Sensex The Next Move

Have you ever experienced what happens when you are driving high-speed on an expansive highway and then suddenly come to a grinding halt and get stuck up after moving into a narrow lane? Your feeling of frustration, irritation, impatience and exasperation would be writ all over your face. And your feelings would get heightened further if you see some of the vehicles on another parallel road moving at a normal pace. But your indignation reaches peak when you see two wheelers being driven on footpath and moving ahead despite the logjam.
Something similar seems to have happened with Sensex. While the smart upmove of Sensex from March 2009 to September 2009 was more like a drive on a highway, its movement since September 2009 till date has been more like a vehicle entering a narrow lane. Sensex remained range-bound during this period even while some of its global peers moved upwards which is like the movement of vehicles on the parallel road. The scrip-specific movement in mid-cap as well as small-cap are like the two wheelers driving past and moving ahead of you.
Surely, there is some paradox in terms of movement, since despite India being the second fastest growing economy in the world, it is not among the best performing markets. Just to quantify, Sensex is up by 56 per cent in the last 52 weeks, while some of the Asian stock indices did much better, with Jakarta Composite (Indonesia) going up by 76.60 per cent, Straight Times (Singapore) by 59 per cent, Colombo Index by 126 per cent, SET (Thailand) by 56 per cent and Russia by 92 per cent. On a year-to-date basis also, Sensex underperformed other indices going down by 0.50 per cent while Jakarta is up by 14 per cent, Pakistan by 12 per cent and Colombo by 22 per cent.
We at DSIJ strongly feel that the Indian market would catch up with the other stock markets. On the face of it, Indian stock indices have gone nowhere in the last six months but dig a little bit deeper and one would notice that a lot has changed. We would be looking at the next big move for the market – and we believe that it would be an upward move. There are various reasons for our belief, so let’s look at these reasons one by one.[PAGE BREAK]

Great resilience to global factors
Improving global economy is going to be a major positive factor for the economic recovery in India. The stimulus packages have provided the desired result and the global economy is showing signs of recovery. Japan’s economy is on a growth path and Germany as well as France have already come out of the recession. The US is also technically out of recession. But while the world economy as a whole was improving, there were certain country-specific issues that were creating a negative impact and impeding market upmove.
First was the Dubai World (an investment company that manages portfolio projects for the Dubai government), where the debt-laden company was expected to go bust. The impact was seen all over the world, with the global indices declining sharply on a single day. But the effect was short-lived as resources were arranged immediately to save the company. Indian markets were quick to rebound and the losses were made good within a few trading sessions. A similar knee jerk reaction from the market was seen when Goldman Sachs officials were summoned by the US Securities Exchange Commission for alleged misrepresentation of facts to one set of its investors.
During the same time, Greece’s imploding economy created ripples in the world stock market including India. Decades of reckless spending and poor policies resulted in Greece’s deficit rising to 14 per cent, which is much higher as compared to the 3 per cent limit set by the Euro Zone. Markets reacted more when the Standard & Poor’s reduced the debt rating of Greece to junk and reduced the ratings for Spain and Portugal by a few notches. But the International Monetary Fund came to the rescue and, as a result, the markets have recovered globally.
Even as the markets were just about to come out from the blows of Greece and Goldaman Sachs, another potential crisis appears to be brewing right across our border. It is believed that China’s real estate market is heated up and is on the brink of a collapse. Even its banking sector is reeling under huge non-performing assets. Now, with such critical economic imbalances, if China sneezes the whole world would catch a cold as China is the driving force behind the world economy.
But during such uncertain times, Indian markets have shown strong resilience (by not falling much) to the global fallouts. The Indian economy has been more resilient to the fallouts of the global financial crisis and was quick to bounce back. The Indian markets have mirrored the strong fundamentals and growth prospects of the Indian economy by bouncing back,” avers Sarabjit Kour Nangra, VP – Research, Angel Broking.[PAGE BREAK]

