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2006 - Discovery of India and the rally of disbelief !

2006 is now passe and we are heading into 2007. This year has been a year of India really. Indian Markets have rallied 47% based on the 30 stocks based Sensex where as a broader Nifty 50 gained by 40%. Certainly whopping gains and more creditable after they came over the 42% gains made last year. It was the discovery of India this year and India as an investment destination became the household name. A fund not investing in India didnt know its business. FIIs now registered in India exceed 1000 in number. The five-year, unbroken winning streak has seen the index appreciate 10,525 points from 3,262 at close in 2001 to 13,787 today. And has zoomed 323% in last 5 Years

Sensex started off the year with 9000 crossed and there were only few who would not find the the markets expensive. It was free flow of money and no level could prove a tough hurdle. Starting with 10000 it moved to 11k and 12k but it also suffered a shock in May. Markets had not had any level of consolidation and that created a vaccuum when the sellers came in. Valuation sheets came out and again numbers were looked at ..but then markets slowly and steadily climbed up. However an interesting part about this was that the gains continued to be led by the large caps. ICICI bank., Reliance, State bank of India, HDFC bank, HDFC, Larsen, Reliance, Bharti Airtel, Telco, TCS were the leaders in the Index driving it up to 14000 in the last month of the year. This was followed by profit taking and worries of a May encore !. However things have been stable bringing in some level of comfort and value buying.

It was a year of change at wow-india.com as well. We had our biggest client break this year. It would enthrall you to know that wow-india.com now advises and FII fund which is called Shanti Gestion and is based out of France. The quality of research has improved and we are diligent and objective as ever in our analysis. We have started working on DCF models amongst other things and the impact of that will be seen over the longer term.

It was a year of the BSE capital goods this year taking the cake with 56% gains. This was a sector which seemed highly overvalued but if you were not here you missed the big gains whether it was in BHEL, Siemens or ABB. The laggard was BSE FMCG index which gained only about 18%. BSE Teck index including the media sector was up 50%. . The BSE infra index was up 39%. BSE auto index with 29%, BSE Bankex up 38%. this year and BSE healthcare index saw smaller gains of 22%. However the BSE Mid cap index was up only 30% for the year leaving many investors with not such a positive feel in the pockets.

It was a super year for the world markets as well. China brought in big land reforms and there was no rival to its growth. The markets saw gains.. China +120%, Indonesia + 54%, India + 47%, Hang sang up 35%, Nikkei up 7%. Straits Times + 27%, Taiwan Weighted + 18%, Seoul Composite + 3.9%, DAX + 21%, FTSE 100 + 10%, CAC + 16%.

It is important to note that these performances have come in the face of high crude prices. Crude prices threatened to cross over $ 80 per barrel and this performance was in the face of adverse conditions of rising crude prices and also rising interest rates in US. However it was the later half of the year where it was benign conditions set in with a wait and watch approach by almost every Central bank. This was the sweet spot and many markets have been making all time highs.

GDP growth for India was placed at 8% plus and the only blip came in October where Industrial production numbers showed some drop in growth. Agriculture has been a problem area but increasing disposable incomes across cities and the change in mindsets towards taking EMIs has fuelled consumption. This economy will grow. As we said the economy is doing well and will continue to do well. As we head into 2007 we believe that there are many pockets which are still undervalued and thats where the valuation gaps will get filled.

Among the index gainers.. Reliance Comm gained 127.9% for the year after it got listed in Sensex on June 12 2006.. Followed by ACC 103% , Grasim 101%, Bharti 82%, Guj Amb Cem 78% who made the big gains.

This year it was a sector of the capital goods. BHEL, Siemens, ABB did extremely well not to mention the power companies. Crompton, Voltamp, Emco, Indotech , Jyoti structures et al. The Indo US nuke deal was signed this year. Though the final deal has still the T's to be crossed and Is T be dotted to the satisfaction of bothsides, it has created a big step forward for the Power sector. The other big step was the Ultramega power Projects and the successful bidding and awarding for the same.

Telecom sector was the sector of the year with amazing growth recorded in terms of penetration and growth. The penetration now has increased to about 14% and this is expected to double in a year. Bharti and Rel com were the biggest gainers of this. Hutch continued to hog the limelight about its probable suitors where as Bharti made a high on its Walmart tie up talks. MTNL continues to be a laggard where as BSNL was mired in controversy after awarding some contracts.

Cement sector was the other which never had it such easy in life. The Government at one point even threatened to bring in some price controls. The Developers were crying hoarse but that stopped as they made huge gains on the property prices shooting up. Cement stocks, ACC, Ambuja, Ultratech, Grasim, Kesoram, Century and every company in the cement sector hit gold as cement prices were hiked. The view remains positive as new addition will only be delayed if at all and that the going will remain good for next 12 months at least. We had our clients enjoying our research on the sector.

