Sensex 21000 By March 2010

There is a wave of optimism spreading across the globe. The rocket-propelled upward movement witnessed in the stock markets in the last few months vindicates the optimism. No one would have imagined that most of the global markets would be trading at 16-month high levels on the first anniversary of the collapse of Lehman Brothers which had triggered crisis in financial markets worldwide and resulted in one of the most abysmal slowdowns since the Great Depression and down-trend in international equity markets. The euphoria is all-pervading, which is evident from the fact that since March 2009, when the global markets touched the trough, even the lowest return in the world market stands at whopping 38.40 per cent (from Shanghai  Composite). This is not all, the equity markets in India, Hong Kong and Singapore have bounced back to levels before the Lehman collapse happened.

Apart from the remarkable bounce-back, what is striking is the pace of recovery not only the developing markets but also in the developed markets within a span of just about last six months. Many on the streets (from Wall Street to Dalal Street) were taken aback as markets globally shifted gears to enter into a new orbit, but we were hardly surprised as we had already predicted a bull run not once but many times in the past.

So, there is an air of excitement amongst investors as they continue to witness the forward march of global markets. The euphoria in the market is palpable even as one counter after another hits the upper circuit, volumes rise and FIIs troop in with loads of money. It has been a dream run for the markets and nobody wants it otherwise. But with Sensex nearing the 17000-mark and Nifty crossing the psychological 5000 level, some confusion and doubts have also started creeping in. Is this rally sustainable or will it come to an abrupt end? Will the FII inflows sustain or dry up? Is the valuation of the Sensex reason-able? People have started speaking about the markets in terms of ‘ifs’ and ‘buts’. These are difficult questions with no simple answers. But as always, DSIJ will try to find out answers to these troubling questions like we have done in the past. Let’s put it on record: when everyone on the street was sceptical and uncertain, we have taken a bold stand and have been proved right.

Hitting the bull’s eye

 In the world of stock market, words are words and promises are promises, only performance is reality. At DSIJ, we have been performing on a continuous basis since last 23 years. It requires courage and conviction along with lot of efforts and hard work to take a firm stand and guide investors in times of uncertainty in the market.
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If investors would recollect that in March there was high level of uncertainty and everyone on the street was talking about decline in earnings and its possible impact on the stock market. However, our Editor’s Desk (Issue No 9 dated April 13-26, 2009) categorically stated that “March results season would blossom in full force in the coming days. This time results would not be on the same lines as that witnessed in the last few quarters”. It further stated that “We are of the opinion that all negatives as regards the results have been already factored into the prices. With two stimulus packages making their impact felt on the economy, many of the interest-sensitive sectors are expected to show decent gains on the margins. So, watch out for the better margins”.

Now not many in the industry had anticipated that the corporate results would be good for the March quarter. So, when the results were declared everyone on the street except us was surprised. But let us remind our investors that it was not a fluke and our cover story ‘Bull Is Back With a Bang!’ (Issue No 12, Dated May 25-June 7, 2009) vindicates the same. In this case too, when many in the industry stated that the euphoria in the market may not last long, our Editor’s Desk categorically stated that “With March results better than expected, we are again poised for another bull run. Risk appetite has again gone up amongst institutional investors not only for the Indian markets but all across the world” But here was the masterstroke: “I am expecting the Sensex level of 16500-17000 by December 2009”. And with Sensex now trading around 16800 we take pride in reminding our investors that have been proved right.

But that’s not all. In January 2009, we had stated that equity is the best asset class to invest in 2009. The rest, as they say, is history. Our high quality of research is also vindicated by the fact that we have achieved 100 per cent strike rate for Low Price recommendations. (See table: Complete list of Choice Scrip and Low Price)

What does the future hold?

But all of this is history and stock market investors are always keen to know about the future rather than the past. Since we have hit the bull’s eye predicting the market movement in the past, investors will now be more than curious to know our take on the market at the current level when it is trading at 16-month high. So, we have analysed the market in terms of positive and negative factors to find out where it is heading in terms of market direction from the current levels.
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Abundant liquidity

Liquidity is a prime factor and basic ingredient for movement in the market. Without liquidity, it is impossible for the market to sustain its upward movement. It would be recalled that the collapse in 2008 happened due to liquidity crunch in the global markets. However, with leading financial players such as Goldman Sachs, Citibank, Morgan Stanley, JP Morgan Chase and Bank of America now in sound position, things are looking good on the liquidity front. Further, there is abundant liquidity in domestic market also. This is evident from the fact that the credit growth has been decelerating below deposit growth. The credit growth has moderated to 14.1 per cent as of end-August 2009 from 17.3 per cent as of end-March 2009. The deposit growth, on the other hand, remained strong at 20.5 per cent as of end-August 2009 as compared to 19.8 per cent as of end-March 2009. This has created abundant liquidity in the sys-tem. In technical terms, excess liquidity, including net repo balances and market stabilisation scheme bonds, is to the tune of Rs 145,000 crore. In addition, banks’ investments in liquid mutual funds are about Rs 150,000 crore. All this signifies that there is ample liquidity in the system.

