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Saturday, July 14, 2007
Why global markets are scaling new heights
Stock indices everywhere are hitting new highs. The Dow Jones Industrials, the Nasdaq, the Kospi, the Straits Times index, the Sensex and the Nifty, the Hang Seng, Australia’s ASX200 and even Egyptian stocks have all been breaking records.
How does one explain this fantastic surge in stock markets across the world barely a week after everybody came to know about the dangers lurking in the sub-prime mess in the US? Why is it that the Sensex and the Nifty are setting new records when almost everybody expects earnings growth to slow down and when the Infosys results have revealed the damage that can be caused by the strong rupee?
The usual answer to these questions is that it’s the result of liquidity. Liquidity has been the explanation offered for this bull run ever since it began in 2003, although there are differing accounts of why such a flood of money appeared in the first place.
Some blame it on profligate central banks, others on an excess of savings over investments. Liquidity is an all-encompassing term that means different things to different people, but in terms of numbers it boils down to one statistic: The ratio of global financial assets to annual world output has vaulted from 109% in 1980 to 316% in 2005, according to data compiled by the McKinsey Global Institute. Between 2002 and 2005, world financial assets increased from 272% to 316% of global gross domestic product (GDP).
Doesn’t the fact that interest rates have been rising across the world in the last couple of years mean that liquidity is coming down? Yet a rise in the Fed funds rate from a low of 1% to 5.25% seems to have had little impact on asset prices.
The same goes for the rising interest rates in Britain and the Euro area. Serhan Cevik, Morgan Stanley’s vice-president for North Africa and West Asia, points out that the market capitalization-weighted average of short-term interest rates in the world has increased from 1.5% at the end of 2003 to 4.3%.
There are several explanations. One of them is that interest rates are still low by historical standards. Till recently, despite the rise in policy rates, the yield on the US 10-year treasury note was well below 5%. Another version is that, because globalization has led to the induction of low-wage countries like India and China into the world economy, competition has increased and inflation is no longer a threat.
Accordingly, central banks find that they can stimulate their economies without stoking the inflationary fires. Part of the excess supply of money does go into the real economy, pushing up growth, but a lot of it flows into financial assets, boosting their prices. Yet another explanation is that interest rates in Japan are still very low, which is why the yen has become the funding currency for the carry trade. It’s only when the Bank of Japan starts to tighten, so goes the argument, or when the yen starts appreciating, that liquidity will be hit.
There are other reasons for liquidity to be abundant. The central banks of some developing countries, especially China, have been huge creators of liquidity, as they accumulate foreign exchange reserves, releasing local currency in return. (That’s exactly what’s currently happening with the Reserve Bank of India’s (RBI) attempts to prevent the rupee from appreciating.) The forex reserves, in turn, are parked in foreign currency bonds, usually in US treasuries, driving down interest rates there and adding to liquidity. Recent data show that China added $266 billion to its reserves in the first half of the year, while Russia, Brazil and India (Bric) added another $200 billion or so. That’s a $466 billion addition to liquidity by the Bric countries alone, without taking into account the surpluses of the West Asian oil exporters. As Cevik points out,
“The accumulation of foreign assets by oil exporters and Asian countries increased from 3.7% of global GDP in 1999 to 9.5% last year.”
Besides these central banks and the oil exporters, there are other players who add to liquidity by financial leverage, through the creation and widespread adoption of new financial instruments that cut up and bundle risk in new and complex ways. It’s estimated that the total amount of exchange-traded and over-the-counter derivatives have increased exponentially from 26% of global GDP to an astonishing 789%. The rapid growth of these instruments has enabled credit to be enhanced despite monetary tightening. Cevik says that derivatives and securitized debt instruments account for almost 90% of global liquidity, while traditional monetary aggregates represent a mere 10%. That is why commentators are so worried about the sub-prime contagion in the US—if its impact spills over to other asset classes, the contraction in credit could be explosive.
But for that to happen, interest rates need to go up further. The Bank for International Settlements has said that a rebound in the cost of oil as well as rising wages, increasing capacity utilization and falling unemployment may be stoking inflation. But it is by no means certain that inflation is rising.
