DSIJ Mindshare

Has The Bull Run Begun?

It has been almost two months now that we, at Dalal Street Investment Journal, have been harping upon the fact that India’s structural strengths as a growth economy are intact. All the gloom surrounding the economy in general and the markets in particular is about to dissipate soon, and the markets look like they have a good chance of resuming what some would like to call a SECULAR BULL RUN. With most of the issues already beginning to mellow down to levels that are now seen to be manageable, it is just a matter of time before we actually find ourselves in the midst of a full- blown bull phase.

Of course, like all good things in life, it pays to take stock of the factors that will take us there and be careful of the pitfalls that could surface. It is well known that over the recent past, the markets have evolved in such a manner that it is just about unpredictable as to when the bulls would be down on their knees and the bears would be ready with their claws drawn, which could tear off your portfolio returns.

Coming back to the most important question that we are seeking to answer here – has the bull run begun? Here is what we think is happening.[PAGE BREAK]

The Current Situation

So, what does the current market situation look like? Well, it seems to be quite confusing. The macro-economic fundamentals aren’t exactly encouraging, with lower IIP growth, slower GDP growth and higher inflation. On the other hand, the markets have witnessed a good up-move. The Sensex has gone up by nine per cent since the end of May 2012. The MSCI India Index has also witnessed an up-move of around 11 per cent in the same  period. The markets have defied all the negativity surrounding it, moving smartly upwards in the last three months.

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Despite the slowing GDP growth (6.5 per cent in FY12 and a much lower 5.5 per cent for the first quarter of FY13), FII investments have continued unabated. Year till date, we have seen a net inflow of USD 12.2 billion, out of which around USD 2 billion was pumped in the month of August alone. Importantly, the Reserve Bank of India’s steady refusal to lower key interest rates has also been factored in by institutional investors.

Naturally, confusion persists. With the macro data not being very supportive, what is driving the markets? Many on the street are surprised as the markets are seen shifting to a new level, but we aren’t. We had already pointed out the silver lining to the markets in our issue dated 15th July, 2012. Thereafter too, we have remained positive about the Indian equity markets and are being proven right by the way the markets have been behaving.

The euphoria is back, with FIIs flocking in with tonnes of money and the volumes rising day by day. The market movement is quite surprising, but surely no one would want it to get jinxed. The question on people’s minds is, is this rally sustainable or will it meet an abrupt end?

While everyone is looking for clues, like always, we at DSIJ, have some answers to these troubling questions. We believe there are factors that are pointing towards a further upside for the markets.[PAGE BREAK]

Valuations

This is not the first time that we are mentioning the fact that the stock markets are all about valuations. In the markets, it is the valuations that make anything look good or bad. Be it a particular stock or the overall markets, smart investors always buy when the valuations are attractive and try to sell when the valuations are stretched. Hence, the most important factor that needs to be looked at while deciding on whether a bull run has actually been flagged off is whether the valuations are at levels which suggest a buying opportunity.

Dinesh Thakkar, CMD, Angel Broking, says, “With the markets underperforming since such a long time, the valuations are at multi-year lows of just about 12.5x the FY2014 earnings”. At the current levels, the valuations look quite attractive, and hence, the risk-to-reward ratio is favourable for investors.

Gaurav Dua, Research Head, Sharekhan, adds, “Valuation multiples have corrected to around 13x-13.5x (based on the year forward consensus estimated earnings of Nifty), which is at a 10-15 per cent discount to the long period average multiples”.

Before getting into the valuations, here are some other factors that are indicating that the markets have just one way to go unless some major worry erupts somewhere to spoil the party of the bulls.[PAGE BREAK]

June 2012 Results – Signs Of Positivity

In our previous issue (DSIJ Vol. 27, Issue No. 19, dated Sept 9, 2012), we had spoken of the positive signals that are emerging from the June 2012 quarter results. We had categorically stated that though the  quarterly results appear gloomy on the surface, there are certain key positive takeaways. Increased depreciation costs (which had witnessed a decline in the preceding two quarters) led by Large-Caps indicates that the capex cycle has not come to a standstill and companies are still going in for a good amount of capex. Secondly, though a negative impact on margins was visible in the June 2012 quarter on a YoY basis, the scenario was better than that in the March 2012 quarter, which had witnessed a severe impact on margins. We had also quoted that the earnings downgrade for FY13 is over, and we may see some betterment in H2FY13.

