Has this leg of the rally come to an end? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Has this leg of the rally come to an end? 

A  A  A
In this issue:
» World Bank President optimistic on India touching 6% growth
» Market cap of TCS crosses the Rs 5 trillion mark!
» FIIs inch towards their investment caps for certain sectors
» Goldman Sachs' ambiguous take on gold
» ...and more!

All the major hurdles - General Elections to the Union Budget - that market participants were waiting to cross over the past six months have now been dealt with. And the way the Indian stock markets have reacted, it's safe to say that the outcomes of all these major events have been favourable.

But, what has happened in the past is now done with. The key question, as always, remains: what now? Are Indian stocks still investment worthy? Or has the time for investors to take a "cautiously optimistic" approach on markets arrived?

While expectations of India doing well in the future - and thus the companies to reap the benefits from the same (the optimistic part) - are high, there are a bunch of factors across the world (the cautious part) that could prick into this seemingly little optimistic bubble that has propped up in the recent past.

The current mood seems to be mixed, which could easily confuse a naive market participant - the individual investor. Opposing views are flying around now given the very sharp run up in stock prices. Some are of the view that with the run up in stock prices, their valuations have followed suit and thus, story may not be as compelling as before. This is the view of financial behemoth Goldman Sachs. The rationale for the same is that the next leg of the rally will be driven by earnings and reforms rather than sentiments.

On the other hand, you have investors taking broader views of things; stating that Indian markets are the place to be. As reported by the Economic Times, India's weight in Global Emerging Market (GEM) funds has hit a record high of 10.5% in the month of June this year. During the market peak of 2007, the same stood at 7.5%. While this share has been quite volatile in the years following 2007, the optimism started to build up ever since hopes of the Modi led government coming into power started increasing. And from what it seems, the funds are "overwhelmingly" bullish on Indian stocks even now!

We also came across an interesting write up by Dr. Steve Sjuggerud wherein he explained the rationale behind buying into a particular BRICS fund. His basis for the same is that these nations are trading at a greater discount to the US markets than what they did in 2004 and 2008. In fact, the same newsletter also carried a story on why it makes sense for American investors to go global considering that valuations - P/E and dividend yields - of US stocks are way higher than those of the developed nations; thereby not making US stocks bargains anymore.

In short, what this means is that there could be more money coming in the direction of non-US markets, including India.

What is our take on this? Well... we generally take the views of major brokerage houses with a pinch of salt. But as far as Goldman Sachs' view on market valuations is concerned, we concur with it. We have been keeping an eye out on the same for the past few months. In fact, this story was covered prior to the elections as well. But as the markets have run up substantially since then, it warrants a change in view.

Having said that, the Sensex is not the only gauge of market attractiveness. At the end of the day, no matter what the market situation may be, stock prices will eventually reflect the underlying fundamentals of their respective companies, and that is what investors would be better off gauging is what we believe. If valuations do seem to have run ahead of fundamentals, it would not necessarily be a bad idea to make the most of the current optimistic scenario.

Do Indian stocks still have enough juice in them to justify current market valuations? Let us know in the Equitymaster Club or share your comments below.

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01:40  Chart of the day
The recent rally in stock markets is attributable to huge FII inflow. Engineering sector stocks were the prime beneficiaries of this liquidity pumping exercise as foreign investors re-jigged their exposure from defensives to cyclicals. But it seems that this rally may fizzle out soon. That's because FIIs are on the verge of reaching their sectoral investment cap in industrials amongst others. It may help to note that every company sets a maximum FII limit for its stock. And once the limit is reached, further investment is not permitted.

FIIs about to max out on their Indian exposure?
IT - Information Technology, Fin. - Financial, Tele. - Telecom,
CS - Consumer Staples, HC - Healthcare, CD - Consumer Discretionary, Ind. - Industrials

As can be seen in today's chart of the day, the available headroom left for FIIs to invest in industrials is just US$2.2 bn. Even utilities and consumer discretionary are on the verge of reaching their maximum available limit. Obviously, if future fund flow in these sectors is restricted, their upside potential could get capped. And this may well happen with industrials soon! Hence, investors have to be extremely cautious. A cap restricts further flow of funds and thus upside. It also leads to excessive volatility. Even capital erosion can't be ruled out as any negativity could result in basket selling.

The various subsidies that India doles out are like an Albatross around its neck. It is actually one of the key reasons why Indian economy has not been able to take the next big leap. And when Jim Yong Kim, the World Bank President came visiting the country recently, he too shared a similar perspective. He is of the view and rightly so that fifty percent of all the subsidies in the country actually end up in the hands of the top 40% earners in India. Consequently, it is not a progressive system at all. It in fact benefits the wealthy more than it benefits the poor. Mr Kim was therefore mighty pleased that the Government is looking to bring the same under control and usher in a fresh round of fiscal consolidation. Mr Kim also sounded very optimistic about India going back to the 6% plus growth rate. He argued that India had lots of natural assets. Therefore if the Government moved quickly towards implementing reforms like the Goods and Services Tax (GST) for example, it can add as much as 1% point to India's growth. Well, we are in total agreement with Mr Kim. All that's needed are few bold steps which the Government should not abandon in favour of populism and petty vote bank politics we believe.

