Who is in the driver's seat of Sensex 20,000? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Who is in the driver's seat of Sensex 20,000? 

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In this issue:
» China's IPO market has dried up...
» Global forex market in a state of flux
» Will selling gold end the US' debt crisis?
» Wal-Mart push for the US economy
» ... and more!

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Even at 20,000 the benchmark BSE Sensex is nowhere close to its historical peak valuations of around 22 times earnings. The last time it came close to these valuations was in 2007 and 2010. But this time around a considerable rise in earnings growth shows an upside in valuations even at Sensex 20,000 levels. No wonder, global fund managers see 2013 being a fabulous year for emerging markets like India. But there cannot be anything riskier than considering these opinions to be all encompassing.

The Sensex' rise up to near 20,000 levels has been driven by just a handful of sectors. Prime amongst them being realty, FMCG, consumer durables, auto and healthcare. Now, one can argue that evergreen sectors like FMCG and healthcare tend to find favour when the going gets tough for the economy. But the earnings of realty and auto sectors are not just cyclical. They even react sharply to fall in economic buoyancy. The realty sector in particular also carries the burden of high leverage. This can be poison at a time when cash flows get strained. Anchoring to the possibility of lower interest rates fuelling demand can only take realty and auto sector valuations so far. In fact at price to earning (P/E) valuations in excess of 20 times, we believe investment in each of these sectors warrant caution. Nevertheless a careful look at long term fundamentals could help investors hunt bargains even in these sectors.

Data source: BSE

Note: The PE multiple for BSE Healthcare Index is steep due to the extraordinary losses incurred by Dr Reddy's and Sun Pharma which impacted the sector's trailing 12-month earnings.

Whether or not 2013 turns out to be a fantastic year for Indian stock markets, valuations will eventually run the course of reversal to the mean. Hence use 'margin of safety' to guide you in both directions. Not just in selecting 'what to buy' but also judging 'when to sell'.

How do you judge when to sell stocks in your portfolio? Share your comments with us or post your views on Facebook page / Google+ page

01:35  Chart of the day
One of the major concerns for Indian government is to cap fuel subsidies. After all, the same is a major contributor to India's fiscal deficit. But one look at global oil prices and consumption levels tells us that India is relatively better off. Not just in terms of prices but also per capita consumption levels. However, the only way to make more energy available for economic growth is to look for new sustainable resources. Something that the US has been successfully doing with shale gas.

Data source: RBI, JP Morgan presentation

Why does anyone invest in an asset? The answer as you rightly guessed is to earn returns. But what if you are unable to earn returns on your investment? Such is a dilemma being faced by private equity (PE) firms in China. The PE firms typically invest in private companies and look to cash in on their investments when the companies go public. And this strategy worked well till recently as China and Hong Kong were the epicenters for mega IPOs. But given the gloomy stock markets in China, IPO activity has almost dried up. As a result PE firms are finding it increasingly difficult to realize returns on their investments. The tougher part is that most of them are nearing their usual investment horizon of 5 to 7 year period. As a result they are getting all the more jittery as the date to return cash to their investors gets closer. However till IPO activity picks up again PE firms are left stranded. Unlike other countries China does not have secondary market for transactions that fall within the purview of mergers & acquisitions. This means that one PE firm cannot sell its stake in a company to another PE firm with ease. In the current environment the need to develop this market has become increasingly important. Till that happens PE firms do not have much choice but to sit and wait for IPO activity to pick up again.

Are these tremors a sign of a bigger earthquake to come? The finance portal businessinsider.com certainly seems to think so. Relax, we aren't talking geology here. But tremors of the financial kind. Apparently, volatility in the international foreign exchange market has been rising from its ultra low level. Indeed, it was clear from how fast the Japanese Yen fell. However, the oriental currency is not the only one to come under pressure. Swiss Franc, considered a safe haven until recently, has also lost some of its lustre. And the US dollar too is expected to follow suit.

So, what do these developments really mean? Does it mean that the capital is being reallocated? There is a belief that it certainly is and eventually, the allocation between bonds and equities will also become unstable. Right now, everyone seems to be on a money expanding spree and thus, this instability is not rising to the surface. What is in plain sight though is the fact that unlike the period between 2007 and 2012, a strong market this time has not been accompanied by a weak dollar. In fact, markets have been stronger even as the US dollar has inched higher. Thus, this breaking away from the past trend is certainly an indicator of something new to come. Time to brace ourselves perhaps.