Back home, however, the situation could be different. The topping out of interest rates has led to a sharp rally in equities. The Bombay Stock Exchange Auto index, for instance, is up around 9.5% in the past one month. But given the pressures on the rupee and the fact that market interest rates are lower than policy rates, the RBI may have no alternative to hiking the cash reserve ratio. The weight of money, however, tends to smother all doubts.
Stock Market Scam, Scandals
In February 1947, when the first finance minister Liaqat Ali Khan pulled the rug from under the business barons by raising the marginal income tax rate to 98.5 per cent, Dalal Street saw its biggest ever fall. Shares of Tata Deferred (now Tata Steel), tumbled close to 60 per cent and so did that of many others. Several brokers went under.
Markets can no longer go kaput these days; nor can brokers. Thanks to the sophisticated trading infrastructure and robust regulations, the market is a safer place to invest in.
While both business and markets have largely moved out of government shackles, the role of the government in the development of the stock market through setting up institutions like Unit Trust of India (UTI), National Stock Exchange (NSE) and the Securities and Exchange Board of India (Sebi) — each of which served a useful purpose — or by bringing in more companies to the public markets, cannot be undermined.
Through the seventies, eighties and till the mid-nineties, public sector institutions like UTI, LIC, GIC, and public sector mutual funds ruled the market. With the entry of foreign investors, these have become marginal players.
The real boost to the stock market came after the government asked foreign companies to dilute their stake to the public in the mid-seventies.
During 1976-77, about 120 foreign companies came out with initial public offers and raised Rs 140 crore, adding another 1.8 million shareholders. Some prominent companies that became public were Reckitt Benckiser, Russell Tea, Colgate, Ponds and Hindustan Lever.
Similarly, the real impetus to trading came after the introduction of the badla which enabled investors to carry forward positions, rendering greater liquidity to the market. With lingering doubts about the misuse of the system, badla was banned and re-introduced several times before it was finally replaced by derivatives in 2001.
According to M R Mayya, who served as executive director of the Bombay Stock Exchange for seven years between 1987-93, the government-administered pricing for IPOs worked in favour of investors.
“Since public issue pricing was regulated by the Controller of Capital Issues, there was gross underpricing of shares during the IPO with the result that stocks would quote at multiple-times their issue price when they made the debut on the bourses,” he says.
The issue price was decided based on three years’ average profits and these profits were discounted at 15 per cent to determine the price-earnings ratio and the final issue price. Most issues were thus priced at a significant discount to the worth of the company. For example, Colgate came out with its issue priced at Rs 25 and was subsequently quoted at Rs 105.
Once the CCI was abolished and free pricing allowed, the primary market exploded with gross mispricing of shares and ultimately collapsed in 1993. The new issues prompted many new stock exchanges to come into effect like Jaipur, Ahmedabad, Kochi and so on. The NSE and Sebi came into being as a fall-out of the frequent scams in the capital markets.
Some concerns of the past still remain, as in the case of a roaring bull market, that merchant bankers may be pricing public issues at levels not justified by fundamentals purely because of excessive demand from foreign investors. Another concern is the grey market.
In the initial years, official trading used to happen only for a couple of hours a day (12-30 to 2.30 pm). This was followed by kerb (unofficial) trading because players liked to react to late news. But even after official trading hours were extended, kerb deals continued.
“Kerb trading used to take place notoriously on the street. I use to bring the police and drive them away,” says Mayya; “there was a class of people from Rajasthan who specialised in kerb trades. They used to run the market and execute the off-market transactions.”
Initially, newspapers used to publish both official as well as kerb rates because they had a bearing on the market price the next day and also threatened the integrity of the market.
Similarly, even before the introduction of derivatives, traders had access to these instruments. A veteran trader, Babu Phatak, pioneered the idea of option trading called Jota Phatak. Jota was the right to buy (call option) and Phatak was the right to see (put).
“At one level we could not stop this, and at the other level there was a feeling that it caused no harm to the overall market,” Mayya remembers.
Share Dalal - then and now..
K R CHOKSEY ON BROKERS THEN AND NOW.
When Kisan Ratilal Choksey participated in the annual general meeting of Madras Cements Limited in Rajapalayam in interior Tamil Nadu five decades ago, he was one of 15 shareholders at the AGM and the only one coming from 1,500 miles away. “Two company officials came to the railway station to see me off,” recalls Choksey.
