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Stockmarkets: Read, before you leap! - Views on News from Equitymaster
 
 
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  • Jun 30, 2005

    Stockmarkets: Read, before you leap!

    As we are well aware, the Indian stock markets have hit new lifetime highs in the recent past. The bulls have had a party on Dalal Street. They have been aided by factors such as ample liquidity through strong Foreign Institutional Investors (FIIs) inflows, powered in recent times by Japanese funds wanting a slice of the action, overall buoyancy in the markets, improving sentiment in sectors such as FMCG due to rains hitting the country and strong expectations of the continuation of the 'India story' over the longer term.

    However, the fact remains that at such high levels, with the indices in uncharted territory, investors must exercise some amount of caution. Even after Tuesday's 100-point plus correction, indices are still well over the 7,000-point mark. Where the indices will go tomorrow or in the next week or month is anyone's guess. We take a look at factors that have driven the markets upward in recent times, present our concerns regarding this market and reason as to what we can expect going forward over the longer term.

    Factors causing the bull-run
    Domestic consumption and favourable demographics:India's population is the largest in the world after China, at over 1 billion people. Such a huge domestic market makes a compelling reason to sell one's products and services in India. However, the major point to note is not just the enormity of our population itself. If we dig deeper, we find that a major portion of our population is below the age of 30. Apart from that, data from NCAER shows that the high-income class is also growing at a steady pace.

    This implies that in the next ten years or so, purchases of consumer durables, FMCG products, cars, petroleum products, computer hardware, software and a myriad of other items by this class is going to power the economy forward. Undoubtedly, exports are also growing fast, but given its massive population, India remains largely a domestic consumption-led economy, unlike, say, South Korea or Japan, where the small populations of these countries and also an indifferent attitude to spending by the Japanese people has resulted in corporations in those countries having to resort to exports to drive growth. Consumer spending was estimated at Rs 21 trillion in 2004 and is growing at a rapid rate. Thus, long-term expectations about strong domestic consumption-led growth going forward have driven markets upwards.

    India Inc.'s earnings growth: Combined with this, Indian companies continue to show robust earnings growth. This has averaged in the region of 15% to 20% for the Sensex companies and more importantly, it is the quality of earnings that has been good. There needs to be sustainability in earnings growth and that can only happen when growth comes from 'core operations' rather than 'other income'.

    Driven by this factor, and others, FIIs have been pumping record amounts of money into the Indian stock markets since the beginning of 2003. The FII ownership in Indian stocks has risen considerably during this period. They have been among the major drivers of the bull-run witnessed in the last two years. In recent times, Japanese investors have started India-dedicated funds and pumped in millions of dollars in the past few trading sessions.

    * 2005 to date

    Our concerns
    Spiraling oil prices: Quite clearly, spiraling oil prices are a cause for concern. Oil prices have hit record highs of late and a secular up-trend on this count will not augur well for Indian corporates. This could eat into corporate profits through higher input costs on the corporate side and higher petroleum prices on the consumer side, raising the specter of inflation and reduced consumer spending. This could affect sectors such as auto and commercial vehicles (CVs) and other sectors as well, due to the adverse effect on consumer spending.

    US interest rates: With the Federal Reserve resorting to finally increasing interest rates since July 2004, a further upside to US rates is only expected. Depending upon the quantum of the rise and Mr. Greenspan's comments about the way he views the US economy, FII flows could go back to the US, since the yield on US assets would rise. It should be noted that a certain amount of FII money could be just 'hot money', which is a 'fair weather friend' and at the slightest instance of danger, 'flies out' of the country!

    Linked to this point, the US economy is undoubtedly the driver of the global economy today. It accounts for over a third of global GDP. US consumption fuels global growth and if the US sneezes, the entire world will get an infection! Given the frothy property market in that country further compounded by the fact that it is mainly a debt-driven bubble, a bursting of the bubble could mean considerably reduced spending power of the US consumer due to an increasing debt-burden and by extension, a slowdown in global growth, which will surely affect India in some way or the other.

    So, what to expect?
    In the near future, it is difficult to predict exactly as to which way the markets are going to go. Major drivers we believe will be the progress of the monsoons and the upcoming first quarter results of corporates. Any negative surprises on this front, particularly for major companies could result in negative sentiment in the near term.

    However, we have always maintained that in any market, be it a bull market, bear market or flat market, there are always some stocks that are worth buying. We would surely advise a bottom-up approach to stock picking, as a number of stocks, particularly mid-caps, have run up far too much and are not justified by their fundamentals. Therefore, investing in fundamentally sound companies at reasonable valuations is the best bet for an investor to make money in the long term.

    Given solid earnings growth expected over the next few years, apart from factors such as a favourable demographic profile resulting in strong domestic-led consumption, going forward, improving quality and sustainability of earnings, strong export-led growth in sectors such as software, auto ancillary and pharma and increasing global recognition of the 'India story' leading to even more FII participation, we remain positive on the Indian markets from a long-term perspective.

     

     

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