The debt ceiling has again come to haunt the US. For those unaware of the term, the debt ceiling, as imposed by the Congress, refers to the debt level that the US can carry at any given time. While the Republicans have been opposing the idea of raising the debt ceiling yet again, the idea of having a trillion dollar platinum coin issued was doing the rounds. Fortunately, better sense seems to have prevailed and the idea has been rejected. So the next alternative appears to be selling the huge sovereign gold deposits. The US Treasury has about 261.5 million ounces of the yellow metal. At the current gold price, that could raise over US$ 440 bn. But even this idea has been dumped by the US Treasury Secretary Tim Geithner. Selling gold would appear like a fire sale. As per him, this would affect US' reputation and have adverse global implications.

It is worrying that the US policymakers are refusing to acknowledge the magnitude of the crisis that their economy is facing. If you are unable to service and repay your loan, what would you do? Sell some assets, maybe gold, and repay the loan right? But governments tend to take a different course. They make the debt cycle so vicious that they keep borrowing debt to service old debt.

But there are other reasons, too, why selling gold may not solve the US debt ceiling crisis. This is because the US government currently borrows about US$ 100 bn of debt every month. So selling the Treasury gold would cover up just over 4 months of the debt obligations. So it remains to be seen what new trick US policymakers come up with to further postpone the impending crisis.

Just like its peer India, instances of corruption have tainted the Chinese economy as well. And one need look no further than the banking sector for that. Indeed, the Chinese banking sector is largely dominated by state run banks. And now it has to deal with one more problem; too much cash. According to an article in the Financial Times, the Postal Savings Bank is one such example in the country. It is the nation's fifth-biggest bank by deposits. But it has lent out only a small part of that cash. Its loan-to-deposit ratio stands at less than 20%. This is in stark contrast to the Chinese industry-wide average of around 70%. There are other problems too. Typically the mandate of most of these state run banks is to lend for infrastructure. But with so much surplus, a lot of this cash is going towards financing deals which have no connection with the proposed mandate. Chinese banks had already come under fire earlier for lending indiscriminately to the property sector thereby leading to the creation of a bubble. Obviously, more will have to be done to clean up the financial system in this country.

More often than not it is the central banks that are responsible for rejuvenating an ailing economy. But in US it seems a retailer has taken a bid to do its bit as well. World's largest retailer Wal-Mart Stores Inc has decided to buy US$50 bn worth of US made goods for retailing. In the past, the retailing giant was criticized for selling too many goods from low cost countries like China. But now the focus has changed to domestic sourcing. The company has also decided to hire 100,000 people over the next five years at a time when the unemployment rate in US is close to 7.8%. Both these moves are likely to give a much needed boost to the US economy.

Selling something that is procured domestically adds to the nation's GDP. Also, sourcing from internal suppliers will reduce current account deficit. That's because imports would decline since a product that was being imported earlier is now sourced domestically. Secondly, hiring people from the US will reduce unemployment rate. It will in turn have an impact on consumption levels as well. It seems after the Fed's push, now we have a Wal-Mart push for the US economy. And if executed as planned it can produce desired results.

Profit booking in auto and commodity sectors kept the benchmark indices in Indian equity markets below the dotted line for most of the session today. The BSE Sensex was trading lower by around 86 points at the time of writing. Other major Asian markets too closed lower while markets in Europe opened flat to negative.

04:50  Today's Investing Mantra
"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." - Warren Buffett

  • Warren Buffett - The Value Investor
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    2 Responses to "Who is in the driver's seat of Sensex 20,000?"


    Jan 18, 2013

    On oil, the chart showing prices and consumption is incorrect - India is the 4-5th largest buyer of oil globally, and pump prices in India of petrol are 30% higher than US, and diesel prices ~ 3% lesser, as I see from weekly price data at eia - a US government website.

    Can you please verify?


    prakash k s

    Jan 17, 2013

    interesting to read the plans of walmart to employ local people, buy local produce, which very much looks similar to the swadeshi movement of INDIA,PRIOR TO INDEPENDENCE channelised by the efforts of GANDHIJI
    and the silent multitudes of men and women who started making khadi on the CHARKHA.hence, it is very prudent for every country to import technology,machinery and skilled manpower,produce locally avoiding importing finished goods.

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