Incorporated in 1961, Madras Cement is not a favourite stock on the bourses today, but Choksey, 69, says he has earned enough and more from the stock. Choksey’s experience with Madras Cements is the story of the enormous change in the India stock market over the past decades.
For starters, the size of the investor base has gone up dramatically. “Even raising a few lakhs was a Herculean task because people did not understand shares as an asset class like we do today,” Choksey says.
Most capital investments were funded by borrowings and the equity cult only really took off after the seventies when Dhirubhai Ambani entered with his big bang public offer that laid the foundation for the Indian stock market.
“Dhirubhai had an overwhelming feeling that if investors were not kept happy, he couldn’t get more money and that would limit his growth. So he treated investors as family members,” says Choksey, who runs his 28-year-old broking firm, K R Choksey Shares and Securities. Reliance Industries Limited now boasts a shareholder base of over 1.8 million crore investors.
Then, again, from an information scarce world we have an information overload today. Choksey had to wait for a company’s annual shareholder meeting to know about its plans and prospects, while today companies have to mandatorily report quarterly financials and material events impacting share price.
“At that time we did not have even telephones, but now we have conference calls organised by companies, and also websites, television channels and pink papers analyse the market threadbare everyday.”
As against today’s fat research reports, Choksey says he was one of the very few to do one-page reports on companies.
Though the basics of investing were the same, research was constrained by lack of adequate resources. Finance as a science too was still evolving.
“I used to look at the gross block for the past years to see if the company was building capacities to sustain growth, and then see if the price-earnings for the share were justified or not,” says Choksey, who started off as a partner in his family-owned M K Choksey & Company in 1961 after acquiring a commerce degree from Mumbai’s Poddar College.
It is the faith in fundamentals that helped Choksey and others survive stormy times and grow their businesses.
“I used to study during lean markets and sharpen my skills,” adds Choksey who still attends his office in Jeejeebhoy Tower. Being up-to-date is even more important today because very few companies are able to sustain businesses successfully for a length of time due to changes in the economic climate.
Even as unsuccessful companies perish, new companies are added to the list, increasing the choice for investors. Till the eighties, the number of securities traded was less than 400; the IPO boom of the early nineties took this number to around 4,000.
If it was fundamentals for some like Choksey, it was gambling for others. A leading operator in the seventies and eighties, Manu Manek ruled the market till Harshad Mehta came to the forefront.
“Manek was a legendary personality and a powerful operator who dictated the market,” says Choksi. Without his nod, it was impossible to become the director of a company. Apparently, on the day of election, he would send the name or list of directors to companies — and only those people ever got elected.
Though everybody appeared aware of this, no charges were ever levied against him. Omnipresent in the stock market, his favourite hunting ground was Indian Iron, which recently merged with SAIL.
Among leading operators in those times were San Bagh Chand for Scindia Steamship Navigator and Sumtilal Jamnalal for Century Mills. Harshad Mehta and Ketan Parekh came much later, in the early and late nineties.
One thing that has not changed though is rampant speculation. Ever since stock trading began some 180 years ago, speculation has been rampant and, after the introduction of badla, there would be speculation on speculation!
“Since positions could be carried forward under badla, members would come to know who is building positions in which counter. Speculators would then bet on the strength and weakness of the operator in the stock. In fact, a number of operators/brokers failed because they accumulated huge positions and finally could not exit from the stock,” remembers Choksey.
This was one of the factors the capital market watchdog was investigating during the Ketan Parekh-led scam in 2001, when Anand Rathi, the president of BSE, was charged with misusing his position to support a bear cartel allegedly formed by market operators Shankar Sharma and Nirmal Bang to bring down the bulls of the time. All three were eventually exonerated.
Choksey’s business values have not changed in the face of changes in the broking industry.
“It was a royal business with two hours of trading, and a lot of holidays — about 4-5 days for Diwali, a week or 10 days for Christmas, and holidays for festivals and state and central government holidays. Now, you’ve got to serve clients round the clock, all through the year, and even that’s not enough.”
INVESTMENT STRATEGY
The bulls are showing no signs of getting dizzy at the top. Stock specific or rather result specific approach needs to be adopted at this stage. Bears will hope that the bulls cave in after spending some time at the peak. Only a global meltdown could dampen sentiment at this stage.
