Shift in balance?

Vishal Chhabria & Jitendra Kumar Gupta

While the markets have rallied substantially in the recent past, macroeconomic indicators and corporate earnings need to improve further for the rally to sustain.

After a forgettable 2008, a year which saw markets falling a whopping 52.4 per cent—it fell by another 15.4 per cent between January 1, 2009 and March 9, the day when the BSE Sensex reported its lowest close of 2009– the recent rally has brought some cheer. The BSE Sensex is up 38.83 per cent since the low on March 9 till date, reporting gains for seven weeks in a row. While the rally in Indian markets is led by various factors including robust inflow of foreign (FII) money and surge in global markets, there are a few key questions that need to be answered.

It is all the more important given that fundamental indicators have not improved meaningfully and there are visible risks ahead. The Street, too, looks divided on the future course of the market as well as earnings outlook for India. Among other key questions are whether the current rally signifies a beginning of a new bull phase or it is just a part of the bear-market, is the worst over and what investing strategies one should adopt. The answers are all the more tricky. The Smart Investor spoke to a host of experts, both domestic and foreign, on what they read into the current rally and the way ahead. To know more, read on.

On high octane
The rally has been substantial and swift. The 30-share BSE Sensex has risen by 33.5 per cent in just six weeks (from March 9 till April 21) and another 2.84 per cent over the next week, taking total gains to nearly 39 per cent over seven weeks. This performance is the second best among key global markets (Click for table How markets compare). Interestingly, all the 15 popular global markets have reported gains, with eight of them up between 20 and 30 per cent during the six weeks. Thus by far, the domestic market rally is driven by and reflects improved global sentiments.

In other words, it also suggests that even as India is economically dependent (by about 85 per cent) on domestic consumption in terms of GDP growth, its financial markets to a large extent are influenced by global sentiments. Additional proof: FIIs have invested $1.08 billion (since April 1) or $1.4 billion (since March 9) till April 21—domestic institutions have pumped in about Rs 750 crore – as compared to $1.65 billion of sales between January 1, 2009 and March 9. The case is not significantly different for others markets.

This change in global sentiment is led by positive news flow in the recent past including the new Geithner plan (in US), the G-20 meet (committing a $1 trillion boost), US President Barack Obama talking about things getting better, the stimulus packages and monetary measures undertaken earlier by various governments and central banks.

Additionally, says Raamdeo Agrawal, MD, Motilal Oswal Securities, “With Q1 results of Citibank and some others in the US somewhat better, there is a hope that the worst is over in the US itself. The combination of these events and the purchase by FIIs is what has changed sentiment. Lack of fresh negatives and some positive developments led to the US rally, which world markets tagged on to. Because, in synchronised market place, relative valuations do come into play.”

Nilesh Shah, CIO, ICICI Prudential Mutual Fund says, “The Indian markets were beaten the most and today, we are seeing that we are recovering fast as well.” In India, too, figures from sectors like auto, cement and steel have shown some improvement in recent months. And, at lower levels, the valuation of the Indian market was also compelling with the BSE Sensex as well as many companies trading in single-digit PEs.

However, some believe that there are technical and others factors that have led to this rally. Says Andrew Holland, CEO-equities, Ambit Capital, “Initially, I think it was short-covering; globally as well. The risk appetite has increased a bit, but it is like if people see markets go up they need to get performance so they put money to work as quickly as possible. I don’t see the retail investors rushing back to buy.” He adds, “There are funds sitting on cash, and some of this is flowing into the market.”

Bulls, bears or in-between?
Even as this rally has brought some cheer, there is a difference of opinion regarding its sustainability and future course. While a few term the current rally as the beginning of a new bull market, others are sceptical and believe that markets may decline and test their lows made earlier. Some others feel that markets are in consolidation phase.(Click for Expert Views)

Says Anthony Bolton, president-Investments, Fidelity International, “I believe that a new bull market has started and will last several years, although the exact trajectory is very difficult to predict. There is lots of cash on the sidelines. Once people feel left out and deploy it, we could see a big up move.” On the economic recovery, although some of the forward economic indicators are improving as compared to last year, he does not expect a fast recovery.

On the flip side viz. a few believe that we are still in a bear phase. Says Andrew Holland, “We are by no means in a bull market.” The reason for believing so is that the demand scenario may remain weak and the recovery is likely to be prolonged. He says, “The consumer savings rate in the US is now going up to 4 per cent from negative 2 per cent. Almost 70 per cent of the US GDP is consumer spending. If they started to save, then the recovery is going to prolong. I am expecting data and earnings to get worse and therefore we go back to where we were, which is in a deep recession.” Little wonder that Holland expects the markets to come down again.

