Liquidity Spells Hope For Markets
9/20/2012 9:03 PM Thursday
Dr. V K Vijaykumar
Geojit BNP Paribas Financial Services
- The ECB’s decision to embark on unlimited bond buying has improved risk appetite substantially. This has initiated a ‘risk on’, lifting all the stock markets.
THE LIQUIDITY EFFECT
- In the context of receding risk aversion, more money is likely to go into stocks. In India, the valuations are now fair at around 15x the forward earnings, but the liquidity surge can stretch valuations further.
The Indian markets have an under-current of buoyancy now in spite of the several headwinds that the economy is facing. The reason for this is the humungous liquidity chasing the stocks. The decision taken by the ECB to embark on unlimited bond buying, preempting a catastrophic financial contagion, has improved risk appetite substantially. This has initiated a ‘risk on’, lifting all the stock markets. India too has been a major beneficiary.
India is currently trading at a PE of around 13.5x. This might appear expensive compared to the the MSCI Emerging Markets Index, which is trading at a PE of around 10.5x on one year forward earnings. However, considering the better prospects for India, it can be said that this marginally higher valuation is justified. In spite of the declining growth rate, it is important to remember that India will be one of the fastest growing economies of the world ahead. In the year 2012, only five economies across the globe have posted a growth rate of above five per cent.
We have come to the end of the earnings season for the first quarter of the present fiscal. It can be said that the financial numbers posted by India Inc. during the quarter ended June 2012 were more or less along expected lines. There were some sectors that have witnessed better earnings prospects. As already anticipated, private sector banking, pharma, IT and FMCG have witnessed better growth during the quarter. We believe that these sectors will continue to do well ahead too. Going forward, it can be said that the corporate earnings growth is likely to be around 10 per cent and the EPS of the Sensex will be around Rs 1200 for FY 2013E.
Celebrated economist John Maynard Keynes once famously remarked, “Politicians will do the rational thing, but only after exploring all other possibilities.” The UPA, for more than a year now, has been doing nothing on the reforms or policy front and consequently, choicest criticism with regard to policy inertia, governance paralysis, etc. has been heaped on the government. Fortunately, at long last, the government has awoken from its slumber and has started taking rational decisions. The decision to hike diesel prices by Rs 5 per litre and opening up FDI in retail for willing states and allowing FDI in aviation are like welcome showers in a drought.
The market has welcomed these initiatives. The Sensex and Nifty are at one-year highs. The global environment is also favourable, with the ‘risk on’ initiated by the Draghi initiative to buy unlimited quantities of stressed European country bonds and QE3 from the US Fed. The humungous amount of liquidity to be released by these initiatives will certainly chase all asset classes. But safe asset classes are rare in the present world characterised by growth scarcity and growth scare. The US and German bond yields are at abysmally low levels, real estate markets are not likely to look up in the near future and gold has already been pushed up to bubble territory. In this context, where will the money go?
Yes, a part of it has already gone to the stock markets. In the context of receding risk aversion, more money is likely to go into stocks. In India, the valuations are now fair at around 15x the forward earnings. But the liquidity surge can stretch valuations further.
The present environment has changed the risk appetite, and therefore, defensives like FMCG and pharma may not participate in the rally. In fact, there may even be profit booking in these segments. A switch to safe and promising cyclicals may be considered. However, a sharp decline in defensives, if that happens, may be used as an opportunity to accumulate them, since the growth story in these segments is bright. It makes sense to remain invested in private sector banking and select IT stocks. For banking and auto, the coming days will be better since a rate cut can be expected in the October 30th monetary policy review.
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