Sensex hits fresh highs: Time to focus on microcaps? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Sensex hits fresh highs: Time to focus on microcaps? 

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In this issue:
» Tough times ahead for real estate?
» Too soon to cheer fall in CAD
» Foreign investors prefer India over China
» Time to invest in gold?
» ...and more!

BSE-Sensex is in news once again for hitting fresh highs. Even BSE Mid Cap stocks seem to be joining the rally. Narrowing current account deficit, strengthening rupee and inflow of FII money have fuelled the Sensex. But is this rally sustainable?

There is nothing in the economy that suggests an improvement in the investment cycle. While inflation levels have eased, it is mainly on account of easing food prices, something that is subject to high volatility. Structural and cyclical issues still persist and inflation concerns are far from over. As such, consumption is likely to stay under pressure. With elections trammelling key policy implementations and announcements, the regulatory scenario is unlikely to improve either. In short, we believe that there is a significant dichotomy between fundamentals of Indian economy and recent index movements. This has made large cap rally highly vulnerable to a plethora of factors such as adverse outcome of elections, likely delays in key reforms and outflow of hot money.

So what should investors do in such a volatile scenario? We believe it is time to go for bottom up approach. Investors should place their bets only on companies that have strong fundamentals and are available at reasonable valuations. And microcap is the space where such value buys are likely to be found. Unlike Sensex that seems to have broken all barriers, the BSE Small cap index still trading at 49% discount to the highs seen in January 2008. To some extent, the caution is justified. This is because the BSE Small Cap stocks are inherently more risky. The risks range from low liquidity, limited track record, higher borrowing costs, weak corporate governance, less transparency and less resilience to weak economic cycles as compared to their large cap companies.

However, there are stocks within this space that have been unfairly penalized because of over simplification of such risks. There are companies that score well on parameters like management quality, balance sheet quality and growth prospects. However being in the small cap space that investors have been shying away from; such companies are less tracked and are available at attractive valuations. With strong fundamental analysis and risk filters, investors have the opportunity to make stellar returns with such companies within the microcap space.

Over the long term, such small cap stocks with robust business fundamentals and strong management support are likely to yield attractive returns. That said, investors would do well not to put all their eggs in a single basket and stick to the asset allocation in a way to optimize returns without exposing themselves to unreasonable risks.

To conclude, instead of getting carried away by the Sensex rally which might be driven by speculations regarding elections outcome and hot money, investors should turn attention to smallcap space for potential winners in the long run.

Do you think investing in the microcap space in current times offers good options to pick value buys? If yes, then go ahead and read full details about this "niche" strategy that has the potential to help you select a series of winning microcap stock picks.

01:50  Chart of the day
High interest rates and sky rocketing prices have been a primary reason for slowdown in the real estate sector. Bureaucratic delays which create artificial scarcity have been an equal culprit. Such a prolonged era of unaffordable prices has now started impacting the volumes of most real estate companies. As per a study conducted by Knight Frank, sales volumes of India's top real estate companies have almost halved over the last 8 quarters. As can be seen in today's chart the sales volumes in 3QFY14 showed the biggest fall of about 43% YoY. Also, the volumes have declined consecutively over the last 4 quarters.

These are ominous signs for the industry. Until now the real estate developers held on to the prices as the demand was intact. In fact, some developers even sat on huge inventories. They refused to lower prices believing that intermediate slumps were temporary in nature. However, a secular decline in volumes for five consecutive months is an indication that affordability has become an issue for most people. If prices refuse to correct volumes can decline further. Perhaps, such a correction may bring some sanity into the market.

Real estate sector facing slump in volumes

Last year India faced some serious challenges on the current account front. The Indian rupee got severely hammered. In response to these adverse developments, Indian policymakers pulled the plug on rising gold imports. Since then, gold imports have fallen sharply and exports have witnessed an upward trend. In recent months, foreign institutional investors have been pumping money into the stock markets on the back of expectations of change in leadership post the general elections. This has augured well for India's current account deficit. However, it would still be too premature to raise the toast. Risks of high inflation still persist. Secondly, any unfavourable electoral outcomes or global shocks could spook foreign institutional investors (FIIs) and result in a mass exodus. As such, Indian policymakers should take the current stability in the current account as an opportunity to initiate structural reforms that would fix the current account problem in the longer run.

Gold fared quite badly in 2013 as the announcement of taper by Fed and the rally in the stocks gave the impression that the US economy was on the mend. But we are already into 3 months of 2014 and the story for the precious metal has taken a U-turn. Indeed, gold has witnessed a rise in prices from around US$ 1,200 an ounce on January 1 2014 to US$ 1,300 an ounce on March 27, 2014. One of the major reasons for this has been the increasing prevalence of geopolitical risks namely the Ukraine crisis. History has also proven the same thing. Thus, gold rallied after the 9/11 terror attacks as well as after the US invasion of Iraq. As reported by the International Business Times, tensions between China and Japan over control of the Senkaku islands could also escalate over the next two years. Not just that, US recovery if any has still been very fragile. Thus, even if the Fed is gradually tapering QE now, should the economic scenario take a turn for the worse, it will not be surprising if the Fed resorts to expanding its monetary base once again. All in all, geopolitical risks as well as loose monetary policies by central bankers make the case stronger to have gold as part of one's overall investment portfolio.

India may not have given a tough fight to the Chinese dragon when it comes to economic growth. But global portfolio managers do consider India as a good alternative to China going forward. At least this is the sense that a Director at Deutsche Asset and Wealth Management gave recently. He is hopeful that India would get a stable and a strong government post the elections. And therefore as a consequence, reforms will also be speeded up. He also cited elections as one of the reasons behind why inflows have been slightly tepid so far this year. Another reason of course is the US Fed tapering which could cause short term jitters in emerging markets. This could then lead to better entry points from a long term perspective as per the manager. This goes to show that tapering or no tapering, foreign investors do seem to be positive on the country's long term prospects. And this is certainly comforting to know as it is this class of investors that have been the key drivers of the Indian markets in the past.

Election hopes may have taken the sentiments in Indian stock markets to new highs. But that does not make the economy any less vulnerable to global uncertainties. Key amongst them is the Fed's decision to raise interest rates. While it may seem some time away, any tightening in global liquidity is certain to hurt Indian stock markets. Moreover, the currency stability that India has witnessed over the past month or so may not be here to stay. The sharp decline in the current account deficit is the most important reason why the rupee stabilized. As per Business Standard, a lot of funds have come into India in recent weeks in the hope of a business friendly government. This money will flow out just as quickly if that hope does not materialize. To top that a tighter global liquidity situation could only exacerbate India's currency volatility and deficit woes. So while the going is good, it would only be wise on the RBI's part to shore up the forex reserves. The reserve kitty could act as insurance for difficult times ahead.

In the meanwhile, Indian stock markets pared early gains but continued to remain buoyant. At the time of writing, the benchmark BSE-Sensex was up 39 points (+0.2%). Realty and power stocks were the biggest gainers whereas FMCG and capital goods stocks were the only losers. Majority of the Asian stock markets were trading positive led by Hong Kong and Indonesia. Only China and Taiwan markets were trading weak. Most of the European indices have opened the day on a positive note

04:50  Today's investing mantra
"Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it." - Peter Lynch
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