Selective stock picking is the way to go - Dipen Shah
12/16/2011 11:08 AM Friday
In the past few weeks and months, the markets have been weak. The fall has been all across the globe, and has come about on the back of the growing concerns on Europe and the US.
The issues of US and Europe, both of which have unsustainable debt burdens, are well known. The debt burdens are pushing some of the countries (especially in Europe) on the verge of declaring bankruptcy. The European countries have been scrambling to make several changes to address these issues.
Recently, the European Union has announced a revised treaty, whereby the fiscal position of all member countries will be scrutinised by a central committee, and any breaches will be subject to penalty. All 17 Euro countries have agreed to this overseeing. In turn, the weaker countries are expected to get greater financial assistance from the ECB, which will be managing the temporary EFSF (European Financial Stability Fund) as well as the permanent ESF (European Stability Fund). These measures may ward off immediate threats of defaults, though they may not solve the structural problems of these countries.
While the global factors have impacted the markets worldwide, India has underperformed most of them. The reasons are, obviously, local. In the recent past, we have witnessed high inflation and increased interest rates. Also, slower decision making on the policy side has had a severe impact. Thus, corporate India has reported weaker numbers.
The Indian markets have largely underperformed the markets of most other emerging countries. FIIs have been net sellers (cash markets), though marginal, in the current calendar. This comes after a year of record purchases made by them. FIIs bought stocks worth about USD 29 billion in the previous calendar. Their activity has been muted because of concerns on the global front as well as on domestic issues.
The rupee has depreciated sharply over the past few months due to concerns on the fiscal deficit, trade balance and the global economic situation. This is also likely to have had an impact on the FII sentiments. The global economic situation has led to a flight to safety, with funds flowing to the US Treasuries, which has partly led to the depreciation of the rupee. Currency fluctuations have an impact on the returns of FIIs, and with the rupee depreciating sharply, fund flows have been greatly impacted.
Domestic factors would also have impacted flows. The moderation of economic growth, high inflation and interest rates have all had an impact on growth of corporate profits, impacting FII flows in turn.
On the valuations front, the Sensex is quoting at about 12x-12.5x of FY13’s consensus estimates. This is almost at the lower end of the long-term range in which the markets have quoted. Based on this historical range, the markets may not go down significantly unless in the event of a catastrophe (default by a country, bankruptcy of a large bank globally, etc).
On the domestic front, we have seen early signs of food inflation falling to about 6.6 per cent last week. While the base effect is expected to be more pronounced in the next few weeks, prices have fallen even on a week-on-week basis. All in all, we may see the WPI coming off in the next few weeks. This may augur well for interest rate-sensitive stocks and also for the markets.
With regard to reforms, there is still uncertainty on how much and how swiftly they will be carried out. While we have started seeing some signs of aggression from the government, major decisions need to be implemented for these to translate into higher growth. We expect to see more initiatives in areas like land acquisition, mining, pensions, banking, DTC, etc. in due course of time. The continuing delay in GST is especially something that should be addressed on a priority basis.
Assuming that interest rates stabilise/moderate and some reform initiatives play out favourably, the markets may find support at the current valuations, subject to volatility in the near term. However, we reiterate that reforms are a pre-requisite for the markets to stabilise and move up sustainably from the current levels.
As there is still some uncertainty on some major issues listed above, we recommend that investors take a conservative approach. At the current valuations, one should look at making gradual investments in select sectors and stocks. Note that panic situations normally throw up good opportunities for long-term investors. We are positive on the growth prospects of India from a medium to long-term perspective.
For new entrants into the equity markets, the current scenario may seem far from enticing, with respect to making investments. However, the past track record has shown that investments made in select stocks under trying circumstances usually lead to significant gains. Also, sharp falls in the markets have generally preceded strong rallies over the past few years.
We believe that a bottoms-up approach is best suited to the current circumstances. Thus, investors should look at companies that are fundamentally sound, led by capable and ethical managements and have strong balance sheets. Companies that have net cash on their balance sheets should be preferred. High return ratios are an added advantage. There are several such companies available across sectors like IT, FMCG, Pharma, Banking, etc.
One can also have some exposure to stocks in beaten down sectors like Capital Goods and Infrastructure. These stocks have the potential to outperform in case the markets reverse on the upside. Some of these stocks also have strong balance sheets, though growth rates are a matter of concern as of now.
- Dipen Shah, Head- Fundamental Research, Kotak Securities
Find More Articles on: DSIJ Magazine, Equity Strategy, Product, Large Cap