The bear market rally has begun

I've been warning bears for a couple of weeks that the market was due for an aggressive bear market rally. That rally has clearly begun.

I have often referenced the rubber band theory in my writing. For those not in the know, the rubber band theory is nothing more than the tendency for any market to regress to the mean. And the further a market is stretched away from the mean, the more violent the snap back tends to be once the pressure is released.


Markets are really no different. The further you stretch the stock market the more violent and persistent the snap back tends to be once the turn occurs. At the recent yearly cycle low on August 9, the stock market had stretched to ridiculous levels, both sentiment wise and technically. This should generate an extremely convincing bear market rally.

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Market valuation eroded

For every rupee of earnings managed by BSE Sensex companies, investors are today willing to pay only half of what they paid in January 2008.

The market meltdown of 2008 has seen the Sensex value fall by 35 per cent till date, but it has halved the price-to-earnings multiple (PE multiple) for companies in the bellwether index.

The PE multiple of the Sensex, which was at a rich 28 times (based on historic 12-month earnings) at 21,000 levels, has plunged to a staid 14 times now, Bloomberg data shows. The lower valuation indicates that investors now expect Sensex companies to grow at only half the rate that they factored in, in January.

World over, investors value companies based on potential growth and the PE multiple is one of the widely used tools to evaluate how expensive or cheap stocks are, relative to their growth prospects.
Worst in a decade

The erosion in Sensex PE multiple in this meltdown may be the worst in a decade, even including the dotcom crash of 2001.

Banking and realty companies have been worst hit, with SBI seeing its PE multiple fall from 20 times to just 6, while DLF has seen its PE plunge from 90 times to 8 times.

Reliance Industries, Jaiprakash Associates, SBI, Tata Steel, Reliance Infrastructure (formerly Reliance Energy) and DLF, are among companies that have seen their PE multiples trimmed to half their January level.

Many of these companies have seen their valuation fall even as they managed a sharp ramp-up in their earnings for 2007-08.

DLF (earnings per share grew from Rs 13 to Rs 47 between FY07 and FY08), Bharti Airtel (Rs 21 to Rs 34), HDFC (Rs 69 to Rs 100) are key instances.
‘De-rating’ stocks

While concerns about rising interest rates have prompted investors to tone down growth expectations from bank and realty companies, worries about the economy slowing down have made them ‘de-rate’ infrastructure and capital goods stocks.

Companies in the Sensex basket that have managed to escape this bout of de-rating are Infosys, Satyam, Ranbaxy Labs, Cipla and Hindalco, which have more or less held on to their PE multiples.

via BL

Market View

Post the Federal Reserve decision to cut the Fed Funds rate by 50 basis points to support liquidity and bolster the economy mid week we saw markets rally. This rally was accentuated in emerging markets as the risk trade was again reignited. However, this is a broader statement which needs further examination. Currencies are likely to play a role in global allocation of funds as investors reallocate those depreciating towards appreciating currencies. In fact if you look at flows of funds last week, we saw only a trickle in international funds flow, in comparison to emerging market funds. We expect further rates cuts over the next 6 months to address the situation in the US and UK. This will place a continued upward bias on emerging market allocation.

All above returns are upto 21st of September 2007. In this environment investors are likely to re-assess exposure to the US, UK and other markets which may be impacted by the sub-prime issues and depreciating currencies. In essence these may be seen as more risky markets than emerging markets. Markets like China and India will be primary benefactors as growth is visible and more reliant on domestic factors. This indeed would be a sea change to investor mentality and we feel it is likely to happen sooner rather than later.

India Strategy

We remain bullish on the prospects for India being a more attractive investment destination for investor funds. In the last report we stated a view of 5,500 to 6,000 by the first quarter of 2008 based on this bullishness. In this environment we expect Large Cap stocks to dominate the move upwards as

FII’s will focus on more liquid counters which are $1 billion or higher in market capitalization. Accordingly the small and mid capitalisation stocks are likely to show a lagged impact, however the political risk stands in the way of a unified local market appreciation.

In fact local mutual funds are likely to be sceptical due to their views on political risk and the impact it can have on the market. Local valuations are also likely to blown out of proportion for the time being as liquidity takes hold. We do not expect this situation to be ongoing, but may last till year end in a similar pattern to October, November 2006.

In addition sectoral positioning and stock picking abilities will be the major differentiator in performance. There are isolated ideas on rupee appreciation (underweight IT and Pharma) and a falling interest rate outlook (overweight Banks and Housing related). These positions are likely to be accentuated in the current market with players likely to follow a momentum based strategy.

Experts on the Markets

The Sensex closed above 16,000-mark for the first time, and market experts feel more gains will follow with some hiccups on the way.