FIIs Flocking With Money

Historically, large foreign institutional investors (FIIs) have been the major drivers of the market. FII inflows have been the major driver of the current market rally. Since the start of the rally in March 2009, FIIs’ net buying has been to the tune of Rs 58,075 crore and in 2009 it is Rs 49669 crore. Contrast this with the net outflow of Rs 52,987 crore in 2008 and the spectacular turnaround in FII money is evident. Actually, we have got back almost 93 per cent of money taken out by FIIs in 2008.

The moot question, however, is: will this trend continue in future too? Amitabh Chakraborty, President (Equity), Religare Capital Markets, says “Until December 2009, FII flow will be positive as India provides growth and a stable government adds to the investment thesis”. We are of the opinion that FII inflows are expected to sustain on account of certain factors. The first factor is that the rupee is appreciating against the dollar, which provides a very good hedge to FIIs.

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In the simple terms, they are investing in rupee and even if the market moves southwards, they will still make money on account of rupee appreciation. K R Choksey, CEO & MD, K R Choksey Shares & Securities, says “With the import bill going down, it might result in Indian rupee strengthening and further attracting the FIIs”. Secondly, the improved political stability in India is also an important factor. Thirdly, the huge FII outflows in 2008 happened due to global liquidity crunch, with parent companies of FIIs badly in need of funds. This situation no longer prevails and hence net outflow is ruled out. Lastly, FIIs like growing economies and India would continue to be the second fastest growing economy in the world after China.“On relative basis, Indian markets will be one of the fastest growing markets in the world. So the relative performance would definitely force FIIs to pump more money in the Indian market,” says A N Sridhar, Fund Manager-Equities, Sahara Mutual Fund. Also, FII registrations in India since last one year have showed marked improvement.

Retail investors will make a comeback

Retail investors will come back as there exists a huge retail appetite for equities among them. Most of them have missed the bus in the current rally and they have been sitting on the sidelines tracking their existing portfolios. This is evident from the lukewarm response recent IPOs got on the retail front.
However, they seem to be gradually making their presence felt in the secondary market. Growing retail investor interest can be gauged from the fact that indices tracking the SME space have outperformed the leading indices in the last one month. Also, rising trading volumes in BSE’s B-group stocks is an indication of growing retail participation. The B group attracted daily average volume of 30 crore shares and turnover of Rs 1753 crore in September 2009, as compared to volume of 16.6 crore shares and turnover Rs 1,005 crore in July 2009.

Global economic recovery

Stock markets are considered to be the barometers of country’s economic health and stock markets usually recover ahead of the economy as it is a leading indicator. Look at the year-to-date performance of the global indices, the changing scenario both on global and domestic front is quite evident.
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Let’s first have a look at the global scenario. With stimulus pack-ages taking the desired effect, global markets are showing signs of recovery. Japan’s economy is on the growth path in the second quarter, while Germany and France have already come out of recession. The US is also said to be out of the woods and Ben Bernanke, Chairman, Federal Reserve, has indicated that the recession in the US is over in technical terms. Further, lower new jobless claims, improved consumer confidence index, revival in real estate market and the increased industrial production figures only indicate recovery in the US economy. Even the commodity cycle has recovered in quick time as firming prices indicate return of confidence in the economy. Not only base metals, even precious metals have seen a spurt with gold now trading at all-time high.

Improved domestic scenario

There has been marked improvement in the economic scenario on the domestic front also, with many factors indicating towards economic recovery. Growth in Index of Industrial Production (IIP) has been very strong in past few months. GDP growth is expected to recover and is estimated at 6.5 per cent for fiscal 2010. Even the 6.10 per cent of GDP growth in first quarter is much higher than the 5.1 per cent growth in the preceding quarter. “We see the good economic growth going forward and India is going to be amongst the fastest growing countries,” says Sridhar. Other factors indicating economic revival are increased consumer spending, fresh hiring by companies and sectors like real estate, automobile and cement witnessing higher sales numbers. The two-wheeler sales growth accelerated to an average of 18.3 per cent on Y-o-Y basis for three months ended August 2009, as compared to the negative 9.9 per cent registered in the December 2008 quarter. Ditto with passenger car sales. The increased advance tax numbers indicate that better corporate performance is expected in September quarter too, while improved excise collection indicates rising manufacturing activity. “Gradually, the markets might get better as excise and advance tax collection figures are good, while the major happening on the energy (oil & gas) front will fundamentally help India in the long-run,” says Choksey.