Janet Yellen was expected to be much better than her predecessor. At least when it comes to communicating the Federal Reserve's stance on the liquidity situation. However the Fed chief has chosen to give out as confusing signals as Ben Bernanke. She has reiterated that the Federal Reserve has enough scope to keep interest rates at zero much longer than anticipated. This is because both growth and inflation remain below target.

The FOMC had earlier indicated that it could raise interest rate from zero 2015 onwards if the US economy performs as projected. However, Ms Yellen once again committed to keep the rate low for a 'considerable period' after ending the monthly bond purchases. The aim of doing so seems simply to assuage market concerns that tighter liquidity may lead to sell off in high risk assets and crash in prices. Ms Yellen's commitment of keeping rates low does not bode well for global markets that have seen asset bubbles forming across asset class. Indian investors in particular need to remain wary of cheap funds flowing into asset classes like equities and real estate.

Goldman Sachs. The name brings to mind an opportunistic, giant corporation that seems to follow the Machiavellian approach where ends justify means. Given its size and financial clout, though, its views and forecasts are actively followed by investors across the globe. But should you really read too much into what Goldman says? After reading this, you would perhaps think thrice before taking Goldman's views seriously. We came across an interesting article in zerohedge.com that highlights failures and contradictions in the views presented by Goldman.

According to the article, for one, Goldman totally went wrong on its predictions about the economy, the US stock markets and gold that it had made around the beginning of 2014. Earlier, it had forecasted gold prices to fall to US$ 1,066 per ounce by the end of 2014. But with gold prices remaining buoyant following healthy buying by various gold ETFs, Goldman has finally revised its target for gold to US$ 1,200 per ounce. But even while raising the target price for gold, it continues to maintain a Conviction Sell rating on gold. Doesn't that sound ambiguous? Whatever the case be, international gold prices are hovering close to US$ 1,300 per ounce. We would certainly not give much weightage to what Goldman Sachs says and stick to our philosophy of keeping gold as an insurance against bad times.

As the markets scale new highs, India's largest software company, Tata Consultancy Services (TCS) has also achieved a milestone. The market capitalisation of TCS has crossed Rs 5 trillion or Rs 5 lakh crore mark! This is remarkable for many reasons. Its size is greater than the combined market cap of the next four largest Indian IT firms: Infosys, Wipro, HCL Tech and Tech Mahindra. What's more, TCS is bigger than the combined size of all other Tata group firms too. How has TCS reached this exalted position? And can the stock sustain such a premium?

The first question is easily answered. TCS has sustained a high growth rate over the years. This has come along with excellent profitability, margins, return ratios and cash-flow generation. The dividend payout has been good too. While its peers like Infosys and Wipro have struggled with growth and management issues, TCS has gone from strength to strength. This is evident from the fact that all its business divisions are aiding its growth. But what about the second question? Currently the stock trades at about 24 times its TTM earnings. Can such valuations be sustained? We believe the answer lies in the continuity of the company's growth momentum. TCS has not surprised on the downside in its quarterly results. The market has given the stock these valuations based on the assumption of sustained good performance. However, TCS could lose its premium billing if it delivers negative surprises for a few consecutive quarters.

In the meanwhile, the Indian stock markets continued to trade weak. Only the small cap stocks were trading in the green. At the time of writing, BSE-Sensex was trading lower by 15 points. Sectoral indices were trading mixed with metal and realty stocks being the major gainers while consumer durable and oil & gas stocks were trading in the red. Majority of the Asian indices were trading strong led by China and Hong Kong. However, these Japanese and Indonesian indices were trading weak. European markets opened the day on a weak note.

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4 Responses to "Has this leg of the rally come to an end?"


Jul 26, 2014

The bullish trend will continue a couple of months on the strength of positive note among Corporate s and investors in respect economic reforms by the new govt. The bullish impact will be more in IT, Infra and Agro-based sectors. If the government won't come up to the expectations of the investors, the bubble will burst by the end of the year


Jayant Bhandari

Jul 25, 2014

P/E gives a very deceptive understanding of the Indian market, for if you really want to compare you must adjust it for inflation. Indian earnings yield is half as much at bank interest and dividend yield is much, much lower. US stocks are better than Indian on both respects. Moreover, growth of earnings in India is maybe 10%, just about meeting bank interest rate. I would rather keep my money in a bank than invest in Indian general stock market. Or better still short the Indian index.

Like (1)


Jul 25, 2014

The Indian markets are beyond a doubt in fully valued if not over-valued territory

The number one driver of equity and real estate asset prices is actual and expected interest rates in the investing source country. FIIs are responsible for driving Indian markets higher. Till the expectation of near term rates changes FII funds will continue to be risk chasers.

QE from the US Fed has driven the last wave. Expectations of QE from the ECB are driving the next wave.

Individual investors can enjoy the ride but do not loose sight of the risks. Be aware that FIIs have hedged and will hedge their risks.

The ove-riding message to individual investors is do not put in money required in the short term and stick to your asset allocation model. 90% of portfolio returns come from debt:equity asset allocation and less than 10% comes from stock specific selection.

Like (1)


Jul 24, 2014

Invest for long time is good idea. Stable govt. good admin and groth model. what more you want to grow!, If you can not grow with all these vitamins it is prrof that we are not eligible to exist !

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