You can definitely expect these in 2011

Jan 1, 2011

In this issue:
» What will the PE multiples look like in 2011?
» Should you buy stocks or gold in 2011?
» Where are the oil prices headed?
» The sectors that could outperform in 2011
» ...and more!!

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India Inc. basked in the glory of higher profit margins in 2009 and early 2010. With the crisis showing no signs of easing off, the pessimism spilled over to commodity prices as well which tanked considerably. Indian companies did not complain as raw material costs dipped and profits surged. But one was always doubtful whether such robust margin expansion could be sustained. And that it was only a matter of time before input costs would spike up again.

We fear that this is exactly what can unfold in 2011.

Commodity prices have surged in recent times. Industrial commodities like oil, copper, steel and the like have all seen a rise in prices. This has not only been due to increased demand for these commodities especially from the emerging markets but also due to investors pouring money into the same in their quest for better returns. And we believe that commodity prices will continue to remain firm in 2011 as well. To add to that interest costs in India will not come down anytime soon. On the contrary, these may be seen inching upwards. This means that India Inc. will have to brace itself for higher costs and consequent shrinkage in profits.

What will these mean for the PE multiples? The current net profit margin of top 600 companies is close to the highest in 12 quarters. With very little upside in net profit margins, the PE multiple of India Inc. is bound to look more expensive. So will FIIs keep piling into Indian equities at the same rate as before? We don't think so. Investors could thus do well to remain cautious to that extent.

Amongst high commodity prices, rising interest rates and FII outflows, which do you think will be the biggest risk to Indian stock markets in 2011? Share your views with us or post them on our Facebook page.

Data source: Equitymaster
*Net profit margins of 600 companies forming part of Equitymaster database

 Chart of the day
One of the most important things to look at for 2011 is where to invest. Should one choose stocks or go for commodities, especially precious metals?

Today's chart of the day presents how each of these assets have performed over the past 5 years. While stocks have gone up significantly, the precious metals - gold and silver - have massively outperformed them. However, the question is - will silver and gold continue to outperform stocks? Well they have proven themselves to be safer havens over time. And this has attracted investors who have poured money into them and most likely will continue to do for some time to come.

But a word of caution here! Gold unlike other investments acts as an insurance policy. Like a home insurance policy that protects us against any loss on our homes, gold protects our nest egg against inflation. Given that the world over, central banks are hell bent on debasing their currencies, they are just laying the ground for high inflation in the future. However, you need to be careful to not have an over exposure to this insurance.

Data source: Kitco, US Energy Association, Prowess

Amidst all the noise surrounding the surge in gold and silver prices in 2010, one commodity that saw less media coverage was crude oil. And this was despite the fact that its prices were also on a gradual rise throughout the year. In fact, crude oil prices rose 18% in 2010, and are up a whopping 175% since their lows of early 2009. We believe the oil prices will continue to rise in 2011 as well, propelled by improving global economic scenario and therefore rising demand for the commodity. Pessimistic as we may sound, this would be a dampener for India's current account deficit that is already high at around 4%. A higher current account deficit and most short term money (FII inflows) to fund it could act like a double whammy for the Indian economy.

Recovery or no economic recovery, there is one unit that is likely to run out of capacity in the US in 2011. We are referring to the US mint.

Even after several rounds of cheap money (fondly called QE by the US Fed) finding its way into the economy, Ben Bernanke's job is far from done. In his attempt to find employment for the Americans the central banker will get his currency printing machines to work overtime. Rest assured the credit rating agencies will still put the 'AAA' stamp on US government issues. And the US dollar will still find buyers in China. The cheap money may not create jobs in America. But what the incessant rounds of QEs will do is wreck havoc with the prices of good assets in emerging markets. From mines in Brazil to houses in China to stocks in India - everything will get ridiculously overpriced. And we fear that saner central banks in Asia will lose all their time in firefighting Bernanke's ill sensed QEs instead of concentrating on policy making.

The Sensex didn't perform as well in 2010 as it did in 2009. Nevertheless, it did give inflation beating returns and hence, an investment in it at the start of the year would have certainly increased one's wealth in real terms by the end of the year. However, at current valuations, quite a few bets would be off the table we believe. The same is true for most of the sectoral indices as well. Especially the ones that are the most expensive like the capital goods index, the FMCG index and the auto index.