Though nobody is taking a call on where the index will be in the near-term, experts, across-the-board, continue to be bullish on Indian equities. Nimesh Kampani, chairman, JM Financial "The basic issue is that the way the markets have gone up. The flow of FII money will increase in India and that is the expectation of the market. With the interest rates being cut, the appreciation of rupee, and looking at the rise in Asian markets today, it can be assumed that there has been a flow of FII money into the Asian markets. Sectors such as infrastructure, cement, steel and power look good, as we expect growth in these sectors. Rakesh Jhunjhunwala, billionaire investor and stock trader I’m and I have been bullish on the Indian markets. There is no change in my view S Ramesh, COO, Kotak Investment Banking Markets will be driven by liquidity, and money will move into markets like India where the growth story remains intact. The rise from this level will be driven by sectors like banking, construction and engineering. We are just coming out of a global meltdown, and the rise from here will be sector-specific and global-event driven. Krishnamurthy Vijayan, CEO, JP Morgan Asset Management We believe that since India is one of the best investment opportunities in the next few years, we will continue to attract investments - onshore and offshore. We have been consistently overweight on sectors that capture the Indian growth story, and have been underweight on auto and downstream oil. Vijai Mantri, CEO, Deutsche AMC We are very positive on India. The Indian growth story is completely driven by domestic demand. While there may be some bouts of volatility, I don't see any constraint on corporate earnings growth. We are very bullish on capital goods, engineering and power. I think Indian markets are fairly valued but India may see a rate cut taking cues from FOMC. Alok Vajpayee, CEO, Dawnay Day AV The Indian market is following the global trend. I will not be surprised to see it at a much higher level. Some ups and downs will be there, but we will continue to see markets moving up. There could be a rate cut in India. There is lot of momentum in liquidity in Indian markets and I think they are at a fair valuation. Investors should look at specific companies rather than across-the-board buying. Second quarter results will be in line with our expectations. Ramesh Damani, member, BSE Markets have clinched 16,000 with a huge bang. Bulls are going to be in command. It reflects the strength of the Indian economy. We can say that it is India's time under the sun. The road from here onwards looks very good. India's domestic story is being driven by corporate fundamentals and earnings that are very strong. I am bullish on domestic sectors like logistics, cement, banking and underweight for the time being on technology. May be by Diwali this year, we can expect a rate cut. Amar Ambani, Vice President (research), India Infoline The 50bps rate cut by the Fed, the first in over four years, has keyed up global markets as well as Indian equities with investors breathing a sigh of relief. Talking about Indian markets in particular, the Fed cut, along with control over inflation and an improved political situation, has helped boost enthusiasm. A look at the advance tax figures also suggest that quarterly numbers are likely to be healthy. The feel-good factor of the Fed verdict will continue for some more time with increasing inflows in India where there are some very good investment opportunities. Suyash Choudhary, Fund Manager, StanChart Asset Management By delivering a 50 bps cut in the federal funds rate yesterday, the Fed has aimed at countering the detrimental effect on the broader economy arising from the tight credit conditions. The move has been accompanied by a cut by 50 bps on the discount window, which will further facilitate liquidity transmission into the financial system. While bonds world-wide are still cautious, equities have reacted very positively to the Fed move. Given that the move will help in restoring global financial stability, it is likely to positively affect domestic asset markets as well. Ritesh Jain, Fund Manager (Debt), Principal Mutual Fund The change in the Fed policy reinforces our near-term view on the benign interest rate environment. Inflation risk should continue to subside in this environment and will lend an element of flexibility to policy. The foreign flows in emerging markets may look up putting pressure on the domestic currencies to appreciate. The central bank may have to intervene aggressively to stem the uptrend in local currencies adding to domestic liquidity. While equity flows into emerging markets are likely to be good, the markets will also be watching for the corporate earnings in the current quarter. We expect the markets to remain strong. With the global interest rate environment turning benign and with most of the prominent central banks changing their stance in favor of growth than their concern on inflation, we may see even the domestic yield curve shifting lower over a period of time. Kaushal Sampat, Chief Operating Officer, Dun & Bradstreet India The cut in the Fed rate is likely to have some impact on the Indian economy. The widened interest rate differential between India and the US could result in a further surge of capital inflows (especially FIIs), which may lead to an appreciation of the rupee. The RBI may be under pressure to intervene in the forex market to preclude appreciation of the rupee beyond its comfort zone. The RBI could consider a decline in interest rates given the recent dip in the growth rate of industrial production and inflation being at a 17-month low thereby allowing the excess liquidity to flow into the economy through increased credit off take. Sandeep Nanda, executive vice president (research), Sharekhan The 50bps rate cut by the US Fed was ahead of expectation and thus a positive surprise. This prompt action has allayed concerns about a slowdown and will be positive for equities across the world including India. We expect cyclical and interest rate sensitive sectors such as banks, autos, metals to do well. There will now be greater pressure on the RBI to cut interest rates in India, which should boost earnings growth in FY2009. Kunj Bansal, CIO (portfolio management services), Religare With the FOMC announcing a 0.5% cut in the rate, the debate of an impending slowdown in the US has only increased. Moreover, the exact magnitude of the subprime crisis is yet to play out. Signals from Europe and Japan are not as salutary as they were in July. Crude has resumed its relentless pursuit of a three-figure price after a brief pause. These developments portend a steady increase of lows to those economies, which are essentially growing due to the domestic demand factor. Therefore, India would stand to benefit as a consequence. That does not mean that everything is fine in the domestic space and that we are likely to see an out performance across sectors. The political undercurrents are far from positive. Further, the latest set of IIP numbers has revived the talk of a possible slowdown in the industrial growth going forward. The performance of the monsoon, on the other hand, has given sufficient reason for cheer. In essence, what we are saying is that whereas directionally there is nothing much to worry as far as the way forward is concerned, and the markets shall continue their northward journey. However, intermittent blips cannot be ruled out.

