Back With A Bounce

The current rally has largely been because of the extraordinary stimulus packages announced by the governments of various countries. For this rally to now sustain itself at these levels and valuations, it will need to be backed by corresponding upgrades in earnings’ estimates. Though industrial activity has picked up in many countries, unemployment rates in most of the developed countries remain at concerning levels. This is going to have an impact on the increase in demand from end customers, which in turn is vital for this momentum to continue. Hence the possibility of a W-shaped recovery still remains open.

Though the recovery in India has also been, to a certain extent, helped by the stimulus package of the government, yet, the Indian economy stands a better chance to sustain and outperform. At its current levels the Sensex trades around 16x of its FY11 estimated earnings, which is about 13 per cent premium to long-term average PE multiple. Hence, by no means are the valuations compelling enough for the markets to sustain at these levels. It will need to be backed by upgrades in earnings’ estimates. Coming to relative valuations, Indian markets historically have traded at a premium to other emerging markets based on certain factors viz. lower dependence on exports, better corporate governance, transparency and regulations, and a sound banking and legal system.

Also, the Indian economy has shown better resilience and the ability to bounce back quickly, which is likely to keep growth prospects better as compared to many emerging economies. India is the only country which has given thrust to growth as compared to fiscal deficit. After the turbulence seen over the last 12-18 months it was necessary for the government to step in and help the economy to stabilise and put it back on the growth path. Hence, fiscal deficit is likely to remain at elevated levels in the foreseeable future. Interest rates have bottomed out and may move northwards by the end of the current fiscal due to huge government borrowing and also to some extent due to the RBI policy action which may be necessary to contain inflation that is likely to start moving up from 3QFY10 onwards.

The next major trigger for the markets will be the Q2 results and the earnings’ upgrades based on the same. In terms of a long-term perspective, we are bullish about power equipment and the financial services sectors. Large power generation capacities being added all over the country will lead to increased business for companies engaged in the manufacturing of equipment required for the same. The financial services sector is still a non-penetrated area and there is lot of scope for insurance, banking, asset management and other services.
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Volatility is likely to remain high and though stock markets have run up sharply over the last four to six months, the equities will still outperform over a longer term. Therefore the weightage will be tilted in favour of equities. The actual stock/sector selection may vary depending on the risk appetite of the individual investor. I would also like to keep some portion of the portfolio reserved for precious metals. Our advice to retail investors is that they need to keep their expectation of returns at realistic levels and use any major corrections in stock markets to add good companies to their portfolio with a long-term view.