Is it time you prepare for Sensex 24,000?
(May 6, 2015)
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In this issue:
» Sensex falls 700 points
» Are rental yields attractive in Asia?
» The Real Estate Bill gets stalled
» ...and more!
2014 was a great year for the Sensex as it rallied by around 30%. But 2015 has, so far, been a completely different story altogether. As we speak, the BSE Sensex has plunged around 700 points in intraday trade and fell below the 27,000 mark. But that is not all. The Sensex has largely remained flat in 2015 so far, but the volatility has been quite high. Several factors can be attributed to this; some of these being the rally in crude prices as well as fresh concerns over retrospective taxation. But the biggest factor according to us is the earnings of India Inc not catching up with the run up in stock prices.
So is this all? Or is there more correction around the corner? When the Modi government assumed office in May 2014, there was a lot of expectations riding on it. After being led by a largely ineffective UPA government, a lot was riding on the PM Narendra Modi introducing some much needed reforms that will take India's growth to the next level. This was the prime catalyst of the surge in the Indian stock markets. This meant that should the Modi government fail to deliver, prices were bound to correct.
The Modi government will complete one year in office in May 2015. The kind of reforms that were expected from the government has not taken off at the pace envisaged. Some key reforms such as the Real Estate Bill (calling for greater transparency in India's dubious real estate sector) has been deferred on the back of stiff resistance from the Opposition. The implementation of GST is also taking time. All of this points out that getting bills cleared can prove to be quite a herculean task for the government.
Does that mean that one should start writing off the Modi government? Certainly not, we believe. But the recent spate of correction does highlight some crucial points. The rally last year was largely based on expectations of reforms. But these reforms were never going to be implemented overnight. It was bound to be slow. This is something the Indian stock markets ignored in the general euphoria and most stock prices zoomed even though earnings of India Inc were yet to pick up. And the latter was largely due to things not really picking up on the ground; a fact that the management of many companies, during our interaction, pointed out.
So although we are not experts at pointing out where the Sensex will be headed next in the near term, the possibility of some more correction cannot be entirely ruled out.
Indeed, in an interview published in the Business Standard, this is what Marc Faber, author of 'The Gloom, Boom & Doom' report had to say, "The S&P BSE Sensex went till the 30,000 mark and we can now easily drop to 24,000 - 25,000 levels." Faber's view is that while some reforms have been implemented, the pace of reforms overall has been very slow.
Indeed, there have been many companies, whose price to earnings multiple has risen to beyond 40 times, which is quite unsustainable in our view. Moreover, we do not advocate just generally investing in Sensex based companies simply because it will do well in the longer run. The idea is to be stock specific and only invest in those companies where the earnings potential remains strong backed by a sound business model, good management and reasonable valuations. So, a further correction in the Sensex is something that we will certainly most welcome as it will just increase the chances of recommending some good quality stocks to investors.
Do you think that 2015 will see more correction in the Sensex? Let us know your comments or share your views in the Equitymaster Club.
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Whether the real estate sector is in a bubble phase or not was a question we had for the promoters of a well respected affordable real estate firm a few years ago. And the response we got was that whenever rental yields fall close to 2% levels, it would be safe to assume that things have heated up.
The Indian real estate sector has been going through troubled times for a while now. High prices have led to a massive inventory buildup, big enough to meet demand for as long as two years in some of the major Indian cities. To add to that, new launches continue to hit the markets. Demand has come down considering that the focus on affordable housing has been less, thereby making the properties way out of reach for the majority of the population. Not to mention that with other asset classes such as equities doing well, real estate as an investment destination has become less favoured as well.
Here's another indication as to how heated up things seem. Today's chart of the day indicates the rental yields across major Asian economies. And as you would have guessed it, yields in India are the lowest amongst the pack. We came across this story on Seekingalpha.com. But the data therein was referred to from an article put up on livemint.com earlier.
Are rental yields attractive in Asia?
The long term prospects of the Indian housing sector are favourable, no doubt - especially considering the major difference in supply and demand. However, with factors such as lack of transparency and the high prevalence of cash transactions (read black money) being the norm amongst most developers, a much needed correction in prices is only being delayed.
If the market forces were to take over, it would only lead to a sharp reduction in prices we believe; especially considering that funding new projects with inventory pile up is a situation that would be difficult to hold on for long.
In fact, here's another proof which was mentioned in the same article. The difference between rental yields and interest rates was provided for the same countries displayed in the chart. And the difference remained the highest in India - about 8% as compared to 0% for Malaysia and 2% for countries such as The Philippines, Thailand and Hong Kong, thereby indicating that investment in property by taking on debt is not feasible in India.
Continuing with our discussion on real estate, the BSE-Realty index was amongst the top losers today on news of the Real Estate (Amendment) Bill and the Constitution (122nd Amendment) (GST) Bill 2014 getting stalled by the Congress-led opposition in the Rajya Sabha. The real estate bill is now proposed to be sent to the select committee of the Rajya Sabha. The opposition, led by the Congress, has been opposing the amendments made by the NDA government, claiming that it goes against the interest of the buyers and as such is pro-developers.
Well... all we can say is that there is a high need of bringing about change in this space and hope that the government brings in the best practices and considers the best interests of the buyers. After all, to achieve the 'housing for all' target in less than a decade from now, positive changes would be much required to be brought in at the earliest; not to mention that implementation and execution of the same would take its own pace.
Sentiments in the Indian markets remained dull throughout that day. At the time of writing, the Sensex was trading lower by about 700 points or 2.5%. Weakness was seen in stocks across the board with engineering, realty and power stocks being the most affected. The midcap and smallcap indices fell by about 3% each today as well.
"Partly, it's habit. Partly, it's just that stocks mean business, and owning businesses is much more interesting than owning gold or farmland. Besides, stocks are probably still the best of all the poor alternatives in an era of inflation - at least they are if you buy in at appropriate prices." - Warren Buffett
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