Will this rally sustain?

After a significant fall,a bounce back in the form of what is known as a bear market rally was inevitable. No fundamental reasons can explain the current rally; it is mostly being attributed to technical factors. The rally began due to short covering buy back of shares that market participants had previously sold short.

One reason being attributed is that having plunged the depths,the markets had to bounce back sometime,and they have done so now. The markets were oversold globally and we were at the height of pessimism, says Shashank Khade,senior vice president-portfolio management services,Kotak Securities.

Moreover,the bailout packages in the US have helped stabilise the situation. Foreign institutional investors FIIs have contributed to the rally. The signs of revival in the US economy have helped sustain the rally, says Khade. And in India,a loosening of monetary policy has infused liquidity into the markets. Availability of easy and cheap credit in the last one month has brought liquidity into the markets, he adds.

Domestically,while Q4FY09 results did not point to a major improvement in corporate performance,they did not spring a negative surprise either. Q4 results were not as bad as people had expected them to be, says Amar Ambani,vice president-research,India Infoline.

Usually,markets move ahead of fundamental improvements in the economy. If the markets expect that the fundamentals might improve in the second half of this year,they would discount this improvement much in advance. But right now the fundamentals havent changed much. The rally occurred mostly due to technical reasons, says Khade.

According to Daljeet Singh Kohli,head-PCG research,Emkay Global Financial Services,Most of the stocks that led the rally belonged to sectors that lack strong fundamentals,such as realty and news-driven sectors such as fertilisers.

Current scenario

In the US efforts are being made by the government to revive the economy through bailout packages and stress tests of the banks a plan to fortify the financial system by revealing how much capital banks need. The slowdown in the pace of flow of bad news from the West is being taken as a sign that the worst might be behind us.

Within India,headline inflation,as measured by the wholesale price index WPI,has declined sharply from more than 12 per cent in August 2008 to near-zero levels of 0.70 per cent for the week ended April 25,2009.

The credit-deposit ratio,defined as the proportion of loan-assets created by banks to deposits received,is showing signs of improvement. The ratio increased marginally for the month of March 2009 after falling continuously since October 2008. This indicates that banks,which were extremely reluctant to lend at the height of the crisis,might be turning more optimistic and See table: Falling since Oct. 08,now up again and lending more easily to corporates.

According to Kohli,The Indian economy is not badly impacted. The major problems were due to commodity-led inflation and the credit crunch. The latter was the result of lack of belief within the bankers community. But now inflation is slowing down and the credit situation is improving.

In recent times,cement despatches and automobile sales have picked up. But the capital goods sector is still lagging and may take some time to revive,says Khade.

Institutional investors rally

When the markets had fallen substantially there was huge risk aversion. But now FIIs and domestic institutions such as mutual funds are once again investing in the markets.

Mutual funds were net buyers in the secondary market in March for the first time this calendar year with net purchase of Rs 1,763 crore.

FIIs were net buyers in March and April. In April their net investment stood at Rs 7,039 crore. Explaining this behaviour,Ambani says: There has been a belief that once sentiments improve money would return to the emerging markets. Among these emerging markets,India is considered a better option due to the broad-based structure of its capital markets and the option to invest in hundreds of companies here. So it became the obvious destination.

Retail investors missing

While institutional investors led the current rally,retail investors were conspicuous by their absence. The sharp 50 per cent rise within a short span of two months growth took most retail investors by surprise.

After the losses they sustained last year,most retail investors were still nursing their wounds. Many would have sworn not to invest in equities for their entire lifetime.

Normally retail investors enter the markets in the advanced stages of a sustained bull run. So it is not surprising that they have not participated in the current one. In a rally like this there tends to be a lot of disbelief among retail investors. The fright of losing capital is higher than the expectation of high return,hence retail investors do not participate in the initial stages. Retail money will only come in when investors see a substantial accretion to their investments, points out Khade.

The outlook

One bit of uncertainty that the markets have to contend with is the outcome of the Lok Sabha elections and whether it will produce a stable government at the Centre. Though most of the news related to the elections has already been factored in,some knee-jerk reaction may be expected once the actual results come in, says Kohli.

After such a sharp upward move,a correction is overdue in the markets. But with so much money still waiting on the sidelines to be deployed,the correction has not happened yet. According to Khade,Due to the incremental money that is coming in from participants who missed the rally,and the optimistic view that more money will be pumped into the market,scepticism has vanished. Hence the correction is not expected to be acute.

On the valuation front,the markets are currently trading at a one-year forward multiple of 15-16. The rule of thumb for emerging markets is that the maximum multiple one can assign is two times GDP growth. Thus,for an expected GDP growth rate of 6.5 per cent in FY10,the markets are already fairly valued at a Sensex PE level of 15-16. The markets have already discounted the growth for 2010,so there is not too much room for further upside, says Khade.

As for the fundamentals,Kohli says,One is unlikely to witness the downfall of more big financial institutions in the US. The pace of bad news coming in from the US is slowing down. There are hopes of revival although it will take some time for an economy of that size to stabilise. He expects the recovery in the Indian markets to begin sometime between the second and the last quarter of this financial year,while he expects the real economy to start showing faster growth from 2011.

What should you do

Investors tend to enter the markets when it is at a historical high and exit it when it hits a low,when they should be doing the opposite if they want to make money.

According to Kohli,This rally lacked fundamentals and is not the right time to enter. One should be prepared to buy after dips. One should look for stocks that are fundamentally strong. Understand the product and have a clear view of why you are buying the stock. For the next one year,go for companies having quality management,proven track records,high quality of corporate governance,and strong balance sheets.

Ambani recommends that one should go for stocks that have high visibility and are not burdened with heavy debt. In case of mutual funds,he suggests investing in diversified equity funds that invest in top BSE 100 companies with a good track record.

Khade suggests investing in companies centred on the domestic economy. Look for India-centric stocks or companies whose business models are based on Indian demand rather than on global outsourcing. Since the global markets will take more time to stabilise,India-focused companies are likely to fare better in the near to medium term.

Thus,if you have missed the current rally,there is no need to despair. Firstly,since the current rally was not based on fundamentals,the gains could dissipate due to a possible correction. If you are in the markets for the long run,focus on researching fundamentally strong stocks and buy them whenever the market dips and offers good value. u

niti.kiranexpressindia.com