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Of course, it is true that global events lead to risk aversion as fund managers take out money from the emerging markets. But there could be more sentimental reasons rather than fundamental reasons for pulling out from markets like India. Emerging markets are the places where actual growth is happening. Further, if one recollects, the developed markets were the hardest hit on account of financial crisis while emerging markets were the ones which had weathered the storm well. So FIIs pulling out seems to be a rare possibility for the Indian markets. Rather, the FII inflow figures have been quite positive which indi-cates that there is a huge appetite for Indian equity. In the first three months itself the FIIs were net buyers to the tune of Rs 20,644 crore (See Table: FII Investments). This is the biggest positive for the Indian market. “With Indian economy expected to grow at 8 per cent which consequently drive the corporate earnings growth, the Indian equities would continue to remain on the radar of the global investors”, says Nangra. Concurring with this view, Satish Ramanathan (Head – Equity Sundaram BNP Paribas AMC) says “Definitely, receiving global money is a positive aspect for the Indian markets, otherwise the markets would have fallen by a significant amount. So, we are extremely lucky to receive the global money”. Dhiraj Sachdev, VP & Fund Manager, HSBC Asset Management, agrees and says “FII participation is likely to continue on the back of conviction of India’s sustained GDP growth driven by strong domestic demand.”
But what makes Indian market more exciting is that Warren Buffet, the legendary investor, very recently announced his plans to visit India. Obviously, he is looking at taking exposure in the Indian market. Buffet also believes that there are definite signs of recovery in global economic and that should help world stock indices to do better. Motilal Oswal, Chairman & MD, Motilal Oswal Securities, says “India is one of the major destinations for FIIs to invest and they have been net buyers in a major way in CY10. The global market sentiment will have some impact on the Indian market, but so far it does not look like doing much damage domestically.” He further adds “Indian and the global markets are co-related in many ways. So any bounce-back in the global markets may reflect more than proportionately in Indian markets than other global peers”.

But China still a concern
While most of the global markets are indicating better days ahead, the only concern is about China. The real estate prices in China are touching unrealistic levels and most of the analysts expect the bubble to burst. With banks lending heavily to this sector, the impact of the bubble burst will be much more severe than expected. The immediate or a near term impact of the same on the Indian markets is expected to be negative as sentiments towards the emerging market may turn negative. But the long term impact is expected to be positive as Indian markets will be on radar of foreign investors as India will still be the second fastest growing economy with stringent policy norms. But sectors such as metals would get impacted due to lower demand from China and hence one should adopt cautious approach to metal stocks.[PAGE BREAK]

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Retail investors not participating
Retail investors are an important and integral part of the Indian stock market and their participation is important for the market to move upwards. Till now, retail investors are not very active as is evident from the volume on the bourses and retail applications in the new public offerings. The average daily volume on BSE has declined from Rs 6,200 crore in September 2009 to just Rs 4,737 crore. The scenario is similar with NSE too which has also witnessed a sharp fall in its average daily volume.
But we expect retail investors to come back into the market soon enough. IPOs now are giving good listing gains and this should excite the investors. Till date, total 27 IPOs tapped the market in 2010, out of which as high as 67 per cent are trading at a significant premium to their offer price. In the past, it has been observed that listing gains attract retail investors.
Also, there has been dramatic change in the volume composition in trading. The ‘B’ group counters have seen substantial improvement in their volumes and that too with higher market cap. Despite declining overall average volumes, the B group counters’ volumes have risen smartly.  Today, the B group counters’ volumes stand at Rs 2000+ crore as against just Rs 336 crore in Feb 2009. What has come as a pleas-ant surprise is that trading volumes of A group and B group stocks are almost at the same level. This should attract retail investors as their scrips are gaining momentum, giving them a reason to churn their portfolios.
The higher volumes have had its impact even on the mid-cap and small-cap indices which have reported smart upmove beating even the benchmark Sensex. We have compared Sensex returns with BSE Mid-Cap and Small-Cap since 30th September 2009. The reason we took September 30 is because this is the first time (after global crash) that the Sensex has again touched 17,000. From Sept. 30, 2009 till date, Sensex has given returns of mere 1.63 per cent while the Mid-Cap Index gave returns of 11.37 per cent and Small-Cap gave returns of 19 per cent.  Dhiraj Sachdev, VP & Fund Manager, HSBC Asset Management, says “Although the markets remained range-bound, there have been strong stock-specific returns, especially in the mid-caps, outperforming the indices as a whole”. Gaurav Dua of Sharekhan observes, “What we have seen in the past six odd months is correction with a consolidation trend in benchmark indices. The action shifted to mid-cap space due to large valuation gap between large-caps and mid caps”.
In addition, data for the last 15 days shows that the number of counters hitting 52-week highs or even all-time highs has increased significantly, thereby clearly indicating a stock-specific market movement. Further, there was a good amount of sector-specific movement, as seen in the metal and healthcare sectors which have gained more than 20 per cent since September 30th 2009. Apart from that, IT, FMCG, banking and auto indices also witnessed more than 10 per cent upmove. (See Table: Performance of Various BSE Indices). The only laggards have been oil & gas, realty and telecom providing negative returns during the same period.[PAGE BREAK]

