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Sensex: Where to from here?

Sep 5, 2015

In this issue:
» Infosys: Closing in on TCS?
» Dr Rajan's report card
» A round up on markets
»  ...and more!

 Chart of the day
There are 5,765 listed companies on the Bombay Stock Exchange. Their combined value is a little less than Rs 94 trillion. But here's an interesting point: India's largest companies - the constituents of the Sensex - form nearly half of the total market capitalisation!

That's right: Only thirty companies account for about 44% of the total market cap of the nation!

No wonder the Sensex is considered a 'benchmark' index. For many investors, it's a gauge of market sentiments and returns. In fact, most investors base their opportunity costs on Sensex returns. 'Outperformance' or 'underperformance' is in relation to this index.

When individual stocks underperform, the general reaction is that 'one would have been better off investing in the Sensex'. But have you ever stopped to think about that? In just what exactly would you have been investing? Most investors believe their finds would be spread fairly among the constituents. But that is certainly not the case.

Similar to how the Sensex takes the lion's share of the total market cap, certain companies (and sectors) within the Sensex take the lion's share of the index.

Here are some data points to put things in perspective...

The largest company in the Sensex has a weightage of 12%. The top five companies have a share of 36%. The top 10-60%. And the top 15 (half the index) form as much as 77% of the index!

And when it comes down to the sector-wise spread, the following chart puts things in perspective...

Sensex's fortunes rely on...?

As you can see, three sectors (information technology, finance, and oil & gas) contribute more than half of the market cap of the index. Bring in FMCG and pharma...and the figure rockets to about three-fourths.

It must be taken into consideration that some of the severely beaten down sectors, such as metals and mining, have also played a factor in the change of weights to other sectors. But their share is too miniscule to make a dent.

And thus, if one wishes to take a call on which way the index will move, it would make sense to focus on the major contributors. And going by their valuations at the moment, the trend seems mixed.

Energy stocks, for example, have taken a beating. The IT pack is in the not-so-expensive zone. Within the finance space, certain stocks are trading below their long-term valuations. Others have remained resilient (purely in regard to valuations). The FMCG and pharma pack continue to be the market darling, with valuations way above comfort levels (for us at least!).

As a research house, we do not have a Sensex target per se. But all we can say is that for the benchmark index to go much higher or much lower than current levels-a LOT will depend on this handful set of companies.

More often than not, market attractiveness is gauged through that of the Sensex. Thus, it would only make sense to focus on the risk-reward ratios of the major contributors.

What is your take on the risk-reward ratio of the Sensex at the moment? Let us know your comments or share your views in the Equitymaster Club.

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IT firms occupy an important place in the composition of the indices as we have seen above. However, this does not mean that all of them move together. If we look at the top two IT stocks, Infosys and TCS, one thing becomes clear. Infosys has been an outperformer in recent times, while the stock of TCS has gone nowhere for over a year. The reason of course is the improved growth prospects of the former.

Having said that it's important to note over the last five years, it is TCS which has emerged the clear winner among the two. It's market cap has tripled during this period.

This is in fact why we place so much emphasis on bottom up stock picking. Instead of worrying which stock among the two will outperform over the next few years, investors should take their calls based on the respective company fundamentals. Even if the IT sector continues to do well, rest assured that all the stocks within the sector will not participate in the same way. We believe this is true for all sectors. As such, before jumping into buying any stock based on sectoral trends, it would be imperative to take the time to study the company fundamentals before doing so.

The RBI has had a chequered past when it comes to its governors. Starting with Dr Y.V. Reddy, Dr Bimal Jalan, Dr Subbarao and now Dr Rajan, the central bank of India has been headed by some of the most prolific governors. Their approach to monetary policies has been completely different to whet their counterparts in the West have had. And none have bowed to the demands of the government or the markets to print money or stimulate growth.

Dr Rajan's track record of countering the US' QE policies head on, well before he became the governor of RBI, particularly brought him in focus. In 2005, at a celebration honouring outgoing Fed chief Alan Greenspan, Rajan delivered a controversial paper that was critical of the Fed chief's policies. Dr Rajan argued that disaster might loom and as early as 2009 his views gained wide acceptance.

Therefore it is not without reason that all eyes have been on Dr Rajan ever since he became governor of RBI two years ago. Here too, without bucking to the government's pressures to cut rates, he chose to keep inflation in check. Stability of the currency too is something Dr Rajan has achieved well. But when it comes to improving the asset quality of the banking sector, the governor's actions leave a lot to be desired. Stricter lending norms have come in a bit too late and it will take a lot for Indian banks to get their act together. So while Dr Rajan has scored well on the macro front, micro managing the banking sector is something he will have to get proactive about.

Major stock markets globally continued to witness selling pressures for the week gone by. China posted weak manufacturing data. The index was at 49.7. A number below 50 indicates contraction in manufacturing activities. Further, speculation around US interest rates left the world in a jittery mood. The US labour department data showed that unemployment fell to 5.1%, lowest since April 2008. This may raise the possibility of an increase in interest rates by the US Fed.

The European markets, on the other hand recovered a little from the previous week. The European Central Bank (ECB) surprised the markets when President Mario Draghi downgraded inflation forecast and pledged more quantitative easing (QE). This cheered the stock markets in Europe. Among the major Asian stock markets, stocks in Japan and China were down by 6.4% & 2.2% respectively.

The Indian indices closed the week down by 4.51% owing to negative global cues. The net outflow from foreign institutional investors (FII) during the week stood at Rs 30.4 billion. However, during the same period, the net inflow from domestic institutional investors (DII) was Rs 28.8 billion. In a way, the data is positive in that 'hot money’ from FIIs is leaving the country, which should lead to less volatility in the stock markets.

Performance during the week ended 4 September, 2015
Data source: Yahoo Finance

 Weekend investing mantra
"Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies." - Benjamin Graham

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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3 Responses to "Sensex: Where to from here?"

k.v.subba rao

Sep 10, 2015

I feel the volatility in sensex is likely to continue till announcement of Q3 results in Jan 2016 and may reasonably look up thereafter.



Sep 8, 2015

I do not agree with your comment on Dr. Rajan about his failure at the micro level in the Banking sector.If you have Reliable sources in the Auditing, M&A Risk Mgt.Depts of Banks, Please Check with Them. This change is a long Term process & will take some time to show results.So please have a revisit



Sep 5, 2015

It is NOT the job of RBI governor to micromanage banks. Anycase he can do little in this respect since 70% business is in the hands of PSBs where sycophancy and unprofessionalism rule the roost.

if he can manage well inflation and Exchange rate , he has done excellent job.Growth is mute more due to lack of push and other hurdles than interest rates.

Equitymaster requests your view! Post a comment on "Sensex: Where to from here?". Click here!