Stock trends for 2008

Where will the Sensex end 2008? Coming up with the right answer to that question is as difficult as predicting the quantum of rainfall in an Indian monsoon. In any case, what the Sensex does is often of little relevance to those of us who hold a portfolio made up largely of stocks outside the index basket. So instead of where the Sensex will be a year from now, we crystal gaze to identify some trends for 2008, which could decide how a retail investor should build her portf olio for the year ahead.

Index juggernaut may slow: Indian markets have repeatedly rubbished the notion that investors should expect only a 15-20 per cent return from their stocks. But 2008 may be the year in which Indian stocks, specifically index heavyweights and large-caps, struggle to come up with an encore. Until the end of 2006, profit growth for Indian companies was sprinting comfortably ahead of stock valuations.

Even in end 2006, the PE multiple for the BSE-500 index (22 times trailing earnings) was comfortably ahead of profit growth managed by these companies(31 per cent annually in the preceding five years). Growth expectations built into stock prices, thus appeared attainable.

But the recent stock rally has taken the BSE 500’s PE multiple to a demanding 27 times, though profit growth has actually slackened to 26 per cent in the September quarter.

With stock valuations factoring in high growth expectations, price gains from here on may be moderate, at least for front-line stocks.
Liquidity

Liquidity, unlimited: FII interest in Indian stocks may continue unabated, amidst a turbulent environment for stocks in the US and moderating interest rates in key developed markets. But hurdles, such as the unwinding of PN-routed FII investments ahead of April 2009 and the elections mid-year, suggest a bumpy road ahead. On the positive side, corrective phases may not be allowed to last.

With domestic investors (insurance companies, mutual funds, retail) finally acquiring an avid appetite for equities, the leading names of India Inc may continue to receive buying support on every significant dip. Buying interest from domestic investors has reduced the Indian markets’ vulnerability to global corrective phases recently and this trend may continue into 2008. Should global investors turn more risk-averse, stocks and sectors that play on purely India-specific themes may deliver.
Mid-cap picture

Sunny prognosis for mid-caps: While the Sensex and the Nifty may merely coast along, mid-cap stocks may continue to sizzle in 2008, for three reasons. One, with interest rates set to peak, if not eventually decline this year, mid-sized and smaller companies could receive an earnings boost.

Second, as last year’s rally has already stretched PE multiple for frontline companies, the price-value equation is now more favourable for mid-caps. The search for “value” may take investors — both domestic and foreign — deeper into the basket of mid- and small-cap stocks this year.

Third, recent months have seen a surge in corporate actions by smaller companies. Institutions have made significant purchases in select sectors through the block deals route. Undervalued mid-caps have seen takeover bids, stake hikes by promoters and buyback announcements. Events such as these may top up strong earnings growth from the mid-cap basket.

The bright prognosis for mid-caps, however, will not apply either to small-caps with shaky fundamentals or to penny stocks. This segment of the market has seen indiscriminate buying on a deluge of retail money in recent months, and seems set for a cool-off.
New areas

Stock ideas from new sectors: Of the two pillars of the ‘India’ story, ‘consumption’-related sectors have lagged capex-driven ones in the past couple of years.

Strong resurgence in urban income is now a proven fact and better agricultural growth this year will likely drive rural spending. This may trigger new investor interest in domestic and “consumption”-related themes this year. But playing this theme through the usual routes — FMCGs, MNC pharmaceuticals or retail — may not be the best way to go.

Equity broking firms, financial services companies and banks may be a good proxy to piggyback on the swelling appetite for consumer goods and all forms of investment. The long line-up of foreign players waiting to enter insurance/asset management will continue to drive deal-making and thus, better valuations for recently listed financial services firms. Media stocks, which are catching up recently, remain good picks for investors who seek growth, albeit at a high price. Realty companies, both national and regional, may witness further re-rating as interest rates cool off, and new investment vehicles such as REITs redirect funds into this sector.

For investors looking for value picks that will contain downside risk, pockets of ‘value’ remain in PSU banks, smaller housing finance companies, automobile components (companies with a diversified product profile and those focussed on passenger car OEMs) and select capital-goods makers.

Robust rural growth and spiralling farm goods prices may throw up ‘dark horse’ opportunities from sectors that have been moribund: fertilisers, crop protection and seeds.

Via Businessline