However it was the best year for the developers Bombay Dyeing, Unitech, Indiabulls, Prajay Engg et all had a ball with stocks doing exceptionally well. Atlanta, Ansal Housing and anything to do with realty flared up.

The media stocks also found flavour. Zee was a find our clients will not forget in a hurry. Hinduja TMT also was another big mover not to forget TV 18, NDTV HT Media.

All in all the mid caps had selective runs and there were some from the IPOs. It was Atlanta, AIA Engg, Sun TV which put on mind boggling gains. We missed most though some gains were realised in Hanung and Sun TV. Though it was a year for the air travel travellers the airlines had a tough time with high oil prices and increasing competition. There were more budget airlines launched and competition was intense. Its likely to remain so.

The thrills and spills of year 2006

Another year has drawn to a close and, much like the previous three, it has been a blow-out year for investors. Having used up every conceivable superlative to describe the market movement of the earlier three years, trying to do so this time around would be an exercise in repetition. Investors in large-cap stocks have reason to be happy, as both the Sensex and the Nifty recorded returns of more than 40 per cent over the year.

In a sense, the performance of the equity market in 2006 is both strikingly similar and sharply different to its showing in 2005, on two key counts. The rally in the year just ended belonged to large-cap stocks, as was the case the earlier year; in contrast, the returns have been accompanied by significantly higher volatility year-on-year.

But 2006 will definitely score high in terms of thrills and spills. While it did prove exciting for those on the sidelines to watch the market action unfold, the same cannot be said for investors holding the wrong kind of stocks. In the first four months of the calendar, the indices moved up inexorably on the back of strong liquidity and a solid performance form India Inc; but what happened over the next two months would have been difficult for even a Nostradamus to predict.

In May and June, the market went into a free fall, shedding close to 40 per cent and raising fears that the bears — who have taken a mauling over the past four years — would finally have their moment in the sun. But that was not to be. The market staged a remarkable recovery, as dramatic as the fall, seemingly effortlessly soaring past earlier highs, with the Sensex and the Nifty crossing the magical milestones of 14000 and 4000 respectively.

FII FLOWS

Foreign institutional investors have been the key catalysts of the market since they went bullish on India from mid-2003. Admittedly, FII flows in 2006, at about $8.5 billion (around Rs 38,000 crore), were lower by 20 per cent than in 2005. But this was due to the markets tanking in May and June. But for this, the inflows would have been much higher and the market would perhaps have ended on a stronger note.

The buttressing effect of FII liquidity apart, the market also underwent significant re-rating on the price-earnings front. Now, the Sensex trades at about 20 times expected earnings for FY07 — significantly higher than a couple of years ago.

Seen in isolation, the P-E multiple might seem stretched; but viewed against the stellar growth in earnings over the past three years, coupled with a high return on equity, that multiple becomes quite justifiable.

Even as the market scaled new peaks, reports from leading brokerages flew thick and fast that the indices were overvalued and a case was being made out for a steep correction. Did the diffidence of these proponents of gloom do anything to impede the bull stampede? Not a chance. With a mind of its own, the market simply continued its relentless upward march.

MUTUAL FUND FLOWS

Obviously not wanting to miss the party, mutual funds, too, were busy raising serious money. As of end November, net inflows into equity funds, at Rs 32,000 crore, outpaced by 40 per cent the receipts in the corresponding previous period.

The jump in inflows was propelled in no small measure by a sharp rise in the allocation of household savings to funds.

With marquee names such as JP Morgan, Dawnay Day and Credit Suisse announcing their intent to enter the fund management business, this space promises interesting times in the year ahead.

INITIAL PUBLIC OFFERINGS

Though over 70 companies went to the market in 2006 to raise funds (about 40 per cent more than in 2005), the number of issues that disappointed investors outstripped those which hit pay-dirt. In the latter category were Educomp Solutions and Atlanta (both multi-baggers), Tech Mahindra, Parsvanath Developers, Info Edge and DCB; on the flip side, several issues, notably that of low-cost pioneer Air Deccan and of a clutch of other mid- and small-cap outfits, dashed investor expectations.

As a consequence, scepticism about IPOs was distinctly manifest towards the year end, when even an issue such as Cairn Energy was under-subscribed by retail investors. One can expect a clutch of offers in the year ahead too, led by the big boy in the real estate space, DLF.

SECTOR PERFORMANCE

It is quite amazing how quickly investor perception of a sector can change in just one year. Sugar, for instance.

Last year, it was basking in the glory of high prices, which led to every sugar company being marked up sharply, the way tech stocks were in 2000.

