Sensex riding on optimism

Continued strong corporate earnings growth remains the key driver of the market rally.

At a lifetime closing high of 13,282.91 (10 November), the barometer BSE Sensex is up 41.3% in calendar 2006 so far.

`The market sentiment is positive, as investors seem to have already revised the earnings' estimates upwards for FY07 and look poised to discount FY08 earnings, which is evident from a strong of 77% rollover of October futures to November’, notes Nilesh Shah, Chief Investment Officer, Prudential ICICI Mutual Fund in the latest October 2006 monthly fact sheet.

For Q2 September 2006, the aggregate net profit of 3,096 companies surged 46.7% to Rs 52,272 crore, on 30.8% growth in net sales (sales include other income for banking and finance firms) to Rs 5,14,841 crore.

With expectations that the momentum of earnings growth would be sustained, FIIs have stepped up buying. Strong global liquidity has aided the surge in inflows. By the first few days of November 2006, FII inflow has reached Rs 2,237.90 crore (till 9 November). In the month of October 2006, when the earnings poured in, their net inflow totaled Rs 8,013 crore compared to an inflow of Rs 4,643 crore in August and Rs 5,428 crore in September. FII-inflow in calendar 2006 so far has reached $7.14 billion. In calendar 2005, FII inflow was a record $ 10.7 billion.

A section of the market attributes the solid surge on the Indian bourses to increasing recognition of India’s long-term growth prospects. India’s growth drivers are a favourable demography (large share of young population), robust domestic consumption and acceleration in infrastructure creation. Prime Minister Mahmohan Singh has promised a complete policy on infrastructure, including regulatory and institutional framework, to make it attractive for private participation in the near future. The market has soared in the past two years. From 4,644 on 23 June 2004, it has galloped 186% in less than two and a half years.

Not only earnings but also corporate restructurings, demergers and foreign acquisitions, have lifted investors' confidence in India Inc. In recent months, some big ticket overseas acquisitions were made by Dr Reddy’s Lab and Tata Coffee. If Tata Steel’s planned $8 billion acquisition of Anglo-Dutch steelmaker Corus goes through, it will be the biggest acquisition by an Indian company overseas. Besides, there have been a slew of small and mid-sized overseas acquisitions by Indian firms over the past couple of years.

Indian markets continue to trade at a premium over its regional peers. The premier index, BSE Sensex, trades at a PE multiple of 21.7 based on its trailing 12-months September 2006 earnings.

Market men expected volatility to emerge on the bourses in the near term following a solid surge over the past few months. `Investors may encounter short-term volatility as the market tries to scale further highs or even sustain the current levels, and hence, investors should remain patient and have a long-term investment horizon’, says Prudential ICICI’s Shah.

In its October 2006 monthly fact sheet, HSBC Mutual Fund’s fund manager states that inflation remains the single biggest risk for the Indian equity markets. It was the data that showed cooling off of inflation for the last week of October, which boosted the bourses on Friday (10 November). Yet, the last week of October has been the fourth week in a row that wholesale prices-based inflation stood above the 5% mark. RBI raised its key short-term interest rate by 25 basis points in its latest credit policy on 31 October.

What could suck liquidity from the secondary market in the near term would be some large IPOs that are in the pipeline in the next two months, especially by DLF and Cairn Energy.