Investing based on reform hopes? Oil stocks set expectations right - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Investing based on reform hopes? Oil stocks set expectations right 

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In this issue:
» Job creation remains a key challenges for the Government
» Time to focus on coal and power sector reforms
» RBI stresses on supply side constraints
» SEBI to tighten regulations for equity research analysts
» ...and more!

Yesterday brought with it a harsh reality check for Indian oil and gas sector, and for the stock investors in India. The stocks in the oil and gas sector saw a major correction as a decision on gas price hike was put off for three months.

As far as the reasons for deferral are concerned, such as increase in rates of fertilizer, electricity, piped cooking gas and CNG, these will be the unavoidable impacts, whenever the gas prices are hiked. With any reform or economic decision, there are bound to be certain undesirable outcomes. A recent example of this is hike in the import duty on raw sugar. The same has added to the inflationary pressure for common man. It is because of these side effects that the strategic economic decisions have been kept on hold over the years in the past, leading to the current mess in the economy.

With Modi Government coming to power, hopes are high on reforms and economic recovery. Such is the frenzy that markets seem to be totally oblivious to ground realities of rising inflation and slowing growth. Not to mention the external shocks such as Iraq crisis, a probable flight of foreign capital, rupee volatility, bad monsoons and so on. Any of these could result in two back steps for every step taken forward in the direction of reforms.

However, recent events like delay in the gas price hike, roll back in rail fare hike or denial of a proposal to hike kerosene and LPG prices indicate that current Government might not be without political or populism pressures. One should note that this time, coalition politics has not much to do with it. It seems that swallowing bitter pill is not as easy as it was assumed.

Anyway, the focus here is not the efficacy of the Government. It is too early to judge that. Especially keeping in mind the messy legacy it has been left with. Expecting a quick fix for decade long economic issues will be unrealistic. The fact is that even if the reforms are launched, it will take at least a period of two three years before a balance between various stakeholders and a stable economic growth can be achieved.

But what we would certainly like to question here is the behavior of the market. As seen recently, the current rally is on a very slippery ground. Oil and gas stocks is just one instance. Across sectors, one can see unreasonable valuations. And various themes - such as infrastructure theme, debt reduction theme etc are doing rounds to inflate this bubble. The brokers are selling Sensex levels of above 40k. The fund raising activity is gaining momentum to make the most of this rally, the most vulnerable participant of which happens to be the retail investor. In short, the naive optimism has gotten the better of common sense and reason. However, we would remind investors not to get influenced by all this and be reasonable in their expectations with regards to reforms. Further, we would like to remind them not to compromise on valuations and stick with the best companies while taking investing decisions. Irrespective of the broader macro economic developments, such a disciplined approach is likely to pay off in the long term.

Do you think that the stock market valuations are currently pricing in unreasonable expectations? Let us know in the Equitymaster Club or share your comments below.

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01:30  Chart of the day
Despite improving economic sentiments, hiring at India Inc. still lacks the kind of momentum as witnessed in the past. As can be seen in today's chart, the headcount at top 5 private companies in India increased by just 5% in FY14. Put together, TCS, ITC, Infosys, RIL and HDFC Bank added just 578,804 employees during the fiscal. This is the lowest ever growth figure witnessed in the last 3 years reflecting the fact that job creation was the biggest challenge for the economy last fiscal. Apart from this, renewed focus on employee productivity also gave a setback to fresh hiring. Not only hiring, even salary and wage growth figures reported by the corporates were not that encouraging in FY14 except for ITC.

On an average India has been able to create 550,000 jobs in the last two years. Compare this to the fact that India adds 1 million people to the working age population every month. Though not every person looks out for job in the working age group, the demand supply gap is huge. Thus, we believe job creation and not just inflation management could be one of the biggest challenges for the new government. It would be interesting to see how a pro-business government tackles this issue.

India Inc hiring lacks momentum despite positive sentiments

The commercial exploitation of gas from the US shale gas reserves is expected to be a game changer of sorts for global energy sector. In this scenario, India's energy security interests are best served by moving to a regime where energy prices are market determined. This is because the market determined prices can provide the main signal in investment and consumption decisions. Most buyers of natural gas in India are power and fertilizer companies. These players do not have freedom to increase prices of their own output. Hence the fuel prices (coal and natural gas) too need to be subsidized. In fact, coal accounts for more than half of India's commercial energy. India's power sector depends on coal supplies for 66% of its produce. Yet, the reforms in coal and power sector have been hard to come by over the past decade. Despite having large untapped reserves, India continues to import coal. The new government could therefore consider deregulating coal supply and pricing. Incentivizing energy producers by offering them autonomy in decision making could go a long way in sorting out India's energy woes.

