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Motilal Oswal

By Motilal Oswal 17-May-2010 | 10:55

From my perspective as an analyst, the past week has been tedious because financial markets have been reacting to "headline risks” rather than the long term underlying fundamentals of the economy. Of course, financial markets are always pricing in new and unexpected risks, so this is nothing new. However, the intensity of the situation in Europe (i.e., Greece) and Washington (i.e., financial regulatory reform) makes rational assessment difficult because of the nature of the situation.

Specifically, it is hard to assess how politicians all over the world will make and implement decisions that will have a significant impact on all economic activity. The uncertainty about those decisions is high and the resulting uncertainties will weigh on investment decisions until clarity is achieved. It can be interpreted that the liquidity will become a major issue for global markets going forward. Corporations may find it difficult to hedge against important risks or alternatively, may find that the cost of doing so will rise significantly.

All near term indicators remain bullish, but there has been a diminishing of the positive signal over the past few weeks. This reflects the pullback in risk-taking that occurred since mid-April. It is worth monitoring for further deterioration.

Some of the indicators which could be looked into are as follows

1) The Yield Curves of the G3 nations remains near cyclical and historic highs, but has flattened by 25 bps since early-April. The current steepness of the curve is still indicating a sustained global recovery, but the signal has diminished slightly.

2) The real yield in the US, as proxied by the 10-year TIPS, has fallen by 39 bps since early-April. The 10-year UST yield fell 25 bps over the same time period, which means that the inflation breakeven has risen by 14 bps. Slower growth and higher inflation is not good for financial assets. It is worth mentioning that real yields reflect expected rates of return on capital. Falling real yields are bearish and rising yields are bullish, all else equal.

3) The Industrial Metals/Gold Ratio has fallen by 9% since mid-April. Industrial metals are sensitive to business cycle demand while gold is not. The 9% decline in the index was caused by a 6% decline in the industrial metals index and a 4% increase in the price of gold. Again, this is indicating slower growth and higher inflation on the margin. The Metals/Gold Ratio is up 33% from a year ago. The recent 9% decline does not indicate a reversal of the bullish macro environment. However, the entire commodities markets remain very tentative and vulnerable

To sum up on the markets, I maintain my bullish cyclical view with positive implications and cyclically sensitive industries except commodities. I believe that the recent pullback in stock prices last week is an excellent opportunity to buy.Banks, autos and capital goods are good bets at this point in time

Additionally, the Honorable Supreme Court pronounced its judgement in the RIL-RNRL case today .The principal points on which the apex court laid out clarity is that promoter / shareholder agreements is not be binding on the corporate entities behind them or for that matter the government .Second, natural resources are the assets of the government and it will have a final say in the quantity and price at which it is to be consumed, irrespective of policies and regulations at that point in time or future policies/regulations which might come . This judgment, to my mind could have immense implications for Corporate India going forward. It could also impact bidding amounts for future NELP auctions

The judgement went in favour Reliance Industries. To that extent, there are is a positive implications for the stock . Also there may be excellent value in Reliance Infra (even after subtracting Dadri from the SOTP valuations) at lower levels.