Dec 14, 2005|
Stockmarkets: What's it all about?
Every day, markets are hitting new all-time highs. The economy is growing at a fast clip of around 8%, corporate performance has been robust, the capex cycle is on the way up, affluence is on the rise and the offshoring story is playing out well. These are numerous reasons as to the cause of this phenomenal rise in the indices. In this write-up, we pause a bit, reflect on the causes of this two-and-a-half year bull market rally, fundamental or otherwise and examine the situation at present.
Strong fundamentals, the key
The amazing rally from the sub-4,000 levels in 2003 to the current 9,000+ levels has been powered by good performances of stocks across sectors. Stocks from the IT, cement, metals, banking, auto, FMCG and telecom sectors have all joined in the 'party to 9,000'. There have been numerous reasons for this rise. A swathe of liquidity was created by central banks globally, due to the accommodative monetary policies of these banks. This has led to billions of dollars flowing into the global financial system. With not too many places to park their funds, as developed nations did not offer good returns (the Fed funds rate in the US was at an over four-decade low of 1%), this money started flowing into emerging markets around the world, including India.
The 'India story' is well and truly on and more and more Foreign Institutional Investors (FIIs) are recognising that India has strong growth prospects. There is a lack of alternatives to invest in. Developed markets do not seem to be attractive. As a consequence, emerging markets like Taiwan, Korea and India continue to receive large amount of foreign funds. However, one must keep a close eye on the Fed funds rate, as, if the Federal Reserve keeps raising rates, at some point, some funds may flow out. Given our dependence on FIIs as 'market movers', one must be cautious if this happens.
As far as internal factors are concerned, interest rates during the period have been fairly benign. This has enabled corporates to borrow at cheap rates/restructure their debt and allowed consumers access to cheap credit. Due to strong demand, capacity utilisation increased, which was earlier at low levels. Cash flows increased as well, as no major capex was required in order to cater to increasing demand, since capacity utilisation increased from lower levels and companies started getting this to the limit before undertaking new projects.
But, what next?
All these factors have led to the strong performance of Indian equities over the past two-and-a-half years. However, one must now take a look at the present situation. At 9,200+ levels, the Sensex trades at a price to earnings (P/E) multiple of over 18 times trailing 12-month earnings. This is certainly not 'cheap' by any standards. We firmly believe that one has to take a stock-specific approach. The days of across-the-board gains are well and truly over.
In order to shortlist stocks, one can broadly divide the macro story into various themes, such as 'domestic consumption', which would include sectors like FMCG, consumer durables, PCs, telecom, tractors, auto, cement and retail. 'Outsourcing' could also be another major theme to play on, involving sectors like software, pharma, textiles and auto ancillaries. Plays on backward-linked companies for metals (steel) could also be an interesting bet, such as iron ore companies. Given the massive expansion plans of steel majors, demand for this raw material is expected to remain robust and as a result, growth prospects seem good for the medium term.
Of course, these are largely macro themes and as regards specific stocks, one needs to carefully study individual companies before arriving at a decision, as certain sectors might be interesting, but the companies in those sectors might be having completely different business models. Pharma, for example, may be an interesting long-term story, but then Cipla, Ranbaxy and Dr. Reddy's all have different business models. The risks in these different business models would vary and as such, one needs to understand these risks and then come to a decision.
To conclude, we would say, at the risk of repeating ourselves, that across-the-board rallies of the past few years are unlikely to continue. The markets have valued many stocks at their fair value and these may not be good bargains at current levels. Therefore, the best thing for all investors to do would be just 3 things - read, read and read! Only if you are convinced about the company, its management, business model and future prospects, go and take the plunge. As they always say, self-help is the best help. Happy investing!
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