What 2010 may hold for equity markets

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The Indian markets saw some tepid action last week with no show of strength. Globally too, things are very sideways and this week the Nifty and the Sensex gave up about 2.5% apiece - the Nifty closing below 5,000.

Banks, on fears of imminent interest rate hikes, are underperforming and that's putting a lot of pressure on the market. The breadth for the moment is disserted the market too and even telecom stocks seem to have ended their recent pullback and that's put a bit of pressure as well on the Nifty. Not a strong December thus far, and the views are very mixed as we go into 2010.

In an exclusive discussion with CNBC-TV18, Jyotivardhan Jaipuria, Head of Research at DSP Merrill Lynch and Vetri Subramaniam, Head of Equity Funds at Religare Mutual Fund, spoke about their view on what the new year may hold for equities.

Here is a verbatim transcript of their exclusive interview on CNBC-TV18. Also watch the accompanying video.

Q: How are you feeling going into 2010. You have been cautious for a while, are you still feeling cautious or are you feeling even more circumspect than a month or two back?

Subramaniam: The view is still reasonably cautious. The valuations still are little bit of a challenge and over the next few months, we got to deal with some kind of a withdrawal of the easy monetary conditions that are currently prevailing and we have also got to deal with the issue of fiscal deficit and starting to roll back, the fiscal stimulus that was given to the economy last year.

So there are a lot of challenges and the valuations do not leave too much on the table in terms of making the market attractive. So the next year is going to be challenging and it will be challenging not just for reasons particular to India but also the fact is that we have been extremely correlated with trends overseas, directly correlated with equity markets and other risk assets and inversely correlated with the dollar. I am not seeing those correlations or that kind of induced volatility go away in a hurry. So that's going to be another challenging year next year as well.

Q: What is your perspective getting into next year are you also circumspect or cautious or do you think market will be able to climb these walls of worry that Vetri spoke about?

Jaipuria: This year has been one of the best years we have had in ages and if we see second half this year, I was just seeing some numbers now this is turning out to be a best year for MSCI Asia pack since 1993.

So we had a very strong performance going to be the market so I think next year is going to be a year of consolidation where probably markets don't do much. In fact we have forgotten what a consolidation is because the last time we had a single digit move in the market it was in 1992 and I think next year is going to be one of those years where markets really are going to consolidate and not do too much. Having said that, we are expecting a first quarter correction in the markets.

Q: That is an interesting perspective. In 2008 markets fell more than 60%, in 2009 we have more than doubled. You are saying that this kind of narrow range-bound trade that we have seen in the last quarter of this calendar might actually be more like the picture we will see in 2010?

Jaipuria: Yes, I think after the last three years after so great volatility, I think it seems very anti-consensus to believe that we will get into a narrow range market but typically if you see most years, markets are priced and they end up delivering something that no one expects. Like no one would have believed that this year would give 100% returns.

Because the issues are very clear, valuations are expensive, which everybody believes. Liquidity is not going to go in a hurry. From those base effects, the economies are recovering. So we will just get a year where markets end up maybe not doing much for the year, there will probably be ups and downs but probably when we end next year we will be not be maybe 5-10% plus minus from these levels.

Q: Do you concur with that view or you expecting more volatility into 2010 because of the global events which might come to the fore?

Subramaniam: My sense is that volatility might actually come back and definitely maybe in the Q1 or the first half of the year and the reason for that is also because if you look at the typical volatility measures they seem to have come down pretty dramatically to levels, which were almost prevailing more than year and half ago when we were in far more sober times.

My sense is that you will most probably see a spike in volatility again. The other reason why I think volatility is here to perhaps stay is that increasingly over the last 18 months, we have just seen these correlations become tighter and tighter across the world. It is almost like there is one orchestra conductor out there and all the markets are beating to the same tune and because of this you tend to find volatility much higher than you would have found otherwise. So I think these are times we are living with, and it is something we will have to just put up with for the next maybe year or two.

Q: You are calling for a Q1 correction. Are you calling for a deep correction because we had one of them just a few weeks back, it was 10-12% no more than that? Do you think liquidity still supports the markets at lower levels in case of a Q1 correction or are you calling for a deeper cut?

Jaipuria: It's more like a 10-15% correction, liquidity still going to be easy. I do not see the Fed tightening liquidity in any significant way till late into first half or probably second half of next year. So to that extent corrections will be narrow. But like in India per se, we are going to get negative news like Vetri pointed out: the exit policy comes through; inflation is high and bunching up of paper, which is waiting to come into the market. I think a combination of all this will bring a correction. Globally also, there is too much faith in the dollar carry trade, which at some point probably we see a bit of dollar strengthening, which shakes up markets a bit.

Q: Do you think there might be a deeper cut than the one we have seen over the last six months or so?

Subramaniam: Possibly, I don't think one can rule that out any more. In fact, I felt that way even a month ago during an interview. I said market's been trading in a tight range for a while and my sense is that we are building up to some sort of sharp move and frankly about a month ago, I would have said that put the odds at maybe 70% to the downside and 30% to the upside sort of move more for the seasonal factors.

But the way the data points are playing out and the way the world markets have behaved over the last few weeks increasingly, to my mind, suggests that the risk is more on the downside and my sense is that the next move that we are talking about is a 20-25% sort of move, I don't think it will be small.