IN PERSPECTIVE: OUTLOOK FOR 2012

 This is for investment professionals only and should not be relied upon by private investors.  December 2011

2012: GLOOM vs. OPTIMISM: WHAT’S IN THE

PRICE?

2011 has been an intense year for equit ies globall y, with one cons istent t heme – volatil ity.

Through the tsunami in J apan to unrest in the Middle East, concerns of slow ing US and

emerging market growth to the survival of the euro region, most equity markets have fallen

notably. Would 2012 be any different or does the uncertainty spill over into the next year as

well? Alexander Treves, Head of Investments, Fidelity Worldw ide Investments, India feels

that while the year could be challenging, it also presents an opportunity to build posi tions in

top quality companies that have a long term competitive advantage.

 Alexander Treves is Head of 

Investments at Fidelity, India.

 Alexander joined Fidelity in 2006 as

Director of Research in London having

gained over 11 years of extensive

experience in Research and Portfolio

Management across Asia and the UK.

Before moving to India in April 2010, he

was the Head of Research at Fidelity in

Tokyo. He is a Chartered Financial

 Analyst and holds a Bachelor of Arts

degree from King’s College, Cambridge.

Globally, three key factors that played out this year were the ongoing eurozone sovereign debt

crisis, fears of a slowing US economy, and a sharper than expected rise in inflation in emerging

markets prompting higher interest rates. Apart from these, we witnessed events such as the surge

in commodity prices in the first half of the year due partly to the political stability in Middle East and

North Africa, and the J apanese earthquake and tsunami which disrupted the global manufacturing

supply chain.

Of these, fears over slowing growth in the US have eased with better than expected performance of 

the US economy recently. However, refocus on the fiscal / debt position in the US will begin to gain

headlines as the presidential elections draw closer through the latter half of the year. Inflation in

emerging markets could decline over the coming months and interest rates in many economies are

currently on hold. The year could further test the resilience of the emerging market growth story to

the economic slowdown in the developed world.

However, it will be the eurozone that is likely to dominate headlines and the situation could worsen

further before being contained. Some of the key themes for 2012 could be as below:

2012 COULD BE ANOTHER CHALLENGING YEAR FOR EUROPE

2011 has witnessed developments on the economic as well as financial front in the euro region and

these have prompted reactive and temporary fixes by eurozone governments. The locus of the

crisis has now moved from the periphery to the core economies and even France and Germany

have not been spared. Our colleagues in Europe believe we are in the last leg of the sovereign

debt crisis, and the closer the crisis moves to the core economies, the faster would be the move

towards more decisive action. In that sense, whether the eurozone breaks up or moves towards a

credible fiscal union, 2012 is likely to be a challenging year - albeit the challenges will act as

catalyst for resolution. Recent political changes in Spain and Italy are significant and new

governments are fully focussed on fiscal prudence. Having said that, we may see a general re-

pricing of core, AAA rated sovereign debt. We have started to see the beginnings of this process

and the markets are ahead of the rating agencies once again. The euro region could enter into

recession in view of the constrained bank lending and austerity measures. The length and depth of 

the recession would be dictated by the policy response from the European Central Bank.

US TO AVOID RECESSION, BUT MAY BE IMPACTED BY CONTAGION FROM EUROPE

Historically, US stock markets have had a high correlation with those in Europe. The US cannot be

immune from its linkages with Europe, be it through exports or financial markets or consumer

confidence. The US consumer is still burdened by debt and consumer sentiment is weak, mainly

due to high inflation expectations and static growth in real income. Nevertheless, on a positive

note, the release of upbeat economic indicators in the recent months, including better than

expected growth numbers for the third quarter, have allayed fears of a recession in the

 

 

IN PERSPECTIVE: OUTLOOK FOR 2012

US. Our colleagues tracking the US markets believe that corporate profits in the US are robust.

 This has historically been a reliable indicator of job creation, as confirmed by the latest jobs data,

and a positive indicator for a rise in capital spending and industrial activity. Nascent signs of 

stabilisation in house prices, a decline in foreclosures and vacant house units, and a correction in

housing inventory point to a brighter outlook.