Deficiency monsoon not a concern

Deficient monsoon, which till July was 54 per cent below the long period average, was expected to play spoil-sport, but lately the situation has improved with the deficiency now just 20 per cent. Also, with the share of farm income in total rural income is now lower than 50 per cent (as per government report), fall in agriculture output no longer has very severe adverse impact on rural demand. Hence, despite deficient monsoon, automobile and cement sales figures not only improved on Y-o-Y basis but also improved on M-o-M basis.
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Infra focus will pay off

It is stated that Re 1 invested in infrastructure projects generates Rs 10 and hence focus on infra is the key to growth. We had earlier stated that government spending on infra will improve, which will have a positive impact on growth.
UPA government’s focus has been good and infrastructure spending in India would be about 5.8 per cent of GDP in FY2009. But infrastructure spending is expected to accelerate to 6.5 per cent of GDP over the next 12 months. “The government would complete almost one year till March 2010, so till then sound policies will be on track,” says Sridhar. The government is targeting building 7000 kms of roads every year, thereby implying building 20 kms of roads per day.

Better corporate results

One of the important factors in the current rally has been better than expected corporate results in March 2009 and June 2009 quarters. The Q2FY10 (September 2009) results are also expected to be better, if one goes by the advance tax numbers. The momentum is expected to be carried in the next two quarters too. We believe that most of the sectors are in for good earnings. While automobile sales growth is expected to sustain on account of recent pay hikes for government employees, cement sales are expected to remain buoyant on account of increased infrastructure spending and revival of real estate sector. In our previous cover story, we had analysed the banking sector and with expected increase in capex, capital goods sector is also set for a better second-half performance. IT companies have already showed signs of recovery and the improvement in global scenario is only helping them. “We expect stronger year-on-year growth in the remaining quarters of the current financial year,” says Harsha Upadhyaya, Vice President & Fund Manager, UTI Mutual Fund.

While the aforesaid positives would provide a boost to the market, there are certain other factors which can create a roadblock in the upward movement of Sensex. Now, let’s look at some of these factors.

Stimulus packages are taken back

As stated earlier, the stimulus pack-ages provided by the governments have been paying off now and global recovery happening. But what if the stimulus packages are rolled back?
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It’s common knowledge that recovery has happened on account of stimulus packages and sudden withdrawal of these power boosters in the form of additional capital, tax incentives and even loan waivers will have a negative impact on the markets. As for India, the Finance Minister has stated that stimulus packages are here to stay and this is good news. But globally, the packages have been much larger and their sudden withdrawal would be bad news indeed.

IPOs may spoil the party

IPOs are an indication of promoters’ confidence in market’s sustain-ability. Retail investors consider it as an opportunity to make money. Also, PSU companies tapping the primary market is good news for the markets. So, how could IPOs play spoilsport? It’s because higher pricing by promoters hardly leaves anything on the table for the investors. A look at the recent IPOs reveals that in 2009, except for Edserve Softsystems, hardly any IPO has created value for the investors.

Mahindra Holiday & Resorts, Globus Spirits, Adani Power, NHPC, Oil India, Jindal Cotex were sold at higher valuations. It may be recalled that in 2008 large IPOs such as Future Group and Reliance Power were too ambitiously priced, triggering a decline in the market. So, a repeat of this could impact market sentiments. We feel it is high time at least the government takes the lead and prices the IPOs so that something is left on table for the investors.

Geopolitical risk, rising fiscal deficit and interest rate are concerns

Volatile geopolitical situation is been one of the concerns, although its impact is for short term. Terrorist attacks such as 26/11 in Mumbai or serial bomb blasts of 1993 negatively impacts market sentiments. Our Home Minister has recently warned of more such attacks being planned. If this actually happens, it will not only hurt tourist arrivals but also spoil business environment for the short term. Any move by the Reserve Bank to rein in inflation will adversely impact the markets. “Inflation is expected to rise to 8 per cent by March 10, and RBI will hike rate, sooner than anticipated,” opines Amitabh. But we think inflation till now has not been a major worry and hence RBI’s action on this count is a remote possibility.

India’s consolidated fiscal deficit is estimated to cross 11 per cent of GDP in the FY2010. The rising fiscal deficit will lead to higher government borrowing, which will ultimately result in higher interest rates, thereby impacting the growth. But since the government is currently focusing on growth, any policy action on this front seems unlikely.
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High valuations are a hurdle
In the stock market, it’s valuations that make anything good or bad. So, is the Sensex overvalued, undervalued or fairly valued? If we look at the Sensex P/E at 16,719.50 levels, it is trading at 21.65x. The street expects the Sensex’s EPS for FY10 to be Rs 900-910. Considering these estimates, Sensex at 21000 results in P/E of 23.33x. Although it is lower than other global markets, we feel at these levels valuations are not cheap. Our sense is that on its journey towards the 21000 mark, market may witness a meaningful correction. However, we feel the downside will be capped at 14000-14500 level.

Going ahead, investors should look out for December 2009 and March 2010 results that would be much bet-ter. The Finance Minister has stated that Q4FY10 will be the best quarter, hence investors can look forward to  better earnings in FY11. Sensex being a leading indicator, market should start its fresh journey by December 2009 and then one can expect 21000 by March 2010.