Mar 17, 2004|
Markets: Where next?
Markets have seen a correction of sorts in the last two to three weeks. Not only the retail investors, but also the government seems to be concerned about the same! We take a closer look at the recent stock market trend and ascertain whether there is something to worry.
Just to go back in time, compared to the lows the Indian stock markets reached in April 2003 (post the Infosys results), on a point-to-point basis, markets have seen a one way ride. A number of factors supported this rally. It is pertinent to consider what led the rally first and then ascertain whether these factors are sustainable for the markets to remains strong in the future.
- Valuations - The BSE-Sensex last year was trading at a P/E multiple of 13x to 14x earnings. This when one considers that the Sensex companies have seen a CAGR of around 17% in net profit for the period between FY97 to FY02. Besides, corporates are more productive at this current juncture as compared to the last five years. In fact, in our recent interaction with Mr. Subhir Gokarn of Crisil, he evinced that 80% of growth in profitability was on account of better productivity. So, obviously, we had corrected on the downside more than we should have and as a result, markets gained sharply.
- Interest rates - Mr. Gokarn of Crisil also indicated that almost 20% of the rise in net profit was on account of lower interest rate scenario. Therefore, the cost of finance has come down dramatically, which aided corporates to restructure their balance sheets. On the other side, this provided a fillip on the demand side of products as well.
- Monsoons - Compared to what the country has witnessed over the last three years, monsoons in FY04 was normal and well spread. So, the agriculture sector got a shot in the arm owing to which food grain output is expected to touch 220 MT this year.
- Fund flows - The country has witnessed increased inflow of funds from foreign institutional investors this year and the momentum has remained strong till now. Domestic mutual funds, which were sellers, also turned buyers.
Having looked at these broader aspects that led to the rally, consider whether these factors are favorable for the markets in the future.
- Valuations - Currently, the NSE-Nifty is trading at a P/E multiple of 16 times trailing twelve months earnings. So, clearly, in terms of valuations, we have corrected upwards. We believe that value buying in most of the index stocks is over and further rise in stock prices have to be accompanied by higher growth in revenues and profitability. In fact, in some sectors like auto, power and engineering, expectations seem to be on the higher side. If earnings fail to meet expectations, markets could correct.
- Interest rates - There are two factors to consider here. One is that inflation is on the higher side on the back of rising crude prices and partly because of lower base effect. The Reserve Bank of India (RBI) expects inflation to decline in the near term. Secondly, if corporates starts borrowing money to fund the expansion plans, higher demand for money could pressurise interest rates. Though the magnitude of rise may be lower, investors have to keep a close eye on this.
- Monsoons - Given the country's large dependence on monsoons, any negative news on this front could slower the GDP growth in the next fiscal year. Though there could be some lag effect of last year's good monsoon, it remains to be seen how this very critical factors pans out.
- Fund flows - In a recent Investor Empowerment Programme conducted by us, Mr. Ajit Dayal, Deputy CIO, Hansberger Global Investors, indicated that if interest rates were to rise in the US, it could affect fund flows into the country.
Besides these four factors, there is one more reason to be cautious.
Elections - Last, but not the least. We should never underestimate the importance of the stable government at the helm. We view this as a very critical factor and investors have to exercise caution on this end.
To conclude, it is very important to consider the downside before the upside in the stock market. More importantly, it is not only that we have corrected downwards. The graph indicates that a global index like S&P 500 has seen a decline in the last three months. While we believe that the long-term prospects continue to remain promising and equities, as an asset class, are likely to yield better returns, it is better to be selective.
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