Market View

The market looks healthy, trading in the range of 12500-13000-plus levels as recovery continues. Corporate earnings are strong. The fact that India has under-performed the EMs (emerging markets) may suggest that some catching up could take place, given that investors seem to have regained confidence in Indian equity on signs that Corporate India is in good shape. Despite a positive outlook, bouts of volatility cannot be completely ruled out as the Indian capital market, economy and businesses are no longer insulated from global geo-political and economic events. On the domestic front, the market could remain cautious on account of the RBI's monetary tightening and its consequent impact on the growth momentum. Hence, high return expectations may be difficult to sustain. The market, however, seems to have factored these concerns into current price levels.

ICICI Prudential Mutual

The market continues to witness heavy buying on any sharp correction. The phenomenal strength in global markets has been a major reason for the firmness. Short covering and under-ownership generally have also aided the firmness. However, it has been seen that buying interest reduces considerably at Sensex level of over 14,000.The strong rupee and continued measures to contain inflation could impact profitability in a few crucial sectors. Strong global markets, positive flows and huge cash balances waiting to be deployed provide support from any major correction. Our strategy would be one of caution.

Hidden Gems - Ashish Chugh - Apr 2 2007

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Market View

Our view on the Indian equity market is that after the pre and post Budget fall, the market can be expected to consolidate for some time. With respect to the budget provisions, some of the affected sectors have reacted sharply to discount the implications for them. While, the near term impact of introduction of marginal taxation across the sectors could impact the short term earnings of some corporates, however, the proposed investments in the infrastructure, power and irrigation etc. should continue to buoy the economy and corporate profits in the long term. In the long term, we believe that the focus on inclusive, broad based growth touching every segment of the society is extremely important, because only this can provide a sustainable growth over an extended period of time.

Tata Mutual

The reduction in the indirect tax rates across a host of products, including the key reductions in excise for petrol & diesel, are aimed at controlling the inflation rate, which is currently ruling at multi-year highs.

The markets reacted negatively to the budget proposals, in a weak environment triggered by a global equity meltdown. The key negatives for the markets were the increase in DDT, removal of tax sops for construction companies, inclusion of IT companies under the MAT umbrella and disappointment over lack of any reduction in direct tax rates. The cement sector was impacted from the increased excise rates. The Rs.190 per bag price was considered unrealistic and a possible negative impact was expected on demand from higher prices due to higher excise duty.

OptiMix

The markets have been under pressure in recent times due various factors and the weakness in the global markets had a greater impact on sentiment rather than the budgetary proposals. Indices have fallen across the board due to selling in certain sectors after the Union budget.

The technology sector has been under pressure due to move to include income under MAT and bringing ESOPs under Fringe Benefit Tax. Other sectors to come under pressure after the budget include cement, iron ore exporters and construction. The permission to allow mutual funds to launch dedicated infrastructure funds should help in directing more flows into the crucial sector.

The recent fall in the Indian markets has come about after a strong rally, and in that sense, it was to be expected. The sector-specific measures in the budget could result in downgrading of earnings for those sectors and near term sentiment is likely to remain bearish. Given the strong economic fundamentals, we believe that the medium to long- term outlook remains positive and investors can consider these levels as an entry point into the markets.

FII: +Rs 275 Cr & MF -Rs 191 Cr

Mkt Sources:

FII Gross purchases Rs 2518 Cr Gross Sellers Rs 2243.5 Cr Net Buyers Rs 275 Cr.
MF Gross Purchases Rs 397 Cr Gross Sellers Rs 587 Cr Net Sellers Rs 191 Cr.

