexion point from earning downgrade to upgrade cycle is still away."

Other major risks India may face include a further hardening in crude oil prices and volatility in financial conditions, according to Emkay.

The company said it was favouring technology stocks, including HCL, Infosys, Tech Mahindra and MindTree. It is also upbeat on power utilities, including Power Grid, the private utilities KSKE and CESC, Indiabulls Power and Reliance Power. Health care is another sector it labels overweight, mentioning Dr Reddy's, Wockhardt and Sun Pharma. In the media sector, also a positive focus for Emkay, it highlights Zee, DB Corp, and Jagran.

Meanwhile, it is less bullish, or underweight, on metals because of "muted demand and adverse raw material supply conditions". Emkay said it was also cautious on telecoms stocks because of high regulatory risks.

Investors will be closely watching the central bank meeting on Tuesday. Expectations are for a 25-basis-point cut. But Indian stocks reacted negatively to consumer price inflation data released last Tuesday, which showed an acceleration of 10.9 per cent last month compared to February last year. This has prompted some traders to lower their expectations for rate cuts going forwards.

Higher than expected industrial output data, also released on Tuesday, raised some hopes that the economy might be turning a corner.

"Better-than-expected industrial production data has provided some cause for market cheer in India," said Aninda Mitra, the India economist at Capital Economics. "However, a close look at the data underlines how fragile the recovery remains. The momentum of the industrial recovery may already have peaked. Growth in capital goods production remains negative, suggesting that a long-hoped-for pickup in investment remains weak at best.

"Lacklustre investment will weigh on India's first quarter GDP growth, and does not help its medium-term prospects either. There are signs that the recovery in consumer spending may already be running into the sand."

Capital Economics is forecasting a rate cut for the next meeting.

Espirito Santo Securities points out that stocks managed to rally last year amid unfavourable circumstances, but said there were other elements working in their favour at the time.

"Then again economic fundamentals were weak throughout last year, but the market still rose 25 per cent, in a rally built on a combination of global asset flows and reform momentum since [P] Chidambaram took over as finance minister," said Mr Paulson-Ellis.

"The global policy environment remains conducive to risk assets, suggesting continued flows into Indian equities," he added. "However, India was a disproportionate recipient last year. Now it is no longer a big underweight in portfolios, specific country flows will depend on either continued momentum in public policy, or clear evidence of real economic recovery.

"Our sense is that whilst policy momentum on the interest rate side is likely, policy momentum in political reforms will become harder from here on."