 ASIAN MARKETS RESILIENCE TO PROVIDE GROWTH

Most Emerging Asia economies could not stay immune to the deteriorating situation in the

eurozone and sluggish growth in the US, given export linkages to the west. Capital flows to the EM

have slowed leading to a further sell-off in the equity markets, tightening of credit conditions, and

pressure on some currencies. Some of the countries in the region also face domestic challenges

such as a correction in China’s property market, weaker investment sentiment in India, and high

household debt weighing on consumption growth in Korea. Recent data releases on the growth

front in China and India suggest that economic activity is losing momentum. The second half of the

year could bring in a more optimistic economic tone, particularly if against a backdrop of easing

inflation; there is the prospect of strong stimulus measures in EM economies. China has signalled

the beginning of an accommodative monetary policy by lowering bank reserve requirement in

December for the first time in three years, while the governments of Taiwan and the Philippines

have unveiled fiscal stimulus measures.

 The contrast between emerging and developed economies is likely to become even more

conspicuous in 2012. Investors should be alert to buying opportunities in emerging markets that

allow them to increase exposure at attractive prices. The long-term case for emerging markets is

intact and the existence of a ‘two-speed world’ in economic growth terms is likely only to become

more obvious.

REFORMS AGENDA AND DIVESTMENTS COULD BE CATALYSTS FOR INDIA

Apart from global headwinds, India has also been impacted by a host of local factors due to which

we have had one of the worst performing Asian markets this year. These include sustained

inflationary pressures, a sharp rise in interest rates, and policy inaction on the part of the

government. Added to this has been the significant decline in the Indian rupee later in the year due

to a sell off in risk assets, the worsening current account deficit caused by a high import bill, and

waning portfolio flows.

On the fiscal deficit front, the government has had little success in reducing it since the financial

crisis. Several social programs like the rural employment guarantee program (which gives 100 days

of minimum wage to the rural unemployed) provided substantial impulse to rural demand while

making the fiscal position worse. Furthermore, large subsidy programs for food, fuel, and fertilizer

also added to the adverse fiscal position and inflated demand. Besides, the government has been

able to raise only a small portion of the budgeted disinvestment target so far in the current fiscal

year, although a revival in its divestment program could ease financing pressure.

Consensus GDP growth expectations for India have declined in tandem with the fall in industrial

production, high funding costs, and slowing global economic growth. Nonetheless, a slower growth

rate in India will still be considerably in excess of growth achieved in the developed world. We are

hopeful that the policy environment will improve in light of the marked deterioration in the growth

outlook, as that has historically acted as catalyst for the government to push through tough reform

measures. Even as industrial production data has disappointed, there are some bright spots of 

optimism in the economy. Meanwhile, even as underlying inflation will continue to present a

challenge due to structural issues, and currency depreciation could offset the decline in commodity

prices, a high base effect is likely to set in and result in a fall in the inflation rate in the coming

months. This should be followed by monetary policy easing which could be supportive for equities.

Amongst key performance drivers that we’d look out for in 2012 could be a steady improvement in

infrastructure spending, progress on goods and services tax (GST), range-bound crude oil prices,

and reasonable capital flows. Meanwhile, India’s economy is domestic growth oriented which is

likely to limit the impact of a slowdown in western economies.

Furthermore, to some extent the policy challenges, high inflation and global risk are already priced

into the market. In general corporate balance sheets are healthy and quite a few top quality

companies are currently trading at attractive valuations. Many companies are entering 2012 in

much better shape than they did the financial crisis of 2008. They have kept their cost bases under

control, continue to have access to bank lending even if terms are tighter, and have actively

managed their refinancing needs in the last two years to protect themselves. As always, when

 

 

IN PERSPECTIVE: OUTLOOK FOR 2012

economic conditions get tough, strong companies get stronger and our investment team remains

focused, despite the macro uncertainty, on picking individually attractive companies from a long

term perspective. We are finding some attractive valuations which give us an opportunity to buy

long term growth businesses at cheap levels.

Notwithstanding the disappointment on the growth front, over time we expect India to continue to

liberalise, offering a longer term supportive environment for the next round of economic expansion.

Against this backdrop, the first half of 2012 is expected to present an opportunity to build positions

in top quality companies that have a long-term competitive edge, whilst prudently managing

portfolio risk. Recent hiccups notwithstanding, long term growth drivers remain intact. Favourable

demographics, increasing urbanisation, low household debt, robust growth in domestic

consumption, and a culture of entrepreneurship driven by a healthy corporate sector are all

ongoing favourable trends which increasingly the market has chosen to ignore – thereby offering

opportunity.

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