The Modi government assuming power has been given big thumbs up by the Indian stock markets. And the RBI too sees this as a positive sign. Indeed, the RBI governor Mr Rajan is of the view that the Indian economy should see better days ahead now that there is a stable government at the centre. RBI also believes that the general risks facing the economy are expected to come down. However, there is still a lot to be done. For starters, inflation continues to remain a challenge for the Indian economy. And the RBI has clearly stated that supply side constraints need to be addressed. So that these can complement the monetary policy in bringing inflation down. Readers would do well to recall that one of the reasons why food prices have been so persistently high is because of inadequate storage facilities as a result of which food grains were left to rot. The erstwhile UPA government did not take any initiative in addressing this issue, but a lot is expected from the Modi government. Rajan is also of the view that focus on infrastructure with key emphasis on kick starting stalled projects will also improve the country's growth outlook. Clearly, the work has only just begun for the BJP government.

There might be some good news for debt laden companies in the Union Budget. The finance ministry is seriously considering liberalising norms for external commercial borrowings (ECBs) . As per an article in the Business Standard, the measures may include doing away the limits on the amount of foreign loans allowed, the interest rate, industry quotas and the end-use rules. While market is likely to welcome these moves, we believe it should be done with some caution.

It was not a long time ago that India Inc was reeling under the pressure of foreign currency loans. These loans might be cheaper than domestic ones but they come with the added currency risk. If the rupee depreciates, firms with high exposure to foreign debt will feel the heat. The realty sector especially will have to be watched closely. The current rules do not allow realty firms to raise foreign debt but this may be changed in the budget. Investors will have to be extra careful while investing in such companies.

If SEBI has its way, the equity research reports from many brokerages you read will now give you more information about the analysts concerned. In other words, the analysts who write equity research reports will now be subject to more regulation. Amongst the important regulations is the one where the analyst will have to declare whether the listed firm he is tracking also has banking relationships through one of the other arms of the analyst's broking firm. This is a serious matter because an analyst can always write a positive report about this firm and bring benefits both to his employer as well as the listed firm. In such cases therefore, the analyst is not working in the interest of the small investor and there is a genuine conflict of interest. A disclosure to this effect therefore is a welcome step we believe. Another important regulation being mooted is a common certification for all analysts from the National Institute of Securities Market. However, what may not be possible to track is the quality of the report and whether there is sufficient depth in it. And therefore investors, especially the new ones will have to continue to rely on stock advisors with good long term track record and a reputation for honest practices.

In the meanwhile, the Indian stock markets pared early gains but traded above the dotted line. At the time of writing, BSE-Sensex was trading up by 22 points (up 0.1%). Sectoral indices are trading mixed with IT and pharma stocks being the biggest gainers. However, metal and realty stocks were trading in the red. Most of the Asian stock markets were trading weak with indices in Japan and Indonesia being the major losers. However, the European markets opened the day on a strong note.

04:56  Today's investing mantra
"Behind every stock is a company. Find out what it's doing." - Peter Lynch
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3 Responses to "Investing based on reform hopes? Oil stocks set expectations right"

rajesh bhandari

Jun 28, 2014

no dought sensex will go abive 40 k but its just like land mafia who created black money and holding it
now its stock mafias who have collected stocks and now
recommending indian investor who have totally burned their finger
it is just like nifty manuplation done by big houses only 20 bank stocks represenr bank nifty which is reduclus
i pray for indian investor to safegaurd thier principle
intact there are so many stocks which dont have 10 rs value trading at 400 to 500 times its not economy but etf funds running market so be carefull

Like (1)

s k karavadia

Jun 27, 2014

pm and FM do not know the a b c d...of economics.They know only politics. NDA will never be able to do for economy what Dr. Manmohan sing & Narsinh Rao did.

Like (1)

subramanian M

Jun 27, 2014

I will be very happy if you can produce a white paper on the price movement of various companies pre and post election by segregating companies with strong fundamentals and established reputation.This could be an eye opener for gullible investors who are getting carried away by the market which in my view is a bubble

Like (1)
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