While valuations may seem expensive, investors don’t seem to be in a hurry to book profits. With many more results awaited, a sudden collapse is always in the cards. We don’t want to sound pessimistic. Just reiterating caution at these levels. Expect alternate bouts of gains and pains in the week ahead.
TCS, Zee News, Petronet LNG, GDL, LIC Housing Finance, Cummins, Tata Tea, REL, IDBI, RNRL, Polaris, ACC, L&T, Tech Mahindra, Ranbaxy and Satyam Comp are among the major companies, which are expected to deliver their earnings in the coming week.
Liquidity seems to flow in with FIIs investing around Rs20bn (excluding Friday’s figures) in the cash segment.
Either stay put with fundamentally sound stocks or do your churning and exit counters which have run up too quickly, especially during the last couple of weeks.Weekly Stock Ideas
Buy HDFC (1988)
SL 1970 Target 2030, 2040
Buy R Com (555)
SL 547 Target 575, 580
Buy Bharat Forge (316)
SL 310 Target 328, 333
Buy Crompton Greaves (259)
SL 252 Target 273, 277
SL 313 Target 332, 336
Market Mood
Bulls fall in love with stocks!
I was just guessin', At numbers and figures,
Pullin' the puzzles apart Questions of science,
Science and progress, do not speak as loud as my heart.
Love is blind and the bulls seem to be closing their eyes on any concerns coming their way. The indices are at yet another high. The news flow this week has not been very encouraging. To begin with, Infosys cut guidance. Industrial production for May dipped. Bajaj Auto results disappointed and the coming quarter is again expected to be weak. Valuations, though being questioned, are taking a back seat temporarily. FIIs have lend support to the bulls. Higher metal prices on LME added to the positives.
Tech stocks remained lackluster while metals, Real Estate, Power and Construction stocks clocked gains. Hindalco, REL, L&T, BHEL and Tata Steel were among the major gainers guiding the Sensex above the 15,200 mark. Interestingly, the markets have been changing its leaders from time to time.
The major indices recorded their fifth weekly gain with benchmark Sensex adding 308 points or 2.06% to close at 15272 and NSE Nifty advancing by 120 points or 2.75% to close above 4500 mark at 4504.
Global indices too had a good run. Hang Seng Index closed above 23,000 for the first time. Shares also rose after Fitch Ratings upgraded Hong Kong's long-term foreign-currency debt rating to AA, the third-highest ranking, from AA-. The US markets managed to shrug off disappointing earnings forecasts from the retail sector, renewed concerns about the sub-prime mortgages and rising crude oil prices. Dow Jones recorded its biggest gain since 2003 on Thursday.
Metal stocks shone brightly on Dalal Street. Talks of consolidation in the global metal industry and firm metal prices contributed significantly to the rise in metal stocks. Takeovers in the metals industry and higher commodity prices have been driving up metal stocks in recent weeks. Alcoa led the gains in US Market after Rio Tinto's plan to buy Alcan spurred expectations of more takeovers. SAIL skyrocketed by over 23% during the week. JSW Steel was another performer of the week as the scrip rallied by over 15% to Rs721. Heavyweight Tata Steel was among the major gainers advancing over 11% to Rs692. Hindalco surged by 13% to close at Rs174.
Power stocks were in the limelight on back of increase in Government spending for electricity generation. REL led the charge among the power stocks after Anil Ambani, said he could raise Rs1 trillion to invest in his energy, telecommunications and finance group to tap opportunities in the world's second-fastest growing economy. Tata Power rose by nearly 4% to Rs685 and REL advanced by 13% to Rs675.
Capital Good stocks continued its strong uptrend trend as the index yet again rose over 2.2%. BHEL led the way as the scrip advanced over 8.5% to Rs1690, L&T gained 1.5% to Rs2400, Siemens surged nearly by 5% to Rs1,476 and Punj Lloyd added 3.5% to Rs277.
IT stocks continue to be laggard again this wining week loosing by over 1% in a historic day week for the markets. Infosys reported a consolidated net profit of Rs10.79bn for Q1 FY08 versus Rs11.44bn in the previous quarter. The company also missed its revenue guidance for the first quarter. The company says its FY08 revenues will grow by 17-18% year-on-year and earnings per share (EPS) by 13-14%. FY08 EPS is now seen a t Rs78-79. TCS was down by over 2% to Rs1136, IT Bellwether Infosys slipped 1.8% to Rs1935, Wipro was declined 1.3% to Rs512 and Financial Technology declined 1% to Rs2844. However, Satyam Computer gained 1% to Rs493.
