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Markets: Expecting the unexpected?

Oct 27, 2005

The markets continue to remain volatile as people buy and sell percentages of companies everyday, with no signs of recouping its lost ground. Retail investors as well as Foreign Institutional Investors (FIIs)'s continue to distance themselves from Indian stockmarkets and seem to have adopted a wait and watch policy. Although a large chunk of India Inc. has reported decent September quarter results, some are yet to be announced, while a small percentage have disappointed. However, even we agree that the markets had run up way too fast in the recent past, but then, is this the beginning of the 'end'. Investors seemingly thought that what Warren Buffet practiced or preached was all gibberish and wanted to become rich overnight. For them, stock markets seem the easiest way with anticipated risk to be much less than what is already inherent that stocks carry. In this backdrop, we recently conducted a poll on our website asking people's opinion on their desired rate of return over the next 3 years. The result was quite stiff, 25% said that they would be content with a return of 10%-15% per annum, 34% said they expected returns of anywhere between 15%-25% over the next 3 years each year, while the remaining 41% said they wanted returns in excess of 25% per annum from equities over the next 3 years. While we would not like to comment on any of these voting groups, we would certainly want to throw some light on some macro economic factors before we can reach some conclusion.

Below are some points one must ponder over before arriving at any conclusion with respect to return expectations:

Valuations: Although valuations of large cap stocks do not seem very stretched, the same cannot be said for mid and small cap companies' stocks. Investors have accorded to these stocks valuations at par with their larger peers and in our view, prices of most of these stocks have already factored in the future growth, atleast for the next one to two years.

Fiscal Deficits: The total fiscal deficit of the state governments and the central government is around 10% of the GDP currently. 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 gone 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). There is an upward bias as far as domestic interest rates are concerned, in line with the Reserve Bank of India (RBI)'s outlook.

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 economists, global liquidity is on the decline and is likely to impact the commodity and stock markets in the future.

All these factors put together, will cap earnings growth of Indian companies going forward. One must note that when the bullrun started, the US fed rate was around 1.0% as compared to 3.75% today and analysts anticipate this to go up further. All these factors clubbed together, will impact earnings of India Inc. going forward. We do not say that earnings will de-grow or that companies will post losses on a YoY basis. All we say is that hurdles have increased.

In conclusion, we emphasize that the stock market is no longer an arena, where one can expect dizzy returns like the ones in the past, although there can be some exceptions. Given the increased risk, investors should select stocks that fit into the risk-return matrix. Otherwise, there is likely to be disappointments in 2006 and beyond.

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