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Stockmarkets: Zoom or doom?

Sep 21, 2005

The Indian markets continue to defy gravity and hit new highs, as new sets of magical hands cannot seem to get their minds off the 'buy' button, inspite of crude prices hovering around their all time highs. Investors across the globe seem to have fallen in love with the India story.Here are some of our concerns...
Valuations: Although valuations for large cap stocks do not seem very stretched, the same cannot be said for mid and small cap companies. Investors are ready to give these stocks valuations at par with their larger peers and in our view, prices of these stocks have already factored in the future growth, atleast of the next two to three years. It must be noted that the average price to earnings multiple of the NSE-Nifty Index is currently 17.2 times, which means that the indices are reasonably valued, considering the historic trend. Hence, it means that prices paid for stocks are much more than what they are worth and hence, investors will back off. Experts who do not want to call a 'spade a spade' are now commenting that the index is neither undervalued nor overvalued. While we do not understand what it means i.e. whether it is a signal to buy or to sell, what it reflects is the fact that no one wants this dream run to end!

Crude Prices: India imports 70% of its crude oil requirements and it must be noted that every US$ 10 increase in oil prices knock's off about 0.4% from the GDP growth rate during the following four quarters. Yet, thanks to subsidies, and the left parties, Indian consumers have been protected from the huge surge in oil prices and are not yet feeling the pinch completely. The best reflections of this are our very own Oil PSU's, who continue to reel in the red. However, it is indisputable that there is limit to which the government will take the hit and if the entire burden is passed on to the consumer, then inflation will surge and will certainly slowdown economic growth.

Rise in US Interest rates: Well this one's rather simple, if Fed rates in US continue to rise, foreign investors are likely to pull out money or atleast stop investing further. As per Mr. Yardeni, one of the noted economist, global liquidity is on the decline and is likely to impact the commodity and stock markets in the future.

Fiscal Deficits: The total fiscal deficit of the state governments and the central government is over 10% of the GDP. Continued economic growth and control over public finances are necessary to keep the government's balance sheet under check. Given the sharp rise in crude prices, in the first four months of the current fiscal year, the fiscal deficit has already going beyond budget expectations. We will soon see this impacting liquidity in the domestic market (this is because both the government and the corporates will borrow more). Interest rate outlook continues to remain that of cautious.

In conclusion, there are two schools of thoughts here. Some say that the Indian economy is in the midst of a fundamental shift. The other school of thought says that this rally is purely liquidity driven and that the day Foreign Institutional Investors (FIIs) wake up, investors are likely to lose sleep. People cannot forget the 'Black Monday', the day when mayhem struck and the markets fell like a pack of cards, just a gist of how much control do FII's have in the country.

Well does this mean that we are bearish on the market? The answer is 'no', as even today there are companies that are good and worth investing with a long-term perspective (say two to three years). However, return expectations have to be toned down. Investors should not time the markets and always remember two things what the famed investor Warren Buffet said that 'Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years' and 'Simply attempt to be fearful when others are greedy and to be greedy only when others are fearful'


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