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We are virtually above the 21,000 level
In order to get a proper perspective of the scrip-specific movement and rangebound movement of Sensex, we carried out a study where we calculated the current market capitalization of India Inc which at present stands at Rs 61.65 lakh crore. Not many would be aware but this is the highest level ever – much higher than when the Sensex was at 21,000 level. At 21,000 level, India’s market cap was at Rs 57.96 lakh crore. In other words, we are at six per cent higher market cap as compared to 21,000 levels. There are certain sectoral Indices such as automobile, IT, FMCG and healthcare which are trading at higher levels than the levels of these indices when the Sensex touched the 21,000 level. So, although the Sensex is not showing 21,000 level, we have virtually crossed that level.
Another factor is that the market cap on 30th September 2009 (when the market touched 17,000 level in 2009) was Rs 57.08 lakh crore which is lower than the current market cap. Even if we deduct Rs 1.84 lakh crore, we are still much ahead. Even the advance-decline ratio shows that there are more advances since 30th Sept (See Table: Advance-Decline Ratio). So, this also indicates that while the Sensex has remained stagnant, other counters have moved up sharply.

Monsoon likely to be above average
Monsoon plays an important role in India. But last year, monsoon played a spoilsport and some impact was seen on the stock markets also. Deficient monsoon resulted in negative growth in the agricultural sector, which ultimately proved to be a drag on the overall GDP growth. Now the Indian Meteorological Department has predicted that this year the monsoon would be normal. But last year too the IMD had expected a normal monsoon, but after some initial good phases, there was a dry spell. So only time will tell how the monsoon season is going to pan out. However, if the monsoon gods smile, it will surely create a positive impact on the Indian markets as there will be a good supply of food commodities which in turn will result in lower food prices and ultimately lower food inflation. It was food inflation which resulted in higher inflationary spiral. In addition, the base effect of inflation is also expected to result in the WPI inflation coming down. “On the inflation front, I feel that it is currently close to peak and is likely to taper off to about 5 per cent in the second half of the present fiscal due to base effect and better rabi crop”, clarifies Dhiraj. This may result in RBI not taking stringent policy tightening measures.[PAGE BREAK]

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Resolution of RIL-RNRL Issue
For retail investors, the RIL-RNRL is a real concern. Investors need a trigger and the real trigger has always been Reliance. The moment the verdict on the RIL-RNRL case comes, the markets may break its gloom. Since RIL has the highest weightage in the Sensex and the heavyweight counter has not been moving anywhere in the last few months on account of factors such as lower than expected financial performance and declining GRMs, the Sensex has also remained stagnant. A resolution of the RIL-RNRL issue would help improve the sentiments. Speculation is rife that a settlement will come in latest by next week. The verdict is also expected to come in soon, providing a much awaited trigger to the markets.

Earnings and Valuation
Indian market continues to be avail-able at attractive valuations. India Inc. March 2010 results are good and till date there is no major disappointment. If we take last four quarter earnings of India Inc (including expected March 2010 as only 969 companies have declared their results), the P/E works out to 20.80x which is much lower than what we witnessed when we were trading at 21,000. Even the Sensex P/E at 20x (EPS of Rs 885) would be much lower than 27x of DJ Asia Pacific and 23x of Thailand. According to IMF and Asian Development Bank, we are expected to grow at 8.5 per cent and 8 per cent respectively for FY11, and based on these numbers India Inc should grow at 20 per cent (2.5 times to GDP growth).
On the other hand, we expect FY2011 EPS for Sensex to be around Rs 1050-1075 which gives us forward P/E of 16.50x.  The market would start discounting future EPS by August 2010, i.e., in the next four months. A P/E of 16.50x would be interesting valuation, even for FIIs to start pumping money into Indian market. We would like to emphasize again that the global scare did have some impact on the Indian market in the last few months, but every time the market not only recovered but also made smart gains from that level. We advise our readers to remain invested in the market and use any dip as a good opportunity to build a long term portfolio.