At the end of 2006, however, sugar stocks had lost flavour as falling prices left a bitter aftertaste, with stocks trading at 30-50 per cent of their yearly highs.

At the other end of the spectrum is cement, a commodity that well and truly rocked in 2006.

With demand growing briskly enough to outpace supply — on account of the boom in housing and infrastructure — and leading to higher prices, 2006 will go down as a watershed year for cement manufacturers.

With capacity addition still some time away, we expect to see continuing strength in stocks from this sector.

Other sectors that had a good outing in 2006 include alcoholic beverages, capital goods/engineering, infrastructure/construction and real-estate, and select stocks from the telecom, media and the IT pack.

Pharma, ferrous metals, FMCG, oil and gas, and auto components did not have much to write home about in 2006, though there was still money to be made if one were to stick to a disciplined, bottom-up stock-picking approach.

Sectors that are likely to be out-performers in the year ahead are outlined in the accompanying story below. Also presented is the technical analyst's view on what the charts portend for 2007.

VANISHING ACT OF PENNIES

We will round off with a facet of the market that is featured here because it is conspicuous by its absence. In earlier years, investors' dalliance with penny stocks was a recurring theme despite warnings against such a bias.

Unheard-of stocks with dubious businesses were punting favourites for hordes of investors, who were lured by their low absolute price and the prospects of making a quick buck.

Several such stocks acquired a veneer of respectability by posting manifold gains; in 2006, the tide turned and quite a few stocks slipped into the penny category.

With this, investor bullishness turned into apathy and that meant fade-out time for such stocks. Year 2006 will thus also go down in history as one in which the penny dropped!

How the Sensex swung through the year

2006 was a rocking year for the stock markets. And a rocky one too! Not only did the Sensex show a whopping jump of 47%, it also demonstrated the greatest volatility in the past five years.

An ETIG analysis reveals that the annualised volatility coefficient (AVC) of the Sensex stood at 26% for 2006, compared to 17% and 25% during 2005 and 2004 respectively. The benchmark index was significantly less fluctuating in 2003 and 2002 also, with AVC of 19% and 17% respectively.

The bourses witnessed sharp see-saw movements during the year, with a continuos upward movement from January to May, a sudden crash from May to June and then again, a strong recovery continuing throughout December.

On one hand, the Sensex touched an all-time high of 14000, while on the other hand, it also witnessed its single largest-ever fall in one trading day since 1991. With Indian markets getting more globally aligned, this year witnessed sharper reactions to global macro-economic changes and domestic policy measures.

Annualised volatility indicates the amount of fluctuations in the market movements during the year. The higher the volatility, the riskier it is to invest in the short term. The annual volatility is calculated by taking the standard deviation of daily returns for either the stock or the index and then annualising it over the total number of trading days during the year.

Among the Sensex stocks, Infosys and TCS were the least volatile with AVC of 31% and 32% respectively. Reliance Communications, during its 10-month stint on the bourses, exhibited the maximum volatility of 82% since listing. Tata Steel, in news for its Corus bid, was the next most volatile stock with a coefficient of 48%, followed by Hindalco and Reliance Industries at 43% each.

Twenty-five out of the BSE 100 stocks reported AVC of more than 50%, with United Spirits topping the chart with 83%. Asian Paints was the only stock to move in sync with the Sensex, with an AVC of 27%, while Sun Pharma was slightly worse off at 29%. Smaller companies were even more unpredictable during the year, with the BSE Small-Cap and BSE Mid-Cap indices reporting AVC of 28% and 27% respectively.

On the sectoral front, the metal sector was the most fluctuating of all with an AVC of 41%, while the healthcare sector was the least volatile with a coefficient of just 24% during the year.

Sensex up 47% in 2006

The market ended calendar 2006 on a strong note, with the Sensex settling at 13,786.91, less than 200 points off its all time closing high of 13,972.03 of 7 December 2006.

It rose 46.7% for the calendar year.

The S&P CNX Nifty gained 39.8% for the calendar year 2006.

Banking, telecom, IT and cement shares hogged the limelight in 2006.

After a sharp setback witnessed in May-June 2006 due to fears of rise in US interest rates, the market staged a solid rebound and key indices struck lifetime highs in December 2006.

Strong corporate earnings growth remained the key driver of the uptrend in share prices.

FIIs continued to mop up Indian stocks betting that earnings growth of India Inc. will remain strong in a booming Indian economy. The net FII inflow in 2006 totaled $8.2 billion compared to a record inflow of $10.7 billion in 2005. FIIs mopped up Indian equities notwithstanding concerns about stretched valuations of Indian equities.

Mutual funds bought shares worth a net Rs 11453 crore for the 9-months period April-December 2006.

Sharekhan Valueline - November 2006

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