With P/E for each of these indices close to the 20x-30x mark, they will indeed need strong earnings growth to avoid a steep correction. But the same may not be easy. At least two of the sectors, viz. auto and FMCG rely a lot on cheap raw materials to boost their profits and thus, in an environment where commodities may continue to rule higher, robust growth in earnings may not really transpire. In view of this, some of the most expensive sectors may well see their multiples shrinking as they go through the year 2011. In the same breath, it is quite possible that some of the underperforming sectors of 2010 like metals and power outperform the rest. After all, reversion to the mean is the iron rule of financial markets.

The RBI was completely on the offense in 2010. To achieve its March 2011 target of 6% inflation, key interest rates were hiked several times. It was the most aggressive central bank in Asia last year. And, its hawkish approach is expected to continue through 2011 as well.

You don't need a crystal ball to tell you that. With headline inflation far from being under control and food prices spiraling upwards every day, we can definitely see more rate hikes in the coming year. In a similar vein, India is still in a negative real interest rate scenario. The current inflation rate is higher than the cost of borrowing. This encourages speculation in assets as you can basically borrow for free. But, for savers it's a different story. You are losing the real value of your savings by placing it in a bank deposit. This fact is reflected in deposit growth grossly lagging credit growth in India currently. Well, the only way out of this mess is for inflation to slow down. We sincerely hope that the RBI meets its inflation targets in 2011. It needs to bring out its arsenal of monetary tightening tools. Maybe then we shall see more rational valuations for property and stocks.

The past week was a mixed one for global stock markets. While most of the world's markets ended the week in the green, all markets in Europe closed the week in the red. Expectations of improved corporate earnings in the developed markets offset concerns over sovereign debt crisis in the Europe and China's anti-inflation measures. The biggest gainer of the week was India (up 2.2%) while the biggest loser was France (down 2.5%). The BSE-Sensex gained 2.2% during the week and rounded off 2010 with gains of 17% for the whole year. In Asia barring China (down 1%) all markets closed in the positive territory. In Europe, UK and Germany were down 1.8% and 2% respectively, while the US closed the week with a marginal gain.

Data source: Kitco, Yahoo Finance

 Weekend investing mantra
"We will open the book. Its pages are blank. We are going to put words on them ourselves. The book is called Opportunity and its first chapter is New Year's Day." - Edith Pierce

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11 Responses to "You can definitely expect these in 2011"


Jan 14, 2011

Best MANTRA for 2011 will be to sell GOLD and by EQUITY.Temporary phenomena will not affect long term investors.


Tamal Dasgupta

Jan 4, 2011

i remain positive on the Indian stock market inspite of the obvious problems that all point out...especially high P/E. AND I REFUSE TO PUT MONEY IN FDs with pathetic WHEN INFLATION IS 10%+....would rather risk it.

I think the biggest risk of the Indian market are the rumour mongers who like sleazeballs are always looking for opportunities to short. ICICI and LICHF are great examples of stories blown out of all proportion. So was IPL, Dubai, Greece and Ireland. And now Citibank.

Also we suddenly have become VERY holy and are trying to rate India as corrupt. Please.....whatever has happened thus far has happened within the VERY corrupt framework.




Jan 2, 2011



Anupam Garg

Jan 2, 2011

If i am not mistaken, u guys put a lotta stress on the influence of FII inflows in the performance of markets, at least in 1 newsletter per week.

Canging interest rates may have a direct impact only on banking sector, reversal in commodity prices is on the cards, perhaps tomorrow if not today

the only worry seems 2 b the impatient FIIs who may lose interest if other countries' markets start performing well


s madhusudhana reddy

Jan 2, 2011

commodity prices


Mahesh Singla

Jan 2, 2011



chalapathi rao m s v

Jan 1, 2011

1. Poor corporate governance which leads to financial instability.
2. political instability
3. Higher expenditure resulting in less profits for corporate sector.
4. Correction in the indian equities.


S.R. Jagganmohan

Jan 1, 2011

FII inflow was the main influence in raising Sensex levels so far. The reverse, FII outflow, will be the main risk factor to lower the Sensex levels in 2011.


Atul Saboo

Jan 1, 2011

During 2011 I view, rising commodity prices would dampen the equity market growth. As factors like bank rates and FII inflow depend on inflation and earnings of companies respectively.


Gopal Chalam

Jan 1, 2011

Should be be dependent on FII investment?

If the retail Indian investor enters the market, there should be proper balance between risk and returns

This is unfortunately being lost sight of by most persons

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