On Monday September 3, I wrote to our clients saying that "… people like us tend to get excited when we see a “one way” bet i.e. a situation where the odds are loaded in our favour and the chances are high that we can get the bet right. This is the underlying rationale which has guided my thinking and that of my colleagues, Ritika Mankar and Gaurav Mehta, as over the past eight months we have consistently taken a relatively bullish line vis a vis the Indian economy and its stock market. The one way bet, as we see it, is this - Bernanke, Draghi and Chidambaram really have no choice but to stimulate their economies and the financial markets that their policy actions can influence …"

Over the past two weeks this thesis has worked out as:

>> Ben Bernanke took a dovish line at Jackson Hole on August 31 and followed by delivering QE3 last night.

>> Mario Draghi announced “potentially unlimited intervention” by the ECB in the European sovereign debt market on September 6 and was supported by the German Courts day before yesterday (as they said that there was nothing wrong with the ESF/ESM intervening to buy sovereign debt).

>> The Indian Cabinet (re-energised by a proactive FM) announced a brave Rs 5/litre hike in the price of diesel (as anticipated in our email dated September 11) thereby helping the country’s fiscal position marginally and potentially postponing a fiscal downgrade by at least 6 months.
So how long and how strongly will markets rally in the coming months?

From the first week of this calendar, we have taken the view that the Sensex will hit 18-19K by the end of CY12. We maintain that view and that implies a 5 per cent upmove in Sensex in the next three months.

Other than the “one way bet” theory that we have been discussing for the past month, our confidence in markets rallying strongly stems from our understanding that:

>> The government has launched a proactive “appeasement and outreach” programme wherein key political figures are travelling around the world and meeting MNCs and investors behind closed doors to stress that there are really no ideological differences between the government and the Opposition and that investors should treat the circus that took place recently in Parliament with a pinch of salt.

>> Key political parties are seeking to boost their balance sheets and hence are keen to roll out the red carpet for corporates and investors. It is highly likely, therefore, that the coming weeks will see: (a) Retail FDI and perhaps Aviation FDI getting pushed through by the Cabinet; and (b) The Union Budget in Feb 2013 will implement the Shome Committee’s stunning draft report (published on 1st Sept) in full thereby scrapping CGT on listed instruments.

>> On both sides of the Atlantic, the major Central Banks have over the past three months adopted a very clever strategy which makes it very difficult for short sellers to attack either the bond or the equity markets. The Fed and the ECB, learning from past experience that announcing a large and clearly defined bond buying programme does not have a lasting effect on markets, have kept up a steady stream of commentary which: (a) "talks up" markets; (b) does not clearly define the size, timing and type of programme(s) which the central banks will use; and (c) focuses on putting a floor under the market by stressing that the Fed/ECB is there to douse any flame that might flare up. Ben Bernanke stuck to this playbook yesterday as he said that open-ended purchases would continue until the labor market improved significantly.

“We’re not going to rush to begin to tighten policy,” he said. “We’re going to give it some time to make sure that the economy is well established.”
Even after the recent power packed fortnight of macro action, there are signficant risks to consider and irrational exuberance should be ruled out as: (a) The Indian banking system is heading for serious trouble with something like 10% of loans outstanding in the system being non-revenue generating for the banks; (b) The probability of big ticket structural reform (the sort which requires Parliament to act) being close to zero in the next 18 months; and (c) The supply chain issues in Indian coal, power generation and SEBs being as disturbing as ever and requiring political courage of the sort rarely found in India.

All of that being said, here is how we would suggest investors play the remarkable turn of events which have transpired over the past fortnight.

>> It is difficult to see how some of the frontline B2C names can continue justifying their elevated multiples given the multi-faceted Consumer slowdown currently under way.

Our Distributor Survey (published on 3rd Sept) points to widespread demand destruction in jewellery, zero volume growth in motorbikes, slowing demand growth in electricals. Titan, Hero and Havells respectively appear to be at risk in these three segments. Similarly, Jubilant Foodworks' share price (50x forward P/E) is factoring in a pizza revolution whose source is not obvious to us (maybe, the Naxalites, who control 1/4th of India's land mass now, will sign a distribution deal). Conversely, Bajaj Auto (thanks to exports), Maruti Suzuki (thanks to Swift Dzire), Voltas (gaining market share in ACs and in E&C) and TTK Prestige (strong export growth) appear to be solidly placed and we have buys on all of these.

Methinks reducing FMCG weights and increasing Auto & Auto Ancs weights in portfolios is the logical thing to do now.

>> The large Indian banks - both public AND private sector - continue to head towards a troublesome place where shareholder equity is meaningfully impaired and/or access to wholesale money markets is in question. The banks where we have confident BUYs are BOB (the best portfolio amongst PSU banks), Federal Bank (overcapitalised bank with tolerable exposure to the busted sectors) and City Union Bank (risk averse regional player). Amongst the banks we don't cover, Karur Vysya (regional champion known for prudent risk management) looks interesting. We have been underweight Banks for the past 18 months and don't see any reason to change tack.

>> Among NBFCs (another traditional "underweight" sector for us), our favourite BUY is M&M Financial Services (strong loan growth without compromising asset quality) whilst we see HDFC and LIC Housing Finance's business models as being structurally broken.

>> In Capital Goods, we continue to believe that heavy industrials (BHEL, Crompton, Thermax) will continue to struggle with weak orderbooks and weak op cashflows whilst light industrials (Cummins, Greaves Cotton, Elgi Equipment) look well placed due to exports and relatively robust domestic demand (eg. the Tata Ace engine order that has gone to Greaves).

>> IT Services look likely to benefit both on the tailwind of currency effects and due to the incipient recovery in the US. We reiterate the same point we have been making for 2 years - BUY HCL Tech and TCS; SELL Infosys and Wipro.

>> Metals & Mining and Oil & Gas are sectors where corporate governance issues have traditionally stopped us from getting overly enthused. Whilst we are 'underweight' in both sectors, it is worth taking note of Tata Steel (0.8x P/B; the strongest ferrous play in India by a country mile) and HPCL (0.7x P/B; best play on diesel price hikes). Whilst we understand which way the political wind is blowing, we do not share the market's recent enthusiasm for RIL - the company needs to perform Herculean feats with its cash pile to justify a re-rating

>> In the busted sectors, our favourite BUYs are Torrent Power (ridiculously undervalued for power generator with 0.6x debt:equity and consistent cashflows), Sadbhav Engineering (the strongest road developer operationally and Balance Sheet-wise) and Sobha Developers (the biggest land bank in south India, 0.6x Debt:Equity and operating cashflow positive). The big conundrum that we face is L&T (we initiated with a sell in mid-May) which whilst clearly the strongest Engineering & Construction play in India continues to suffer from weak order book growth and a lengthening working capital cycle.