Considering all these factors, we believe that India Inc. is heading towards a better September 2012 quarter. Inflation has cooled off to some extent in the month of July, with the WPI at 6.87 per cent and CPI marginally lower than 10 per cent. We also feel with the rainfall deficit remaining only at six per cent after adequate rains in August 2012, there is little reason to see pressure on the WPI, which may see some moderation going forward.

Sustained high interest cost has been haunting India Inc. for a while. However, with inflation showing signs of cooling down, we may see some easing on the interest rate front. Though the RBI may not go ahead with rate cuts in its next meeting, one can expect banks to take one step ahead in the direction of a rate cut.[PAGE BREAK]

This, however, is slightly contradictory to what experts feel. There is a rising consensus emerging among experts that the RBI would probably go in for a rate cut at its ensuing meeting slated for 17th September, 2012. If this happens, the markets would be propelled further, adding strength to our conviction of the next secular bull phase.

Another factor that impacted the results of India Inc. was the volatility of the rupee against the USD. While it is true that the rupee has depreciated by 4.2 per cent year till date, this figure masks the volatility in between. After starting the year at 53.29 per dollar, the rupee gained in strength to touch 48.67 per dollar, depreciated to 57.21 again, before stabilising at around 55 currently. This volatility led to large forex losses for many companies, impacting their bottomline.

Nevertheless, in the last one month, the rupee has stabilised around 55 per dollar, and many feel that it will appreciate going ahead. As we have mentioned in the past, one can expect the rupee to touch the levels of 53 to a dollar in Q3 and Q4 of FY13. This will definitely help India Inc. to post better numbers as we have seen in the past, which is also reflected in the current export figures (India’s exports in July 2012 contracted 14.8 per cent, the steepest fall in three years). A dearer rupee does not help exports, but a cheaper rupee will definitely help to lower import costs.[PAGE BREAK]

Earnings Downgrades Over – Expect Improvement Ahead

As we know, the stock market discounts future earnings. Currently, the best part is that the earnings downgrades are already done with.

In this regard, Thakkar says, “The markets have already downgraded the EPS estimates substantially for the year as a whole, so I don’t expect further downgrades”. Hence, one can only look at improvement going ahead. With deteriorating macro data, the Sensex earnings growth estimates were curtailed significantly since the past one year.

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For FY13, the consensus EPS levels for the Sensex were downgraded from Rs 1471 in March 2011 to Rs 1213 in August 2012.

With some support on the inflation front, the expected improvement in margins (expected decline in commodity prices) and some improvement on the reforms front, we believe that the earnings downgrades are over now. The growth would be led by sectors like FMCG, banking, pharma and IT. Some improvement is also expected in the capital goods segment, for which the estimates have been improved significantly. Some pick up in the capex cycle and a fall in commodity prices are expected to bode well for the capital goods companies.[PAGE BREAK]

Contributors To EPS Growth

For FY13 as a whole, the EPS for the Sensex is expected to come at around Rs 1215-1220. However, the moot question is who will contribute to the EPS growth from Rs 1127 in FY12 to Rs 1215 in FY13. The major contributions would be from ICICI Bank (Rs 17), SBI (Rs 14) and HDFC Bank (Rs 13). TCS and Infosys are expected to contribute Rs 11 and Rs 10 respectively.

On the negative front, Tata Motors is expected to witness a decline of Rs 11, followed by Reliance Industries at Rs 6, while Bharti Airtel and ONGC are expected to see a decline of Rs 5 each.

As regards FY14, the EPS is estimated to be around Rs 1380-1385. Here too, the bulk of the contributions will again be from SBI (Rs 17), HDFC Bank (Rs 16) and ICICI Bank (Rs 15). After witnessing a decline in FY13, Tata Motors is likely to contribute Rs 13 in FY14. In addition to these, HDFC is also expected to add Rs 12 in FY14.[PAGE BREAK]

FIIs Expected To Flock In

While India is being held hostage to its own domestically-driven macro challenges on a relative basis, the country stands out among its BRIC peers, which is another indication of a better tomorrow.

