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2007: The Famous Five - Views on News from Equitymaster
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  • Jan 1, 2008

    2007: The Famous Five

    We had dubbed 2007 as the 'year of the unknown' in our review of 2006 and predictions for 2007 a year back - 'unknown' because we were not sure whether the Indian economy would continue to fare as well as in the previous three years. Or whether 2007 will see the Sensex repeating its performance of the previous three years. The economy did fare well, and the Sensex roared as it had done in the previous years. But the 'unknowns' that hit us were the sub-prime crises emanating from the US, the Indian rupee's nerve wracking upward move, the P-Note shocker from the SEBI and valuations of power stocks (which moved from being high to disagreeably high!).

    Here are the famous five that we believed crowded investors' minds during the year.

    1. Sub-prime: What an impact did this have on global markets and financial system! 'Subprime' was perhaps the biggest event that marred both the international and the domestic stock markets in 2007. Most of the world's well-known financial giants like Bear Sterns, Lehman Brothers and Merrill Lynch created complex derivatives based on sub prime loans, which were marked to market and sold. The crisis arose when defaults on these sub prime loans surfaced having a dampening effect on other forms of credit as well. While big hedge funds such as Bear Stearns amongst others had to report bankruptcy, global banks were not spared either and the largest of the lot i.e., Citigroup reported a massive 60% drop in its third quarter earnings for the year. Since complex financial instruments were created around these sub prime loans, valuing the same proved to be a difficult task, as a result of which, the extent of the crisis could not be gauged.

      The overall uncertainty that followed took its toll on global equity markets - until the US Federal Reserve and its counterpart in Europe decided to unleash a fresh dose of cheap money (to the defaulters, of course!). This liquidity injection was because the sub-prime crisis had dried up liquidity in the global financial markets as concerns of a contagion spread far and wide.

      Readers would do well to note that the inflation in asset prices over the past 3-4 years has been largely a result of high levels of liquidity induced by cheap money globally. Now, with money drying out as investors become apprehensive and hold their funds tight (or investing in the rather safe government treasuries), the global financial markets are witnessing increasing levels of risk. The situation was no better as we closed in on the year. The US economy faces a housing market led recession, the exact nature of which will be unraveled only in 2008.

    2. Sensex: After a 44% YoY rise in 2005 and 2006 each, the BSE-Sensex repeated the performance almost to the tee in 2006 as well (46% YoY rise). This surge in the Sensex can largely (or very largely!) be attributed to just three stocks - Reliance Energy, L&T and Reliance Industries. While the index was severely hit a number of times owing to global financial and credit issues, there was really no stopping the surge that followed these hiccups. What is more, the index trumped most of the other emerging markets in the world (except China, Indonesia and Pakistan), backed by continuance of strong earnings growth and flow of easy (and cheap) money from foreign and domestic investors. The Sensex gains were however dwarfed by those achieved by the BSE-Midcap and BSE-Small cap indices - 69% and 94% respectively.

      Top gainers & losers on Sensex
      (Rs) 28-Dec-06 31-Dec-07 Change
      Rel. Energy 521 2,161 314.4%
      L&T 1,437 4,196 192.0%
      Reliance 1,277 2,901 127.2%
      BHEL 1,154 2,581 123.6%
      Tata Steel 477 939 97.1%
      Infosys 2,248 1,773 -21.1%
      Tata Motors 905 741 -18.2%
      Cipla 253 214 -15.4%
      Wipro 608 526 -13.5%
      TCS 1,209 1,090 -9.8%

    3. P-Notes: This shocker came from the stock market regulator, SEBI. As a matter of fact, the sharp rise in the benchmark BSE Sensex over the last 3 years has been attributed to FII investments, with 75% of floating stock in the hands of FIIs and 50% of the stocks held by FIIs being in the form of participatory notes (P-Notes).Further, the incessant FII inflows also brought a sharp acceleration in the rise of rupee against the US dollar. It is in this backdrop that the regulator, SEBI, introduced restrictions on P-Notes in October, citing concerns over the copious inflows and anonymity that P-Notes offer. The proposed restriction on the issue of fresh P-Notes by FIIs brought significant albeit momentary apprehensions in the minds of investors.

    4. Rupee: For better or for worse, 2007 was a considerably eventful year for the Indian rupee. The currency appreciated by around 11% against the US dollar and wrecked havoc on the export oriented sectors such as software, pharma and textiles, while proving to be beneficial to the oil industry. The decline of the dollar against major world currencies and the surge of FII inflows into the country contributed to the sharp appreciation of the rupee. Besides this, in the early part of the year, the RBI refrained from actively intervening in the forex market in a bid to contain inflation, which had shot up to 6%. Not only the FII inflows, the external commercial borrowings (ECBs) and FDI inflows were also instrumental in stepping up the liquidity. This prompted the RBI to place controls on the extent of ECBs to be allowed in the country besides increasing the limit of investments abroad.

    5. Reliance: Did you hear anything else on the street? The 'R' group companies, those with earnings and those with none, those of the elder brother and those of the younger, kept the bulls berserk during the year. Reliance Energy, for instance, deserves a special mention here as the stock led to a re-rating of the entire power pack, simply on the dreams that have been shown of the planned gargantuan expansion over the next 10 years. Power stocks, which were trading at trailing 12-month P/Es of 15 to 20 times rose to trade at P/Es like 37 times (Tata Power) and 54 times (Reliance Energy)! Especially for the latter, much of these valuations factor in what the company plans to achieve in the next 10 years. As a matter of fact, this company has a history of under-achievements in the past and is now talking of 'ultra-mega' plans for the next 10 years. Even if the achievement is to be 100% (better than the best case scenario!), our calculations show that the valuations have been brought to atrociously high levels!

      The R-pack jamboree
      28-Dec-06 31-Dec-07 Change
      Rel. Nat. Res. 22 182 712.5%
      Rel. Capital 607 2,595 327.2%
      Rel. Energy 521 2,141 310.6%
      Rel. Ind. Infra. 549 2,189 298.8%
      Rel. Petroleum 63 223 255.2%
      Adlabs 435 1,370 215.2%
      Reliance Inds. 1,277 2,886 126.0%
      Rel. Comm. 477 741 55.3%

      Other eye poppers from the 'R' camp were Reliance Natural resources and Reliance Petroleum, which have no real earnings on their books but have still lured investors for the growth they promise in the future. That's 'future discounting' at its best!



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    Aug 22, 2017 11:21 AM