Our View:

FII were Net Buyers and one should keep in mind that Inflation is cause for worry. We expect market to trade volatile ahead of budget. Better avoid any fresh position at current level.

2007: Year of the unknown!

Let’s begin by talking some of the things that will or will not certainly happen in 2007. First for the things that are certain. It will not be a leap year. It has been designated as the International Polar Year. Most of the 2007 will overlap with the ‘Year of the Pig’ in the Chinese calendar. Dates from the 1st of January 2007 until the 17th of February 2007 will be in the ‘Year of the Dog’ in the Chinese calendar.

Well, that’s for China. What about India? For us, 2007 will be a year of taking stock. For the economy, the government and policymakers, it marks the end of the 10th five-year plan, thus raising the need to reassess the targets set in 2002 versus actual performance at the end of the plan period. For the stock markets, unlike the Chinese pigs and dogs, 2007 will most likely mark an intense tug of war between the bulls and the bears. These things are certain!

Now, for things uncertain! Considering the current tight balance, there is less surety on the way the Indian economy will fare in 2007. As for the stock markets, will they be able to repeat their performance of the past two years in 2007 as well? Our answer, “Maybe! Maybe not!” That’s the uncertainty!

2006: The year that was…

After a 44% YoY rise in 2005, the BSE Sensex repeated the performance to the tee in 2006 as well (another 44% YoY rise). This strong performance from the benchmark index has been broad based considering that only 2 of the 30 index stocks closed the year with a decline in their market capitalisation. The Sensex surge was despite rising global imbalances and vibes of a domestic overheating. The year 2006 also saw crude prices rising to record high levels and interest rates in key developed and developing economies hardening.

As far as financial performance of Quantum Universe (350 companies) goes, while net sales in the first half of the fiscal 2006-07 grew by 29% YoY (22% YoY in 1HFY06), net profit grew at a stronger rate of 34% YoY (15% YoY in 1HFY06). More importantly, the net profitability of this sample improved from 9.6% in 1HFY06 to 10.1% in 1HFY07, indicating better pricing scenario and lower input cost pressure.

FII activity:

As far as FII activity was concerned, the year saw US$ 8.3 bn of net inflows into Indian equities (US$ 10.7 bn in 2005). While the quantum of investments was low when compared to the previous year, it still played a significant part in the Sensex rally. Another indication of FIIs considering India as an investment destination, apart from the FII investments, is the ever-increasing number of FII registrations with the stock market regulator, SEBI. The same have increased from about 500 in early 2003 to 993 as of today.

The solid economic performance of the Indian economy in general and India Inc. in particular has played their part in the country getting more mind-share among foreign investors. Apart from this, lack of enough growth opportunities elsewhere and a weakening US dollar (owing to the superpower’s burgeoniong current account deficit) has also been prompting foreign investors to invest in non-dollar assets, which is partially responsible for FII money flowing into emerging markets. However, any signs of reversal in any of these fronts would be viewed negatively and investors must remain alert, as this reversal would force FIIs (especially the momentum guys) to reallocate to better opportunities.

What we said at the start of 2006?

Interest rates and the stock market: Our belief that hardening of interest rates in the developed world (the largest suppliers of capital) will have an impact on emerging markets like India (in terms of money flow), was vindicated in 2006. At the beginning of 2006, we had warned investors of this risk, which reared its head during the year.

We clearly saw valuations of stocks/sectors getting upgraded just because there was a demand for Indian equities. And if the crash of May 2006 were any indication to go by, speculators/punters/tippers would have learnt their lessons the hard way. As far as long-term investors are concerned, we had indicated that the crash presented them with an opportunity to allocate (more) money towards equities, while sticking to their respective risk-return profiles.

If investors are to remember, the pressure on Indian equities (and those of other emerging markets) in May 2006 was a knee-jerk reaction to the US Fed’s hawkish stance on interest rates, led by its own excesses and indicated by inflationary pressure on the world’s largest economy. While it was difficult to predict when the Fed will stop hiking interest rates (it finally did it in June 2006), we remained firm believers of the fact that any further rate hike would have an adverse impact on FII inflows into India. Our reasoning was that a further rise in Fed funds rates could have reduced the risk premium between the US and emerging market equities, thus leading to a U-turn in the movement of capital to safer US T-Bills and bonds.

Past performers may be laggards: Our concerns with respect to prime valuations of capital goods stocks did not reflect in their stock market performance as these maintained their outperformer status during 2006 as well (reasons mentioned below). On the other side of the spectrum, pharma maintained its underperformer status in 2006, as it had in 2005 (reasons mentioned below). However, FMCG, Auto and IT indices, which had outperformed the Sensex during 2005, turned out to be relative underperformers in 2006.