The MSCI India Index has seen the shallowest downward revision to the consensus earnings. Data collected by Deutsche Bank clearly indicates that the EPS estimates for the MSCI India Index have been revised downwards by just two per cent. This is much better than the 15 per cent revision for MSCI Brazil and the five per cent revision for MSCI China. In fact, the report suggests that the velocity of the downward revision has accelerated for countries like Brazil, China and Korea, whereas the earnings for MSCI India have stayed stable. This also suggests that India is attractively placed against the other BRIC countries. It is no wonder then, that India has witnessed a strong inflow of Rs 63011 crore (USD 12275 million) in 2012.

Since the valuations of Indian markets are still comparatively cheap, we expect more inflows going ahead. Consequently, the combination of global liquidity and the return of flows to the emerging markets should drive the Indian equities higher. In 2009 too, FIIs were the prime factor behind the strong bounceback in Indian equities.

For a more sustainable rally, however, the policy environment in India will need to improve considerably.[PAGE BREAK]

Policy Improvement On The Anvil

The markets are hoping for measures from the government, and the most likely one is to curb demand pressures and the fiscal deficit through a diesel price hike. The government is also focussing on reviving the investment cycle by allowing increasing FDI limits in multi-brand retail and aviation, as well as faster clearances for investment projects.

While the coalition dynamics continue to play spoilsport, fears of a sovereign rating downgrade may compel the government to move ahead on the politically contentious issues already mentioned, i.e. FDI in multi-brand retail and fuel price rationalisation. Once the roadmap for these changes is cleared, we can expect more upside to the markets.

Recent developments like the conditional approval to RIL for KG-D6 spending budgets (after a long hiatus) suggest that the government is trying to reach out to India Inc. The recent deferment of GAAR on the recommendation of the Parthasarthi Shome committee is also an indication of the same. We expect more such decisions to come in before the monsoon session of Parliament draws to a close.

Further, with the deadline nearing for ensuring a minimum 25 per cent public holding (June 2013 for private players and August 2013 for PSU), the government will try to keep sentiments in the market upbeat ahead of its divestment plans. Even at the current price, PSUs will have to sell additional equity amounting to around USD 19 billion. With the government targeting better divestment figures, we expect it to take some solid policy action now.[PAGE BREAK]

Change In The Political Scenario

The political scenario has not been very encouraging, and in fact, this has been one of the major worries afflicting the markets. Vijay Chopra, Head – Advisory Desk and Channel Sales, Fullerton Securities & Wealth Advisors, opines that, “The politics and politicians of our country have to overcome the policy logjam and move ahead towards improving the investment sentiment”.

This situation could change in two ways. Either the ruling party leadership realises that it is time they take some strong decisions and kick in the right reforms process to change the market environment to a positive one, or there is a completely altered scenario wherein we witness early elections. We believe that either of these possibilities spells a positive for the market.

The change in ministerial portfolios after Pranab Mukherjee was elected as the President suggests that Chidambaram would usher in the same agility in the economy which he had in his earlier stint as Finance Minister. If this doesn’t happen and there are early elections, a change in guard at the Centre backed by some strong decision making could possibly usher in good times on the economic and market fronts.[PAGE BREAK]

Valuations – More Scope For Up-Move

We have already mentioned that the EPS for FY13 is estimated to be around Rs 1213. Based on that, the FY13 Additional EPS Contribution FY13E earnings discount the Sensex by 14x. On the basis of the FY14E EPS, the markets are trading at 12.50x. We are of the opinion that these valuations suggest a good upside for the Sensex.  This is much lower as compared to that of 16x that the Sensex has traded at over the past five years.

These valuations are at the trough, and we have hardly considered any policy improvement in these. If positive steps are taken on the policy front, the earnings guidance will only improve.Leading broking houses are expecting another eight per cent improvement in the FY13 EPS if reforms take place. This will take the FY13E EPS to Rs 1310 to Rs 1312. So, if upgrades happen,  expect another up-move in the Sensex.

Further, keeping the FY14 expectations at Rs 1380, we believe that the valuations at 12.50x on the one year forward earnings (FY14) leave enough room for investors to chase the markets once the roadmap for reforms is  established, even if the initial upside is missed. Even at 16.50x the FY13 earnings, the Sensex can touch the levels of around 20000. Hence, with the markets trading at better valuations and the government set to bring in reforms, one can expect sentiments in the markets to improve and take it to a  new orbit altogether.[PAGE BREAK]

DSIJ spoke to some market experts to get their views on whether they feel that the signs are conclusively pointing at a fresh bull run. Here is what they had to say...