Banking and Real Estate stocks advanced further on expectations that Government may not tinker with the interest rates in RBI meet later this month. DLF, the real estate major rose nearly by 5% to Rs600, IVRCL Infrastructure surged by over 8.5% to Rs423 and Akruti Nirman added 4.2% to Rs496.
Auto stocks gained momentum this week as the index was up by over 3% led by frontline stock Tata Motor as the scrip paced ahead by over 7.5% to Rs766, followed by M&M which gained over 4% to Rs821, Maruti advanced 3.5% to Rs825 and Ashok Leyland added 2% to Rs39.
Infosys... poor results, grim outlook
A 7% gain in the rupee since April knocked Rs2.76bn off Infosys' topline in the first quarter. Gross margins were down 390 basis points while EBITDA margins fell by 300 basis points. Overall volume growth stood at 6.9% while revenue growth was flat QoQ at Rs37.73bn (vs Rs37.72bn). PAT of Rs10.79bn was boosted by other income of Rs2.53bn (coming from forex gains and higher interest rates) and Rs510m of tax write-backs. EPS declined to Rs18.89 from Rs20.30 in the fourth quarter of FY07. Excluding this reversal, the EPS for the quarter would have been Rs18.
The company missed its revenue guidance for the first quarter. It had given Q1 revenue guidance of Rs38.96-39.13bn while reporting its full-year results in April. On the bottomline however, Infosys has surpassed its own EPS guidance of Rs17.84. Infosys cut its full year earnings and revenue guidance in rupee terms considering the sharp appreciation in the Indian currency vis-a-vis the dollar. At the same time, the IT giant marginally hiked its FY08 guidance in dollar terms.
"The sharp appreciation of the rupee against all major currencies impacted our operating margins during the quarter," said V. Balakrishnan, CFO, Infosys. "However, our robust and flexible operating and financial model enabled us to maintain our net margins while absorbing the impact of appreciating currency, higher wages and visa costs." Given the continuing strength in the rupee, the IT sector's misery is unlikely to end soon. Such has been the impact of the rupee that the sector has gone out of favour with most investors. Infosys and the software sector will continue to underperform the market as there is a likelihood of some more pain going forward.
Govt to bail out other exporters
The Government has thrown in a life jacket at the beleaguered exporters, especially the small and medium sized companies, to cushion them from the adverse impact of the sharp appreciation in the rupee this year. The Rs14bn package includes hike in both drawback and Duty Entitlement Passbook (DEPB) rates, besides cheaper pre-shipment and post-shipment loans to SMEs from banks. Commerce Minister Kamal Nath stated that the new DEPB rates are expected to help sustain the export growth. He expressed hope that the package would neutralise the adverse impact of rising rupee on exports.
DEPB rates have been enhanced by 3% for nine sectors i.e., textiles (including handloom), readymade garments, leather products, handicrafts, engineering products, processed agricultural products, marine products, sports goods and toys. For the rest of the items, DEPB rates have been enhanced by 2%. ECGC premium has been reduced by 10% of the existing premium rates. To clear all arrears of terminal excise duties and CST reimbursement, an amount of around Rs6bn has been released. The rates of duty drawback has been enhanced by around 10% to 40% of the existing rates. The rate of interest on pre and post-shipment credit has been reduced by 2%. Responding to requests from exporters, the Government has introduced some additional lines in the Drawback Schedule.
The higher rate of duty drawback would cost the exchequer Rs8bn in FY08, while the Government would bear another Rs6bn to provide a 2% subvention to banks for providing concessional credit to exporters in certain sectors. The subvention would be provided to the banks through the Reserve Bank of India (RBI). The central bank is being requested to issue a circular to the scheduled commercial banks in this respect.
Friday, July 13, 2007
Short Term Trading Calls
Buy Kirloskar Oil Engines with a stop loss of Rs 300 for target of Rs 590.
Buy Shaw Wallace with a stop loss of Rs 250 for target of Rs 370
Buy Unitech with a stop loss of Rs 542 for a short-term (3 months) target of Rs 625
Buy Natco Pharma with a stop loss of Rs 125 for a short-term (3 months) target of Rs 166.
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