Naval Bir, CIO, IDFC Mutual Fund, believes that we are in between. “At this point in time we are in the consolidation phase where the markets are expected to be range bound and hence, we will witness corrections and recoveries from the low levels for some time.”

What next?
While experts share divergent views, the opinion is not majorly different on the fact that the pain has lessened as compared to 4-6 months back. Many also believe that there are signs of the some stability in economic indicators. Says Hemendra Aran, CEO, Aranca, “Confidence levels in economic rebound that can put markets on a growth path seem to be returning slowly. Like in March 2009, the growth in jobless claims slowed to 14,800 after surging to 59,800 in the previous month. Even the consumer expectation index in US rose to 53.5 in March from 50.5 in February, clearly indicating that consumers' outlook on the nation’s economy has improved in March.”

And, this is what the markets have reacted to – anticipating an economic recovery in advance. But, if markets have to recover in any meaningful manner, globally as well as in India, economic growth and corporate earnings have to improve visibly. While India Inc earnings were in bad shape in Q3 FY09 (net profit of Sensex companies fell by 5 per cent), Q4 expectations are even worse with earnings expected to fall by 9-15 per cent year-on-year. Positively, some believe that the trend of decline in earnings should reverse or at least show signs of stabilising post-Q1 FY10. While Raamdeo Agrawal believes that the phase, wherein downgrades for FY10 were continuously happening, seems to be over, Bala Subramanian, CIO, Birla Sun Life Mutual Fund, believes that earnings are stabilising.

In March 2008, analysts were projecting the BSE Sensex earnings for FY10 at about Rs 1,200, which was later downgraded to Rs 800-850 due to the economic conditions deteriorating. Most analysts believe that earnings could now range a bit higher at Rs 850-870. Should this prove true, it will provide a cushion to markets on the downside, making valuations further attractive at lower levels.There is a flip side here too. Andrew Holland believes that earnings will have to be downgraded, and expects Sensex FY10 EPS to be Rs 750.

While the good news is that monsoons are expected to be near normal, the biggest near-term risk is the outcome of national elections. Foreign investors, too, will be closely watching this event given its implications for reforms and policies. Thus, the belief that before and a month after the elections, the markets will be volatile.

What should investors do?
Amid the expectations of volatility and range bound markets, experts believe that this is the right time to build a good long-term portfolio. The ultimate advice to nail into one’s head is whether you make money. Explains Marc Faber, “Whether it is a bear market rally or bull market, it is an academic question. Assuming the Sensex rallies to 16,000 and then falls to 7,500 levels, this would have been a bear market rally, but one that produces a 100 per cent gain. What counts is to make money.” On how global markets are likely to move, Faber says that following a rally until April we would have a correction. This would be followed by renewed strength until July and then weakness again, but the March 6 lows on the S&P 500 at 666 may hold. He believes that for the next few months India should continue to trade up, but interrupted by corrections.

So, if the markets are to go up, then there is a lot to be made. Notably, the Indian market is the second best in terms of growth, next only to China, which provides comfort given that 11 of the 15 markets (mentioned in the table) are expected to report a decline in their GDP growth in CY2009.

On the flip side, an unfavourable outcome in domestic elections may prevent the markets from rising, if not fall, should global markets look up. In the context of the current situation, taking a call on investing may look all the more tricky. What is compelling now, says Gul Teckchandani, investment consultant, “You are getting the price advantage. But, buy with at least a one-year perspective.” He adds, “Apart from the basic checks (management, track record, earnings growth), one can buy stocks with PE with 3-4 in the B-group and 7-8 PE in A-group. Avoid businesses that you don’t understand and ones from export-oriented sectors (excluding IT) where there is a slowdown.”

Among the most common advice by experts, for investors who are already invested and aim to make use of the expected near-term volatility, is to book profits on sharp rallies and hold some cash in the portfolio to take the advantage of the expected volatility. Using the cash to invest on dips (particularly during elections) in a phased manner is also advised. Investors can look at the companies, which are relatively stable and are leaders in their respective segments. Stick to domestic-consumption led stories.

Regarding the sectors and themes that could reap good returns are FMCG, telecom and pharma besides, interest rates sensitive like banking and auto. Selectively investing in infrastructure-related companies (less leveraged and well-diversified) is seen as a good strategy, as irrespective of which party forms the government, infrastructure development will remain a focus area. But, avoid cyclicals and real estate.

source :business-standard