Sector leader: Capital Goods

While the scale of outperformance was significantly lower, the performance was a repetition of what we had witnessed in 2005. During 2006, the BSE Capital Goods index returned 9% more than the benchmark Sensex. And why not! The sector has been a witness to tremendous growth over the past few quarters, owing to large scale infrastructure spending that has directly flowed into companies' order books and topline. And the financial performance has been rewarded by the stock markets. The major beneficiaries have been those who are focused on the power (generation, transmission and distribution) sector.

As far as the other segments of capital goods are concerned - infrastructure construction, hydrocarbons and process industries - growth will be a factor of greater capacity addition and increased private-public participation.

Outlook for capital goods:

World-class infrastructure has emerged as one of the most important necessities for unleashing high and sustained growth and alleviation of poverty in any economy. And with poor infrastructure to support other growth initiatives, the Indian economy continues to be a laggard when compared to its developing peers. From a policy perspective, however, there has been a growing consensus that a private-public partnership is required to remove difficulties concerning the development of infrastructure in the country. The realisation finally seems to be setting in. Considering these factors, we expect the sector to grow strongly into the future. However, scale and execution capabilities will be the key mantras for success for the engineering companies.

Sector laggard(s)

I. Pharmaceuticals: While adverse ruling in cases of some generic drugs and price decline in the US market had led to the underperformance of the healthcare sector in 2005, in 2006, the pressure was on the back of some serious price erosion in the US generics market (due to rise in the level of competition and lesser number of drugs going off-patent) and slow growth in product launches from MNC companies in the domestic market.

Outlook for pharmaceuticals: While the fundamentals driving the generics market continue to remain strong, the brutal pricing environment is a cause for concern. It must be noted that the competition has tremendously increased, escalating the extent of price erosion. Having said that, while the competition most probably will show no signs of abating, a considerable rise in the patent expiries of blockbuster drugs in the coming years is likely to provide a breather to generic companies and boost revenues. The ability to manufacture drugs at the cheapest cost and leverage one's marketing and distributing network to increase reach will be the key to survival.

We also believe that partnerships are likely to play a crucial role in driving growth. This could be in generics (contract manufacturing, authorised generics) or research (R&D collaboration, contract research, out-licensing of molecules) or custom manufacturing for innovator companies. In the domestic market, with the introduction of the patent law and subsequent slowdown of product launches, albeit at a gradual pace, companies entering into in-licensing agreements with innovator companies will have the upper hand. This will ensure a steady flow of product launches in this market. For MNC companies, while new product introductions from their parent's folio will be the key to success going forward, in our view, it is unlikely to be a cakewalk for them. This is because prices of these patented products will most likely be subject to 'price negotiation'.

II. FMCG: After a year of outperformance in 2005, the BSE FMCG Index grossly underperformed the benchmark Sensex during 2006. For every Rs 100 invested in the FMCG index at the start of 2006, yielded Rs 116 (16% returns) at the end of the year (against Sensex returns of 44%). The problem for FMCG companies was not in terms of growth. In fact, 2006 saw strong volume growth numbers from most of the sector companies, largely on the back of robust economic performance and consequently higher consumption spending. Even the rural demand kicked in during the year. The issue that plagued the sector pertained to declining brand strength due to intensifying competition across categories, and added pressure on profitability owing to rising input costs. Even in cases where companies resorted to price hikes to take care of rising raw material costs, the instances were few, indicating a fear of loss of market share. This led to increased volatility in performance of the companies from the sector, and the consequence was seen in their stock prices.

Outlook for FMCG: In 2007, the environment will no doubt be competitive for FMCG players. However, growth will remain a factor of ‘volumes’. Product differentiation and innovation along with technology and processes will be the critical aspects for growth. Also, the leading domestic FMCG players, who have started to spread their wings in the overseas market, will see a greater global shift during 2007. The bottomline from investors’ perspective is to have a balanced portfolio in the FMCG sector (large and niche players) to reap benefits of the consumption story going forward. More importantly, investors need to understand that FMCG is not a high-return sector and to that extent, expectations have to be realistic.

What to expect in 2007?

Volatility, uncertainty, and more of the same! We believe that the Indian and global economy, interest rates, and stock markets are more tightly balanced as we near the end of 2006 than these were anytime in the near past. Let us see where these are headed in 2007

Indian economy: We believe that the three key macro factors of demographics, globalisation and economic reforms, which have led India's strong economic performance during the past three years, shall continue to pump up the economic activity in the country going forward as well. However, there is a caveat to this assumption. While we believe that these factors will aid the economy's strong performance in the coming years, the fact that a part of growth in the past has been a result of the sharp rise in capital flows (in response to an increase in the global risk appetite), which has allowed the government and the RBI to pursue relatively loose fiscal and monetary policies, puts the economic growth to a test of risk. In our view, the government needs to implement measures to stimulate the supply-side by investing in infrastructure, implementing labor reforms, improving the management of its finances and strengthening the institutional and administrative framework.

