Still a Bull market but Cautious with your picks

The RBI, in its quarterly policy review on 25^th jan, upped the inflation targets but didn’t use monetary tightening aggressively. Clearly RBI wants to signal that the supply side and system inefficiencies need to be checked than just the monetary measures.

With interest rates not rising enough, the real inflation is increasing which means that the short term FII funds might pull out and to a extent it is happening. We have seen about $1.3 bn funds moving out in 2011.

In order to bridge the apparent governance deficit, the Govt. is taking symbolic steps by arresting some of the tainted people behind 2G, CWG and other scams. But what is missing is the policy measures needed for long term sustainability of sentiments. The issues around environment, mining, land acquisition and above all the parliament deadlock continue to project vagueness and uncertainty in the minds of investors.

Private sector debt to GDP ratio is close to 0.6 now which is very high considering the past. It also indicates that there could be a lot of bad quality assets which in turn will increase the riskiness of the markets.

We see the continuing uptrend of inflation in the European region at close to 2.4% now but the interest rates are still flat at around 0.5%. The Yen has appreciated almost 10% against Re in 2010, thus eroding the gains of many Japan domociled funds. Accordingly, we are seeing a shift from equity to debt funds.

The Chinese are facing drought conditions in 7 of their provinces further driving the food prices high. China Govt. has to take steps to increase domestic consumption and curb inflation. They are sitting on reserves of $2800 bn. If Euro zone also go for a QE kind of policy, then dollar will have lesser demand and it can impact Chinese treasuries. A low growth model may actually be good for China now.

The long term US bond yields are rising, on the back of upsurge in inflation, expecting a rate increase. The Fed's purchase of govt securities have pushed enourmous liquidity into the system which is finding its way into the markets. The short term rates are almost fixed at 0 while the long term rates are rising. $ is expected to fall further against Euro. It doesn't look like Fed has much ammunition left now than to increase rates. Alternatively, deeper fiscal measures are needed to spur consumption and investment by corporate sector. Otherwise the brief recovery which is seen now will be diffcult to sustain.

We will continue to see volatility in Indian markets until budget time. The markets haven't had any good news over last couple of months. But there doesnt seem to be any structural problems. The forecast says that the monsoon is expected to be normal this year. And the problems with global crude supply seems to be checked for a short time at least.

Stocks with lesser gearing, no FCCB payouts in next 1 yr, and having some cushion to absorb 2-3% of EBITDA drop would be the good picks.