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Journalism of Courage
It has been a rollercoaster on the bourses these last three weeks. On October 17,the Sensex touched its peak 17,326 for the current year,up a dizzying 112.33 per cent from its March 9 8,160 trough. At such levels,valuations were getting stretched. Clearly,something had to give. By November 3,the Sensex had fallen 11.09 per cent from its peak value. Just when it appeared that a rout was in the offing,the markets staged a recovery in the last three days of last week.
Stretched valuations
One reason why the market declined,as said earlier,was that valuations were getting stretched. Consensus estimates for Sensex earnings per share EPS are Rs 925 for FY10 and Rs 1,100 for FY11. At around 17,000,the forward PE had gone up to 18-18.5 times FY10 earnings.
Negative international cues
The biggest driver of the current bull run that started in early March is the Rs 68,410 crore that foreign institutional investors FIIs have invested in Indian equities till date this calendar year. Hence the fate of the Indian market has become closely inter-linked with that of the global economy.
Internationally,a recovery is on. In the third quarter the United States GDP grew by a healthy 3.5 per cent. Housing and car sales have picked up. But on the negative side,unemployment remains in double digits. Some economists also are also of the view that the economic growth visible currently is being driven by the support that the government is giving for car and house purchases.
Explaining the decline in the Indian market at the end of October,Gaurav Dua,head of research at Sharekhan,says: The fear that the economic recovery may not sustain led to higher risk aversion. Higher risk aversion in turn meant lower allocation to emerging markets. Indeed,FII investments in Indian equities have come down in recent weeks.
Governments and central banks across the world are beginning to think of withdrawing the massive amount of liquidity injected into their economies during the crisis. What is spooking the Indian markets is whether the recovery in the major Western economies will sustain once their central banks withdraw liquidity, says Dipen Shah,vice president,private client group research,Kotak Securities.
Adds Anup Bagchi,executive director,ICICI Securities: A slow and gradual exit of monetary stimulus is likely. The timing of the withdrawal will be crucial. Markets will closely watch what the Fed and other central bankers say and do. It is widely expected that emerging markets will hike rates earlier than the developed economies. If this leads to increased interest-rate differential,it could lead to higher inflows into Indian markets, adds Bagchi.
On the other hand,any rise in interest rates in the US,by reducing the rate differential,would lead to the unwinding of the dollar trade. This factor too played a part in the recent October-end sell-off. Investors engaged in the dollar carry trade were worried about the stance the FOMC Federal Open Market Committee,the body that sets the benchmark federal-funds rate for the US economy may take and hence an unwinding happened, says Mayank Shah,chief executive officer,Anagram Stockbroking.
RBIs hawkish stance
In the second quarter monetary policy review,Reserve Bank of India RBI Governor D Subbarao made it clear that the central banks focus has shifted from nurturing growth to containing inflation. Though the Governor left key policy rates unchanged,economists widely expect rate hikes to begin in the January-March 2010 quarter. Markets generally perceive a rise in interest rates as negative. By raising the interest costs of corporates,they affect corporate bottom lines,and hence their stock market performance. In particular,interest-rate sensitive sectors like banking,auto and realty get adversely affected.
RBI raised banks overall provisioning coverage ratio,and it also raised the provisioning requirement for lending to commercial real estate. This led to a decline in banking and realty stocks in the last week of October.
Q2 results: not much to write home about
By and large Q2 results have been in line with expectations,but they are nothing to write home about. For Sensex companies EBITDA growth was 7 per cent while PAT declined by 3 per cent.
Says Dipen Shah: Revenue growth has been slightly disappointing,but this has been compensated for by good margins owing to low raw material prices and low interest cost. Because of this profitability has expanded at a pace that was faster than expected.
Sector-wise results have been a mixed bag. Sectors that have delivered strong growth are auto,banking,pharma and FMCG. Those that have performed below expectations are telecom,infrastructure,metals and oil and gas. Among major companies,Hero Honda,Mahindra,BHEL,ITC and Wipro have done well. RCom,Bharti,Maruti,Tata Motors,Lamp;T,Tata Steel,and Hindalco have been the laggards.
What next?
According to experts,corporate earnings need to rise before the markets can resume their upward march. Says Dipen Shah: We need greater visibility and confidence in FY11 earnings. Till that happens,the markets are likely to remain range bound. Meanwhile,according to him,investors should keep an eye on commodity prices and interest rates. If they remain benign over the next couple of months,corporate results could improve and the markets could start moving up by December, he adds. If,on the other hand,the global economy revives quickly unlikely,if one goes by the Feds recent statement,commodity prices could shoot up. Interest rates are likely to rise in 2010 due to high inflation,but at a moderate pace. Only if commodity prices soar and inflationary expectations build up will interest rates rise rapidly.
Bagchi believes that international cues will play an important part in determining the direction of the Indian market. Provided the recovery of the international economy doesnt get stalled,he says: Due to the attractiveness of the Indian market,I expect fresh allocations to this market to be made next year.
What should you do?
Most brokerage houses are currently advising investors to adopt a bottom-up,stock-specific approach. Says Bagchi: A significant decline will present a wonderful opportunity to accumulate good businesses at reasonable valuations. Adds Mayank Shah: Around 14,000 and below,the markets will become attractive. This is when we will start advising investors to aggressively pick up stocks. He further suggests that cash should comprise at least 25-35 per cent of your portfolio so that you are able to take advantage of the opportunities that come your way. Happy bottom fishing. u
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