As reported in the Economist, “The shining dreams evoked by the world’s recent recognition of India as a great emerging power have always seemed at odds with the messy reality of the country itself. In 2007, dream and reality will collide in each of India’s three claims to greatness: as a country of more than 1 billion people that remains a vibrant democracy; as a power accepted at the global high table and at peace with its neighbours; and as an economy enjoying almost Chinese rates of growth. All three claims will survive the collision, emerging not so much tarnished as strengthened by a new sense of realism.”

Interest rates: We believe that the days of cheap money are near to over. And if the vibes from the RBI are an indication, we shall see more action on the Mint Road. The first week of 2007 will see the cash reserve ratio (CRR, or an indicative rate for broader interest rate scenario in the economy) being raised by a further 25 basis points to 5.5% (already announced; effective January 2007). Considering the globalisation of the international financial system, formulating an independent monetary policy is expected to become more complex in 2007. The RBI will have to take into account, among other issues, developments in the global economic situation, the international inflationary situation, interest rate scenario, exchange rate movements and capital flows while formulating its monetary policy for 2007-08.

Stockmarkets and valuations: At the current juncture, Indian equities, on a broader basis, are trading at almost 19 times one-year forward earnings. While this looks expensive on a peer comparison basis (relative to other emerging markets in Asia and South America), considering our bottom-up approach to stock selection, we still find value in stocks from a long-term perspective. As for our view on the Sensex is concerned, we never had one in the past, and do not intend to have one in the future as well. How does that matter when one is following a stock-specific approach?

We, in fact, hope that the BSE Sensex loses some of its relevance in 2007. There have been innumerable instances in the past when gullible investors have drowned in the sea of stock market uncertainty just because they jumped on their experts’ advise that the ‘Sensex will touch XYZ,000 in 1 or 2 months time!’ It is for this reason we hope for 2007 to witness an increasing irrelevance of the Sensex. And this is what we are asking readers of this article to do. Block the noise! Stop listening to the paranoid experts! Sleep easy!

We believe that one of the biggest downside risks to the performance of Indian equities in 2007 will be a reversal of global capital flows from emerging and developing economies in the case of realignment of global interest rates. Also, slow investment growth on account of higher domestic interest rates with the tightening of monetary policy stance by the RBI will only add to the pressure.

These factor, however, do not alter our view on equities as an asset class from a 3-5 years perspective. While it might not be a one-way ride for stocks in 2007 and beyond, what is more important to note is that equities will provide attractive inflation adjusted returns in the long term. You just have to be rational in your choices and not follow the herd, and you need to value stocks not beyond any accurate or rational reflection of their actual worth. This is not to say that your (equity) investments cannot legitimately enjoy a huge leap in value, but this leap should be justified by the prospects of the underlying companies, and not just by a mass of investors following each other.

The unreasonable belief in the possibility of getting 'rich' quickly is the primary reason people burn their fingers in market crashes. One tends to neglect the fact that there is a direct correlation between high risk and high returns. While the history of market crashes does not in any way foretell anything dire for the future, the best thing that you, as an investor, can do in 2007 is keep yourself educated, well informed and well practiced in doing your homework.

“Trust no future, however pleasant! Let the dead past bury its dead! Act, act in the living present! Heart within and God overhead.” - Henry Wadsworth Longfellow, Psalm of Life

Wishing you all a very happy new year!

Listless trade likely to mark New Year beginning

The year 2006 was a good one for the Indian investors as the benchmarks - the BSE Sensex and the NSE's S&P CNX Nifty - generated returns of 47 per cent and 41 per cent respectively. Even the performance of broader indices - BSE-500 with 39 per cent, the BSE Midcap (31 per cent) and the BSE Smallcap (16 per cent) - should be satisfying to the general investment class. This is the fifth straight year of gains for the Indian markets.

Emerging markets

One of the major reasons for the Indian bourses to show robust performance was the strong inflow from foreign investors. In fact, it was a record inflow in 2006 for emerging markets (including India). According to EPFR, an emerging market fund activity tracking firm, about $22.4 billion entered the emerging markets in 2006 with China attracting half of the amount. Inflows are around nine per cent higher than the record inflow of $20.3 billion during the whole of 2005.

India losing sheen?

Despite emerging markets attracting strong inflows, India seemed to be out of favour with the global investors, at least for now, as overall foreign institutional investments slipped in 2006. According to SEBI data, FIIs were net investors to the tune of Rs 36,539 crore in 2006 - much below 2005 level of Rs 47,181.20 crore - a drop of 22.5 per cent, as they indulged in profit booking at higher levels. In dollar terms, FIIs were net investors of $7.993 billion against $10.701 billion in 2005, a decline of 25 per cent.

