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Stockmarkets: Where to from here?

Aug 25, 2006

The BSE-Sensex has had an exciting run since the month of May this year. That is, of course, if volatility is something that excites you! In May, the benchmark index hit it's all-time high levels of around 12,671, and was seemingly on a non-stop upward move. However, it should be noted that all that goes up must come down, which is better known as the law of gravity, but is very much applicable to the stock market as well. Thus, we saw the Sensex crash from its highs of 12,671 on May 11 to a low of 8,799 on June 14 - a fall of nearly 31% in barely over a month! Now, a number of investors were crying hoarse about how much money they lost after buying stocks at the highs and selling at the lows (which, of course, is the opposite of what an investor must do to make money in stocks). We heard horror stories about how people lost fortunes by leveraging too much - clearly a case of biting off more than one can chew. However, we were always uncomfortable with the way the Sensex was moving non-stop in the upward direction, a clear sign of overvaluation, and had been advocating utmost caution much before the Sensex came even close to these high levels.

The markets have again moved up from their lows, as buying has resumed at 'more reasonable' levels following the crash. What can investors now expect from the Sensex? Any number of views abound on the street, with some quarters giving 7,000 as a possible target, while others give another extreme target of 15,000! We refrain from giving any such number, as we do not predict index levels. We believe that it is better to adopt a bottom-up approach and select the best stocks that have the potential to give superior returns over the long-term. We examine here, a few macro factors taking place that could impact the stock markets and specific sectors.

A higher interest rate environment
For too long, there was a global party, with all-time low interest rates prevailing in major economies globally, including the US, Australia and Japan. This caused money to flow out from those economies into the 'emerging market economies', such as India. Global risk appetite increased significantly, with funds from developed economies scouting the globe for investment opportunities, since their markets hardly offered any meaningful returns. Thus, we had a strange scenario, where fund managers from the US invested in crude oil, gold, commodities, real estate and other such investment avenues, as well as emerging market indices. This caused the bull runs across these asset classes, a unique, unusual and highly risky situation indeed.

However, with the US Fed resorting to a hike in interest rates, this risk appetite has reduced. Now, with higher-yielding US treasuries, some amount of outflows could be seen from emerging markets over a period of time. Given the Indian markets' dependence on Foreign Institutional Investors (FIIs) money, this might have an impact. However, we believe that, despite rising interest rates, given Indian companies' strong fundamentals and growth prospects, these will continue to do well, and consequently, their stocks should also do well on a macro basis.

Higher crude prices
This is certainly one variable that could slow down Indian and global growth to an extent. There have been no major new finds of crude over the past three decades, and given ever-increasing demand from countries like China and India, crude oil prices may not soften in a hurry. Higher crude prices act as a 'tax on growth', since countries need this valuable commodity to run their economies, despite the fact that prices may increase. Sectors that could get impacted are energy (specially oil marketing companies), sectors like paints that use crude-based raw materials, auto, petrochemicals and shipping.

Commodity prices
We are of the view that over a longer period of time, steel prices will trend downward, and are now at a stage where they are going into a downturn, as opposed to the strong upturn seen, peaking in FY05. This will have the beneficial impact of reducing the cost of raw materials for sectors like auto, construction and engineering, which use steel as a major raw material. On the other hand, steel companies will be negatively impacted, due to lower realisations.

Other factors
Geopolitical factors like the recent Israel-Lebanon conflict and North Korea's nuclear programme have the ability to impact sentiment, although they might not necessarily have an actual impact on the country. Given that India is becoming increasingly integrated with the global economy, this factor cannot be discounted. The 'political factor' could also play its part.

A stable government is always a positive factor, and an unstable Centre is certainly not in India's interests. Nonetheless, it also needs mention here that despite the political turmoil that India has seen in the past, the economy has still grown at an average of around 6% per annum over a long-term period.

Conclusion
We believe that it does not make too much of a difference as to what level the BSE Sensex is trading at. What is more pertinent for an investor is the level at which the stocks that he or she wants to buy are trading at. We firmly believe that, in such times, a bottom-up approach would serve investors the best. Always consider the risks in your investment, such as the ones mentioned in this write-up, and go for strong companies that are likely to stand the test of time.


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