Stock Market Analysis

Stock markets have rebounded to make new highs and are likely to continue rising over the long-term. A report.

Arun Kumar, a regular stock market investor, is making substantial gains on his existing equity investments. With the Sensex crossing a record high of 17,000 points, he is both glad as well as worried.

He questions as to how high the markets can go from the current levels. He also wonders with caution whether the market can keep jumping from such higher levels. If the answer is 'yes', then what factors will help the bulls have their grip over the market.

India is now increasingly interlinked with the global economy, which has been grappling with challenges like credit or liquidity crunch following the subprime crisis, weakening dollar, galloping rise in crude oil prices and fears of global economic slowdown especially in the US.

Among the domestic factors, there are uncertainties over interest rates and elections likely next year. Thus, Kumar is perplexed as to whether this is the time to hold on to his portfolio and add more scrips (most of them have gained 30 per cent on an average) or sell off now only to enter at lower levels at every dip?

Like Kumar, many other investors are wondering what to do. Their questions are: Where are the markets headed? How much steam is left? Is a correction overdue? If yes, then how much will the markets slide? Will factors like rising money inflows, inflation, appreciating rupee and economic slowdown in the developed markets derail India's scorching growth?

The Smart Investor helps you answer these questions with the help of market experts and economists.

Rapid fire round
Investors, the world over, gave a euphoric welcome to the 50 basis point cut in interest rates by the US Federal Reserve in response to the credit crunch and interpreted it as a proactive step towards avoiding a recession.

However, the party was merrier for the emerging markets like Hong Kong, India and Brazil, as these markets gained more than the developed markets on account of strong comeback of foreign institutional investors' money.

India, one of the key emerging markets in Asia, has seen FIIs pumping in $2140.8 million in seven days ending September 26.

Starting the week at 16,845 (after crossing 16,000 and gaining 1,000 points only in the week before last), the Sensex zipped past another threshold of 17,000 and gained another 1,000 points within just six trading sessions.

Says Manish Sonthalia, vice president, equity strategy, Motilal Oswal, "The US Federal Reserve has ensured through the rate cut that enough liquidity is available. As liquidity chases growth, which is there in Asia, equity markets in India, one of the fastest growing economies in the world, have also rallied."

Adds Ketan Karani, vice president, research, Kotak Securities, "Asian markets especially China and India have been re-rated after the Fed rate cut, which has resulted in a shift in investments among various global asset classes."

Sandip Sabharwal, chief investment officer, JM Financial Mutual Fund, has yet another reason. Says he, "Indian economy and corporate profits have exhibited robust growth even during challenging times of rising interest rate cycle which started from 2003 onwards."

What's next?
The Sensex currently trades at a trailing twelve month price to earnings multiple of over 20 times. This is still cheaper than its closest comparable peer China, which is trading at double the valuations at 48 times.

The Sensex trades at about 19.5 times and 16.5 times for FY08 and FY09 estimated earnings. Though market experts are cautious over the medium term, they believe that the long-term trend of the Indian markets is that of a secular bull run.

Says Balakrishnan Kunnambath, managing director - Indian Subcontinent, SG Private Banking (Asia Pacific), "Strong liquidity will continue to chase risky assets and drive valuations beyond fundamental fair valuations. We are cautious on the overall market as valuations are in the expensive zone and growth is tapering off."

So is a correction underway? "We expect a correction in the short-term as sectors hit by rupee and interest rates have significant weightage in the index. However Sensex has support at 13500-14500 levels for the current year," says Harendra Kumar, head of research, ICICI Direct.

Even Sonthalia feels that the markets should consolidate and be range bound in the short term.

Sandeep Sabharwal, while agreeing to it goes on to add that it could oscillate 3-4 per cent on the either side. However, long term investors should not pay much heed to the short term gyrations.

Speed-breakers ahead
Market experts believe that the party will last for a few more years. However, this doesn’t mean that the road will be smooth and free of difficult times having reached such high levels. India will have to battle some storms in the medium term.

The appreciating rupee, high oil prices, fears of US economic slowdown, and tapering growth in industrial production and corporate earnings still remain major risks.

However, market experts are unperturbed. Says a much enthused Karani, "Since India is a net importer, the appreciating rupee will be positive." Further, the risk of weakening dollar and US slowdown is limited to sectors like IT and textiles, adds Sabharwal.

High oil prices also pose a limited risk because even if crude oil price have risen more than 30 per cent since the beginning of the year, rupee (the best performing Asian currency in 2007) has also appreciated by 10-11 per cent.

Moreover, corporate earnings growth is also likely to be healthy at 15-20 per cent on a higher base except some sectors like IT, sugar and pharma.

However, some players feel that it is better to watch for August and September data for a better picture as the growth in index of industrial production has slowed down in the recent past.

Softer interest rates-a succour
Among all the factors, market players are watching interest rates keenly. Will Y V Reddy follow Bernanke's lead of reduction of interest rates?

Market participants feel that interest rates could soften going forward. However, economists differ. They don’t expect RBI to follow the footsteps of US Federal Reserve at least in the medium term.

Says D K Joshi, director and principal economist, Crisil, "I do not see RBI signalling interest rate reduction soon as high global crude prices remain a critical risk to domestic inflation. However if inflation remains at the current low levels and GDP growth slows down as expected by us, then we might see a reduction in rates later this year."

Rupa Rege, chief economist, Bank of Baroda, agrees that interest rates are likely to be stable for the time being; however with an upward bias in the second half on account of accelerated money inflows, rising inflation and good demand for loans from agriculture and infrastructure sector.

However, an analyst alleviates fears by saying that Indian corporates are insulated as they are relatively quite underleveraged with a comfortable debt-equity ratio. But continued money inflows remain a risk as it could stoke inflation again.

Strategies to adopt
Investors need to brace up for bouts of volatility due to factors like profit booking at higher levels, uncertainty over interest rates and elections next calendar year among others. Moreover, experts advise investors to whittle down returns expectations.

The trick could be to pick and choose stocks and still make decent gains as the rally hasn’t been broad-based. A better strategy would be to remain invested in sectors or stocks led by domestic growth and accumulate at every dip.

FIIs are attracted to India as the growth is largely driven by domestic consumption and thus are relatively immune to global shocks.

Thus, market experts as well fund managers are most positive on domestic growth stories like banks, infrastructure, power, capital goods, cement, metals and to some extent select media and telecom companies.

India provides huge business potential whether it is for building infrastructure like power, roads, ports and airports (which will require cement and metals) or changing demographics with substantial share of younger population boosting demand for autos, consumer durables, property and retail.

All this requires capital which is partly met by banks and financial services.

JM’s Sabharwal and Motilal Oswal’s Sonthalia are also positive on interest rate sensitive sectors like auto (except two-wheelers), real estate besides banks and financial services. This is because India has to maintain a benign interest rate scenario to keep the growth running.

But investors should be cautious on sectors like textiles, information technology, sugar, pharma and two-wheelers as they are going through a rough phase and various challenges and uncertainties.

But some analysts don’t mind taking a contrarian call on IT stocks as they are available at cheap valuations. Large-caps are going to be the market's favourite due to better liquidity.

Via BS