Market more riskier than in 2008 ?

W ith the BSE Sensex breaking past 19000 after a long spell, the market ‘targets' are being busily upgraded to levels of 21000 plus, the previous market high. But did you know that the rally this time round has been underpinned by much lower earnings growth than in 2007-08?



The Sensex companies reported 10 per cent growth (all references to profits exclude the loss-making oil refiners, given that their size may skew the picture) in earnings in FY10, no better than the slowdown-impacted FY09 and far lower than the levels of FY07 and FY08. However, that is not the only thing that was different in this rally. Here we go:

Slower growth in earnings

In the last bull market between June 2006 and January 2008, the BSE Sensex rose by 131 per cent and in the current rally too, the Sensex has made a similar 139 per cent return.

The Sensex PE moved up from 18 times to 28 during the previous rally and from 14 times to 23 this time round. However, the PE re-rating in 2007-08 was underpinned by companies delivering strong profit growth even as the rally was on.

Sample this: In 2005-06, companies in the Sensex registered a 21 per cent earnings growth and followed this up with a 29 per cent growth in 2006-07 and 27 per cent in 2007-08.

In the current rally, the numbers aren't as encouraging, despite support from a low base. The rally that started in March-09 was on the backdrop of the Sensex companies reporting a 10 per cent growth in earnings for 2008-09. But, with rosy expectations of ‘forward earnings', the market had a breathtaking run.

In 2009-10, the Sensex companies delivered the same 10 per cent growth even as the market PE had already run up to 20 times by end-March-10. The companies in the BSE Smallcap basket, however, recorded a 73 per cent growth in earnings, rising from the low base of the previous year where their earnings fell by 40-odd per cent. The BSE Smallcap index's PE stands at 18 times now.

The first quarter of fiscal 2010-11 too has brought no reprieve from the rather moderate growth. The Sensex companies notched up just 4 per cent growth while the BSE-500 constituents grew 10 per cent. Unmindful of these, the market continues to head north, with the PE multiple of the Sensex rising from 20 times in March 2010 to 23 times now.

If earnings continue to disappoint, investors will eventually have to adjust their expectations downward, warranting a correction.

Smallcaps lead gains

Another differing feature of the recent rally is that the small-cap stocks beat the Sensex by a bigger margin than they did in 2007-08.

Though the Sensex was up by 139 per cent, the BSE Smallcap index has had a dream run over the last one-and-a-half years, appreciating 256 per cent.

In the previous bull market, Smallcap performance was actually much more muted, with a gain of 186 per cent higher than the Sensex return of 131 per cent. A probable correction at this point may dampen the premium valuations stocks in this space enjoy.

In end-January 2008, when the BSE Smallcap index was almost at the current level of 10300, it traded at a PEM of 16 times; the index's price-earning multiple currently is 18 times. The BSE Smallcap index's peak valuation in the last rally was 22 times. But do note that 95 of the 531 companies that constitute the BSE Smallcap index are at a valuation of above 30 times now. Investors may, however, breathe easier if they have mid-cap stocks in their portfolio.

At 21 times, the BSE Midcap index is far from its peak valuation of 27 times in December 2007.

Different sectors lead

The sectors that led this rally have differed too. Realty, infrastructure and power, the three sectors that were multi-baggers in the rally that ended in January ‘08, turned underperformers in the ensuing correction and fell to less than half their peak levels.

Going by this logic, consumer durables (up 385 per cent), fertilisers (up 383 per cent) and banks (up 272 per cent), the top performing sectors in this rally, may be most exposed to correction.

Infrastructure companies have been among the front-runners this time too, making a return of close to 270 per cent.

Investors, nevertheless, need to tread with caution — Unity Infra, the stock which rose close to 770 per cent in this rally, was the one that had corrected by 92 per cent in the fall of 2008-09.

It is FIIs all the way!



The 2006-08 rally was driven by a steady stream of inflows by domestic institutions in the stock market, but this time around they were not that active.

This rally was wholly fuelled by the money the foreign institutional investors poured in.

Between March ‘09 and now, the stock exchanges show that a total of Rs 55,000 crore has been the net purchases in the cash market by foreign institutional investors.

As a percentage of the BSE-500 index's total market-cap, FIIs hold 13.9 per cent now — higher than the December ‘08 level of 12.9 per cent.

That is a signal that any global ‘event' a la Lehman may have very dramatic consequences for the Indian markets, as foreign investors wind up positions here to setoff their losses in other markets.

For investors, this means that it is best to exercise caution on stocks with high FII interest.

Some stocks where there has been a sharp increase in FII holdings between March ‘09 and now are: Apollo Tyres, Dewan Housing, Unitech, HDIL, Sobha Developers, Indiabulls Real Estate, Hindustan Construction and Hindalco Industries.

via BL