However, the total number of FIIs operating in India crossed the 1,000-mark for the first time and has gone up to 1,035.

Consolidation seen

So what is in store for 2007? General view among investment circles is that 2007 may not be as fabulous as 2005 or 2006. A majority of them say that the market has entered consolidation phase. Despite recent slowing down in FII flows, India's macro picture is still intact. Strong economic growth remains the key trigger, with India's GDP for the first half of the current fiscal ended September hitting 9.1 per cent. The RBI has forecast full-year growth of 8 per cent. Corporate earnings have been growing at 20-23 per cent for the last two years. Most analysts are hopeful that the trend may continue for the Indian Inc in 2007 too.

The stock market was expected to remain stable despite concerns that the RBI would raise interest rates early next year with inflation rate nearing 5.5-mark against the Government's targeted level of below five per cent.

This week, the Indian bourses may not be an action-packed one. With overseas funds in no hurry to commit fresh investments and are in profit-booking mood, listless trade may mark the beginning of the New Year.

Corporates are scheduled to announce their Q3 performance soon; Infosys and HDFC Bank would report their earnings on January 11. Market may see fresh commitments from big funds only after seeing the initial trend (Q3 numbers) and more importantly the outlook they are going to present for the next quarter as well as next fiscal.

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!

Mere blips or serious dips?

The past couple of months have seen stock market players swing from shock and pessimism to business-as-usual, with the indices correcting sharply before staging a recovery. With so many developments to mull over, opinions were, as usual, divided across market-watchers. Here are some optimistic and pessimistic views on key developments:

Hike in Cash Reserve Ratio

The RBI finally stepped in to address the issue of excess liquidity by hiking the cash reserve ratio (CRR) by 50 basis points to 5.5 per cent in two stages (December 8 and January 7, 2007), sucking out about Rs 13,500 crore from the banking system. The move is to check inflation, which is hovering well above the 5 per cent mark.

Point: Some analysts feel that the era of cheap money is over. Already, the majority of banks have hiked their prime lending rates, which could squeeze the excess liquidity chasing assets such as equities and property.

Counterpoint: The move may not make a significant difference to liquidity. Though the increased CRR could impact banks' profit margins, there is enough excess liquidity to keep the market moving.

IIP worries

The October quick estimates of the Index of Industrial Production (IIP) from the Central Statistical Organisation (CSO) came as a surprise to many. Industrial production growth dipped unexpectedly to 6.2 per cent in October after recording remarkably high growth rates of close to 10 per cent for the first six months of the financial year.

Point: This is only the tip of the iceberg. The overheated economy could see further cooling off on the back of higher interest rates and inflation.

Counterpoint: It is not appropriate to read too much into numbers for a single month. The timing of the Diwali sales and the holiday season in October this year, instead of the usual November, may have caused the blip. Nothing is wrong with the economy and next month's IIP numbers will bear this out.

High market valuations

The BSE Sensex is quoting at a forward price-earnings multiple of about 18 times and a trailing multiple of about 23 times earnings.

Point: Indian valuations are stretched and the BSE Sensex is trading at a significant valuation premium to other emerging markets. There are several opportunities outside of the Indian market, available at cheaper prices.

Counterpoint: Though the valuations seem stretched, the quantum of funds waiting to enter India is huge and with robust fundamentals and one of the strongest growth rates, India still looks attractive for long term.

US Slowdown

US economic numbers, as well as indicators such as housing starts and industrial production, suggest a slowdown.

Point: The US economy, which is witnessing stagflation and showing signs of weakening further, could pose a threat to the global equity markets.

Counterpoint: the Indian economy and its companies do not rely too much on the US for growth. As India is relatively insulated from happenings in the US, there will be no significant impact on liquidity flows.

Thailand's policy flip-flop

Thailand imposed restrictions on foreign investments which required that investors retain all sums not linked to trade or foreign direct investment within Thailand, for at least a year. This move forced a 17 per cent decline in the Thai stock market and a sharp reversal in the Thai baht, the strongest Asian currency this year.

Point: This move could make FIIs more cautious about allocating funds to the emerging markets, including India, as several countries with appreciating currencies could use such measures to improve their export competitiveness.

Counterpoint: It is unlikely that other countries will adopt this strategy, as this could be counterproductive. That fact that Thailand had to reverse these moves and exclude equity investments from its restrictions could serve as a deterrent to others.

Weak commodity prices

The prices of crude oil, gold and select metals have retreated from their peaks.

Point: Weak commodity prices are a precursor to similar trends in equity market. With increasing cross-border investments and investors moving between asset classes, the weakening of one asset class in the portfolio should impact other assets too.