Ambareesh Baliga
Market Analyst

Under normal circumstances, we could have dubbed this as the beginning of a new bull run as the markets have been steadily moving up, backed by strong FII flows and some of the leaders in the market making lifetime highs. The only logic that does not fall in line is the fundamentals of the economy and the visibility.

I was looking forward to a new bull run sometime in the beginning of June 2012 based on the ‘new window’ which had opened up for the government to push reforms through. The imminent move of Pranab Mukherjee from the Finance Ministry to Raisina Hill had opened up an opportunity for the Prime Minister to get the economy on track. The political fabric too seemed more conducive, with the trouble makers put in the dock and the international and domestic pressure that was building up on the government to reverse the damage caused due to policy paralysis in the last three years.

Alas, they have lost this opportunity too, and now it looks like most of the political parties are preparing for a poll earlier than 2014. Even in case of a mid-term poll, we don’t see any clear winners as of now. Under these circumstances, I don’t believe that this could be a new bull run … liquidity can move it up temporarily, but unless fundamentals support, the up-move can’t be sustained.(...Continued on following page)[PAGE BREAK]

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Ours has been among the better performing ones among the emerging markets, and hence, liquidity flows would continue to be a major driver. Though the upside is limited due to the lack of fundamentals and visibility, the downside too would be protected due to the liquidity inflows from FIIs in the near future. Hence, I don’t expect the markets to crack below 5000/5100 unless FIIs too turn sellers.

The economy is at a precarious stage, with most of the data points, whether it is GDP, IIP or inflation, signaling a need for immediate remedy. The barrage of scams seems unending, and the resultant upheaval in the political scenario would make it difficult for the government to take any reformist steps. The government seems to have missed opportunities time and again, and the current scenario makes it more difficult for the government to act.

The GAAR reversal, which played out on Monday, 3rd September, 2012, is possibly the only major trigger for the markets. Other than minor tinkering, I don’t think that the Finance Minister can push through any of the major policy measures. The Direct Tax Code (DTC) has already been deferred by a year, and GST may not see the light of day till 2014. Even FDI in aviation, which was expected to be a cakewalk, has hit a wall.

Unless the Finance Minster is able to wave the ‘magic wand’, don’t expect the situation to change for the better. Unfortunately, however, this is far from a fairy tale. The next big trigger for the markets in either direction would be the announcement of elections.[PAGE BREAK]

Andrew Holland
CEO, Investment Advisory
Ambit Capital

Saying that the bull market has arrived is a very difficult thing to tell. You have to take short-term as well as long-term calls. At the moment, we are about 12.5x to 13x of the one-year forward PE, and are fairly valued. It is okay to pick some stock.

However, to say that we have arrived at a bull market is a bit difficult to tell at this moment. The reason is that  recently, the GDP forecast has been brought down, and I do not think that has been factored in the earnings. If this continues to move downward, it will put further pressure on the topline and bottomline of companies. We can witness further margin pressures, and are still waiting for what happens with the monsoon. We are also yet to see the impact on the food prices. If they increase, there will be some pressure on the consumer stocks as there will be some downsizing in the consumption levels. There will be some headwinds in the short term, and volatility in the markets cannot be ruled out.

What I believe is that we are in a phase of consolidation, and the markets will only see some improvement once we see the interest rates coming down and the GDP rates moving up. But at this juncture, it will be very difficult to say that the markets are likely to witness a bull run.(...Continued on following page)[PAGE BREAK]

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The FIIs have been positive on India. I think this has more to do with the cleaner shirt in the laundry basket. If you are managing a BRIC fund, you may consider putting more exposure towards India as it looks cleaner than the others in the basket. That is why we are seeing more fresh funds coming towards India. But the growth story for India remains intact. There might be some slowdown, but it will remain intact.

If you think about the period from 2003-2007, the growth has been on the back of the reforms process that was started by the NDA. But this government has so far not taken any such steps toward reforms that are worth mentioning.

