Equity markets seem to be on steroid

Worldwide equity markets seem to be on steroid. We have seen a very strong rally since March 9,discounting all the good news and expecting a revival of the US economy and US consumer confidence by the end of 2009. In our opinion,while momentum is in favour,one should be cautious over the short term.

Where do you see the Sensex by the end of FY10?

We expect the market to correct and consolidate between 12,500 and 15,000. This is likely to happen between August and mid-September,before rallying again to close the year at a high of around 18,000. We hope Diwali will be better this year compared to last year.

In your view,what factors are driving the current rally in the stock market?

Global liquidity is finding its way into risky asset classes,mainly equity and commodity markets,worldwide. Massive fund infusion in the US and credit expansion 1 trillion so far in China has boosted liquidity. The market has discounted the earnings upgrade in the latter half of the year. The risk of disappointment in earnings in the US,therefore,is high,in my view.

Could you elaborate on the negatives?

The market,as I said,is discounting the best-case scenario,what we call the second derivative or change of change. Suppose a company has 1,000 employees and cuts 10 per cent or 100 jobs. Next month it again cuts 10 per cent,or 90 jobs. Hence it has cut fewer jobs,so the change of change is positive,but the job loss is still 10 per cent. Currently the market is in an optimistic mood and is cheering any bit of good news. The entire financial crisis in the US happened due to unbridled credit expansion in the 2000s. Worryingly,the same credit expansion is happening again today in China and the US and the rest of the world. The low cost of credit could result in a larger credit bubble.

What are your expectations regarding investments by foreign institutional investors FII during the current year?

Year to date FIIs have invested over 7 billion. If the liquidity flow continues,it will not be surprising to see the current trend in the market continuing for the rest of the year. Because of the liquidity flow we are bullish on the market up to the year end,notwithstanding our near term view being that of a small correction and consolidation.

What are your expectations from Q1FY10 corporate results? Do you expect to see an improvement in performance happening this quarter?

On an annual basis Q1 will look bad. Sensex companies are expected to report a 10 per cent drop in earnings; ex Banks and Oil amp; Gas the drop will be 12 per cent year-on-year YoY. Margin will show stabilisation in most cases,as raw material costs have come down and companies are cutting other costs as well. So far 21 Sensex companies have reported a 30 per cent YoY growth in profit,but large Oil amp; Gas and commodity companies are yet to report results. Margin is up 100 basis points sequentially to 17.9 per cent.

What are some of the key policy expectations that you have from the government,which you believe will take India to a higher growth path,and hence have a positive impact on the stock market?

Everyone is expecting the government to deliver on reforms,including pension sector reforms; raising of foreign direct investment FDI cap in the insurance sector; reforming the banking sector; modifying the SBI Act; allowing FDI in aviation,retail and other sectors; at least partially making pricing in the oil sector market driven; and of course,divesting government stake in PSUs. Basically the government should show its will to take tough economic decisions,and give an actionable roadmap for reducing the fiscal deficit. Most importantly,it should take steps to minimise leakage and channelise resources to gross capital formation and inclusive growth.

Which are some of the key sectors that you believe will do well over the next one year?

All sectors that are a derivative of domestic demand will do well. Infrastructure,road construction,cement,steel and banking should do well. On a smaller scale,sugar and tea are two sectors that look good as there is a demand-supply mismatch in them.

What impact would a poor monsoon have on the markets?

The monsoon has picked up but it will be deficient this year. The loss of acreage in the sowing season is real. In paddy and sugarcane,for example,acreage has shrunk. However,rural income is not dependent on the monsoon only. NREGA,the rural employment scheme,is a great enabler. Tertiary jobs have also been creating rural wealth. The demographic dividend is there to see in the form of urban migration. Hence,in our view,the effect of slightly below par monsoon will be subdued on the economy and the markets.

There is also talk of inflation rising high by the end of this year. In your view,is that a potential threat that investors should watch out for?

We expect about 5 per cent inflation by March 2010,which is not overwhelming. Investors should look at valuations closely,as in some cases valuations have moved up ahead of actual turnaround in the fortunes of underlying companies. Chasing liquidity-driven momentum without adequate valuation support is often dangerous,in my opinion.