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A sense of reality...

Sep 27, 2005

Call it a fundamental-based recovery! Call it a bounce back! Call it a recovery after a much needed correction! The fact is that markets have recovered most of last week's losses. But a certain degree of uncertainty has crept in the minds of investors in light of this volatility. Where to from here? We have been a long been advocates of the stock markets running ahead of fundamentals on an overall basis, amidst long-term investment opportunity in pockets. But during bull runs, there are enough reasons to justify the bull run, valuations, why someone is buying stocks and so on. But in this article, we wish to highlights few risks going forward.

  1. GDP growth and crude prices: In its latest update, i.e. September 2005, the Asian Development Bank has revised GDP growth rates for many economies. Barring three countries, the GDP forecast for seven other nations have been revised downwards in light of higher oil prices. While GDP forecast for China and Indonesia have been upgraded, for India, it has been maintained at 6.9% for 2005. But for 2006, there is a different story. Assuming that crude prices stay at US$ 70 per barrel, the ADB expects a 1.1% reduction in GDP growth rate of India. Not only this, the budget balance will be negatively impacted to the tune of 0.9%.

    GDP growth (%) - 2005E
    Country Initial Revised* Up/down
    China 8.5 9.2 0.7
    Hong Kong 5.7 5.2 (0.5)
    India 6.9 6.9 -
    Indonesia 5.5 5.7 0.2
    South Korea 4.1 3.6 (0.5)
    Malaysia 5.7 5.1 (0.6)
    Phillippines 5.0 4.7 (0.3)
    Singapore 4.1 4.0 (0.1)
    Taiwan 4.2 3.7 (0.5)
    Thailand 5.6 4.0 (1.6)
    Source: ADB, as of September 2005

    While the FM continues to say that the fiscal deficit target for 2005 at 4.3% will be achieved, the fact that fiscal deficit has reached almost 50% of the full year target in the first four months of the fiscal year does point out to the fact that the fiscal deficit is likely to be higher. Yes, the industrial sector continues to show buoyancy till now. But the continuation is certainly under cloud (already the infrastructure sector has slowed down last month).

    Firm stand (% change)
    Commodity* 1-week 1-month 1-year
    Rubber 1.4 12.2 34.0
    Brent oil 2.4 (5.6) 32.1
    Copper 6.1 1.6 28.9
    Gold 0.8 5.5 13.0
    Aluminium 3.8 (2.7) 1.7
    Source: ARIC, *as of 20th Sep, 2005

  2. Capex cycle: Another 'buy argument' that has been probably misinterpreted by most of the market participants is the capex cycle. Based on our interaction with at least seven banks (public and private), Corporate India is on an expansion mode. We believe that it is a big positive for India. But we have only one issue with the expectations. Most of the capex (steel, cement, aluminium, refineries, capital goods) is likely to start contribution to the topline of companies starting late 2007 (calendar year).

    During this interim period, companies have to bear with the extra interest and depreciation charges for this expansion. Not only this, most corporates have raised money through various international offerings that are equity diluting in nature. Cost savings from here on, on a macro basis (though there are individual cases), are likely to be limited. In fact, they will increase. While we believe that corporate sector earnings have the potential to grow over 17% CAGR over the next five years (between FY00 to FY04, the topline growth of Quantum Universe of 200 companies grew by 21.1% with significant savings in interest (1.6% growth) and very low capital expenditure (6.5% growth)), there is likely to be a lull in the interim. We are not sure how many market participants are attuned to this reality.

  3. Interest rates: Though there are divided opinions with respect to whether interest rates in India will increase or not, we believe that there is an upward bias to the same. Starting this fiscal year, the need for money from the government's perspective has shot up, in light of high crude prices. Corporates continue to borrow and that is reflected in the non-food credit offtake (over 18% growth). Inflation has been benign till now. But it may not be the case, given the price hikes. All put together, an upward bias for interest rates exists.

India is not alone…
Index 23rd Sep'04 23rd Sep'05 Change
Kospi 830 1,176 41.7%
Sensex 5,539 8,223 48.4%
Nikkei 10,895 13,159 20.8%

Where to from here?
We believe that expectations are the key to how the stock market is likely to perform going forward. Expectations in terms of earnings growth, valuations and Foreign Institutional Investors (FIIs) money flow. From a retail investor's perspective, we suggest to hold on to your asset allocation. A bull market or a bear market does not and should not change the risk profile of the investor. Discipline is the key. Let the market participants say what they like. Ultimately, whether you buy or sell (make money or not), your broker will be happy!

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