Counterpoint: Weaker commodity prices may ease margin pressures on companies and bolster earnings. As to allocations, even if commodity prices decline further, the funds originally slated for commodity investments will be reallocated to other asset classes, particularly equities.

2007 will be year of consolidation and rise for the Indian markets

"Market is always right. Markets cannot be taught, they have to be learnt.

"We must have an attitude where we must balance fear and greed," was the hot tip by Mr Rakesh Jhunjhunwala, India's high-profile investor and President of Rare Enterprises, when he spoke at a seminar on `Wealth creation through equity investments' organised by Welingkar Institute of Management here on Friday.

Mr Jhunjhunwala spoke about his convictions that made a case for sustaining the India growth story.

Equities, because of their efficiency in allocating capital and ability to leverage, generated superior returns when compared to other assets over the long term, he said.

Since 1979, the Sensex has delivered 21 per cent returns compounded annual growth rate, which compares well with returns on funds managed by the legendary global investor Warren Buffet, he added.

Opportunities

Mr Jhunjhunwala said that enormous wealth was created over the last five years because opportunities in India have been manifold.

There is a strong case for investing in equities considering its under-penetration today.

He predicts the proportion of household savings to equity to rise to 15 per cent in 2011 from 4.5 per cent now as a result of which about $45 billion would flow into equity markets as against $6 billion now.

He expects 2007 to be a year of consolidation and rise for the Indian markets. According to him, the Sensex may have a floor at 12,500 and a peak at 16,500 in 2007.

Admitting that gains were going to be moderate in future unlike the manifold rise over the last few years, he advised investors to be realistic in their expectations.

He said that markets were unlikely to peak unless they were trading at a multiple of 25-30 times forward earnings. They are currently trading at about 16 times their earnings for financial year 2008.

Growth momentum

Speaking on the strength in India's fundamentals, he elaborated on forces that would sustain the growth momentum.

According to him, growth enablers (such as favourable demographics, higher base of skilled people and education base), liberalisation catalysts (such as competition), fall in interest rates, multiplier effect (on account of reforms), structural changes in quality of corporate earnings and micro trends (such as change in mindset of companies who are aspiring to become global) are likely to drive India's growth story to a higher level.

He, however, cautioned that investors should not forget the four-letter word `Risk' while making investment decisions.

"Patience may be tested, but conviction will be rewarded," he said. Mr K. Rajagopal, CIO, Reliance Capital Asset Management, and Mr Joseph Massey, Deputy Managing Director, MCX, were among other speakers on the occasion.

Market View

We are likely to see some mid-cap out-performance, particularly once the January results give local investors an idea of the story for FY08. Growth expectations are currently around 15 per cent for FY08 on the previous year. However, in the mid-cap space this may be far higher. FIIs may also start to approach saturation of investible limits (due to foreign investment limits) in the large-cap space, which will lead to filtering down into more mid-cap names.

The risk to this situation is the 1 lakh crore IPO pipeline, which may absorb some of the FII demand and deflect from a focus on mid-caps. Additionally, the liquidity issues in mid-caps continue to be an issue for large investors. Finally, in a market like India, momentum tends to take hold at times and we may see further blow-out in large-cap premiums before we see mean reversion take place. If one were to step out from the current trend favouring large-caps and set the vision further, mid-caps represent the opportunity in that space.

OptiMix

Indeed, it seems quite logical that if the world's economies are increasingly intertwined and interdependent they will become less dependent on the United States. From a structural perspective we even feel that fundamental long-term strategies should increasingly be adapted to this inevitable trend. Of course, the extent to which the rest of the world's economies "decouple" from the United States will depend on how much they are "desynchronised" from the US economic cycle and on other specific factors that are endogenous to the various pieces of the global macroeconomic puzzle. No doubt that emerging Asia is still the key piece to this puzzle. This currently seems to be the main concern of market observers.

BNP Paribas Asset Management

Emerging markets (EM) has historically been vulnerable to deteriorating economic and financial conditions in the United States and other developed countries. Slower growth, tighter liquidity, and heightened risk aversion in mature markets generally mean lower commodity prices, less capital flows, and higher interest rates for EM borrowers — conditions that helped produce some spectacular financial crises in the past dozen years. Not a pretty picture, and one that begs the question of what lies around the corner.

Given this backdrop, it is interesting that 2007 growth estimates for emerging market economies continue to be robust, suggesting a potential divergence this time for EM. Certainly the nature of the slowdown (hard vs. soft) in the US is critical to the performance of the EM economies and will shape expectations for EM growth and the performance of the asset class. But fundamental, endogenous changes in the emerging countries suggest EM is far better equipped to deal with a G-3 slowdown in the current cycle than in the past.

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