Going forward, the markets may witness volatility. I am not sure whether the bull run is set to come in. The rally that we have seen is with low volumes, which has raised many eyebrows. Well what I feel is that stern steps from the government will set the tone for the markets like it has happened after the Presidential elections, where the new Finance Minister has started to set the tone towards reforms. What I think is that if the reforms process starts, it may take the Nifty to test the 5700 levels. If not, it may witness a southward journey. I think that if it comes down, the markets will send signals to the politicians that it is not in favour of the steps taken or is awaiting the right steps. Then, they may work accordingly.[PAGE BREAK]

Parag Parikh
Director, PPFAS

As I write, the index is well off its four-month high. But this does not mean much. Several stocks are close to their all-time highs. Some of them are also at their all-time lows. The trend of trading in indices through index funds and Exchange Traded Funds (ETFs) influences us to believe that index movements are true beacons of the sentiment in the stock market. However, this is not entirely true. Hence, irrespective of the level of the indices, the age-old principles of investing are the ones we will have to fall back upon to profit from the stock market. Sure, a strong run-up in the indices will provide the tail-wind, but bull runs in individual portfolios could happen irrespective of the level of the index.

A particular company’s stock price depends a lot on the developments within the sector and the company. In the case of the index, the macro factors which could aid a run-up include some positive developments on the domestic policy front, some let-up on the Eurozone imbroglio and an uptick in global growth prospects.(...Continued on following page) [PAGE BREAK]

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Besides this, a feeling that the July 30 - Aug 12, Indian rupee has stabilised and clarity on the General Anti Avoidance Rules (GAAR) could lead to increased Foreign Institutional Investor (FII) participation.

If no extenuating circumstances emerge, the current apathy will continue. However, as mentioned above, this does not mean that no one will make money during these times.

Apart from the macro triggers already mentioned above, positive developments with respect to some index heavyweights will play a big role could result in an upsurge in the index. A few examples are: 

  1. A resolution of the KG-D6 dispute in the case of Reliance Industries.
  2. Transparent auctions of the 2G spectrum could help in improving sentiment in the case of Bharti Airtel and the entire telecom pack. 
  3. Any hint of a further reduction in interest rates from the Reserve Bank of India (RBI) could help the cause of banking heavyweights like State Bank of India, HDFC Bank, etc.[PAGE BREAK]

Sandip Sabharwal
CEO-PMS
Prabhudas Lilladher

It is difficult to say at this stage whether we are in a new bull run. The downside risks to the market due to the European situation and higher inflation have receded significantly. However, policy inertia at the Central Government level is preventing a new bull market from formulating. There are several emerging markets that have already made new highs, and some reforms or other policy push can be a positive for the markets.

Foreign investors have been continuous buyers into the Indian markets this year, driven by the longer-term growth prospects of the country as well as the fact that India has inflation, and thus, pricing power. Globally, the concern today is deflation, and as such, an economy that has a reasonable growth with prospects of moderation in inflation in the longer run should keep on getting global flows. The potential to get FDI flows is also very high; however, it is constrained by policy inertia as well as capital controls.

The next month will be very important for the markets for two reasons. The first being the fact that the Europeans will be coming back from vacation and the Euro crisis will be in focus again. The actions of the ECB will need careful monitoring. In case they are able to bring about a mechanism to control the yields on Italian and Spanish bonds, we could see global markets including India rally significantly. The second data point of importance will be the inflation figure for August 2012, which should see a decent moderation from last month. This could set the tone for monetary easing and a significant market rally.(...Continued on following page)[PAGE BREAK]

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Today, the markets are in a situation where the global market capitalisation/GDP is at around 100 per cent, and for India, it is at 75 per cent. At the peak of the last bull market, this had gone up to the 160 per cent levels. The reason for this is that we have seen profit compression in India due to higher input costs and interest rates, whereas in countries like the US, the profit margins are at all-time highs due to lower inflation and extremely low interest rates. In my view, the profits margins have now bottomed for Indian companies and will show a rebound over the next two-three years, and will as such result in a market re-rating.

There seems to be a consensus building up in the markets that the month of September 2012 will be tough for the markets and there could be a significant sell-off. As a result, we have seen investors become wary lately. Normally, consensus does not work, so we will have to see. But overall, the global risk rally still seems to have legs, and the probability of an upside is greater than that of a downside. A longer-term shift of money from bonds to equities is likely going forward, as bonds are much more expensive as compared to equities in the global context. As this trade plays out over the medium-to-long term, we will see the markets move up.

Overall, like I said, the evolution of the European situation and a moderation in domestic inflation will be drivers for the markets going forward. The value of the markets is cheap relative to the size of the economy, and the longer-term prospects look quite encouraging.

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