Can this sector alone sustain Sensex rally? - The 5 Minute WrapUp by Equitymaster
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Can this sector alone sustain Sensex rally?

Jan 28, 2015

In this issue:
» Is doing business in India getting any better?
» Yuan moves up in the list of top currencies
» Green nod to stalled industrial projects
» ...and more!

'Priced for perfection!' This is how an article on Zerohedge describes the valuations of US stock markets. Can the same be said about India too? The valuations of benchmark Sensex are yet to touch the highs seen in 2007 and 2010. But that does not mean there aren't pockets that are over priced.

Well the fact that the growth in earnings of Indian companies is certainly not keeping up with the rise in valuations has been well underlined. We have written about the same several times. To add to that the intensity with which central banks in Europe, Japan and China are printing money is destined to keep cheap money flowing in. Therefore investors have some tough choices to make. On one hand they will have the lure of investing in companies that are certain to create wealth over the long term. On the other they need to stick to investing discipline and not buy the wrong stocks at frothy valuations.

Now, when everything in the stock markets seems too good to be true, it probably is! And here we cannot help but draw your attention to stocks from the financial sector. Mind you this is the third time we are highlighting the risks building up in valuations of financial sector stocks. In the last 30 days alone, we have highlighted how joining the revelers, bullish on banking and financial stocks can be fraught with risks! Also the fact that stocks from the financial sector are shouldering nearly a third of the Sensex market capitalization. The last time the sector had witnessed a similar kind of index weightage was back in early 2008. During the market crash that followed, the weightage had dropped down to below 20%. The reason we are pointing out these facts to you again and again is because we do not want you to get carried away with the stories of financial sector dominance in India's growth.

Make no mistake! We are not saying that the upside in Indian banks' and NBFC's fundamentals is limited. Nor is it that the key players will not make a meaningful contribution to India's GDP. But at current valuations, you would be buying the stocks when they are priced for perfection. In other words even a minor disappointment in terms of growth and asset quality can deal a heavy blow to valuations of these entities. Even here we do believe that a handful of companies will be able to deliver on both performance and shareholder wealth creation over the longer term. But the problem with buying stocks at very premium valuations is that the downside risks far outweigh the upside. Not to mention the fact that there are several less deserving entities that are just riding the tide of optimism. And whenever the tide turns, these very stocks could drag the key indices lower.

As per Business Standard, the 2,000 point rally that the Sensex has seen over the past 8 days has also seen financial sector stocks dominate over 50% of the gains. So it is time one should wonder if this single sector can sustain the Sensex rally. We certainly do not think so.

So if your portfolio is too overweight on financial sector stocks, it is time to rebalance the same. Looking for value in less popular yet fundamentally sound stocks could be a good way to hedge your portfolio risks.

Do you think the financial sector stocks alone can sustain Sensex rally? Let us know your comments or share your views in the Equitymaster Club.

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Now if one is to look for value buying opportunities elsewhere in an attempt to reduce exposure to financial sector stocks, what could be the options? Well, at Equitymaster, we do not advocate sector specific investing approach. For investing with a sector approach can unduly expose you to the risks to that particular sector. However, it seems that the manufacturing and infrastructure sectors that have been out of favour for years, could once again come into limelight. Thanks to lack of environmental clearances several new manufacturing and infra projects have been in the backlog for years. However, the Centre is now considering an increase in the validity of environmental clearance to seven years from five years. This extension may provide relief to several stalled projects. In addition the extension could also facilitate investments in these sectors. So companies that were out of favour due to stalled projects could see a turnaround in their fundamentals. And leading the pack could be some safe bluechips that are well placed to capitalize on the opportunity

  Chart of the day
Out of a total of 189 countries, India ranked 142 in terms of the 'Ease of doing business'; in the latest rankings released by the World Bank. It may be pointed out that India's ranking on the list was 131st in 2012. This report, which comes out annually, compares business regulations for domestic firms across the world. Some of the quantitative indicators used by the World Bank to base these rankings include the ease of starting a business, dealing with construction permits, access to electricity, property registration, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency.

Will doing business in India be easier in the future?

India ranks way below its BRIC peers in this list, thereby only giving an indication as to the amount of change and work that is needed to make the country an attractive investment destination - not only for foreign companies but even for local entrepreneurs.

It was only a few months ago when the government set a target of making India part of the top 50 list within a period of two years. While the task may be ambitious, the 'Make in India' campaign seems to have created quite a buzz across the world. All that needs to be done is focus on the improving the key pain points in this regard and things should improve at a substantial pace. As reported by business dailies earlier, some of the key aspects where India ranked poorly were the parameters of 'granting construction permits' and 'enforcing contracts'. However, some of the strong points include 'protecting minority investors' and 'ensuring credit'.

The success of the push towards manufacturing through the Make in India initiative will hardly be successful if India's business friendliness does not improve!

Seems like the Chinese government's efforts of making its local currency - the Yuan - a globally accepted one, is bearing fruit. This we say because the currency has overtaken the Canadian and Australian Dollars to rank fifth in the list of top currencies used to make global payments. The currency ranks behind the US Dollar, Euro, British Pound and the Japanese Yen. As reported by the Economic Times, the Chinese government has been easing controls on the currency and trying to push the acceptance of the currency abroad to reduce cost for traders and increase Chinese companies' participation in global economy. It is also believed that the central bank has signed agreement with a number of financial centers to clear Yuan transactions. The Yuan's share stood at 2.17% of the global payments in December 2014.

While there were reports about the possibility of the Chinese Yuan becoming the preferred global currency of the future, the fact that the American Dollar continues to dominate global currencies only indicates otherwise. Nevertheless, for a so called 'emerging market' nation to achieve this, does make this development a significant one.

In the meanwhile, the Indian stocks markets witnessed a volatile day of trade. At the time of writing the BSE Sensex was trading lower by about 120 points or 0.4%. Stocks from the metals and capital goods space were amongst the top under performers while consumer durables stocks were in favour today. Further, Asian stocks ended the on a mixed note while the European markets were trading firm at the time of writing.

 Today's investing mantra
"If the job has been correctly done when a common stock is purchased, the time to sell it is almost never." - Philip Fisher

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Devanshu Sampat.

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