01/02/2013
What goes up and never comes down? The conventional answer would be age. A more insightful one would be the enthusiasm of the buyer on the stock markets. Last year saw economies across the world being put to test. For equities though it was one of the best. A rupee wagered on the Indian index returned you 1.25, three times what a bank deposit would. The question remains: will the 13th year of the millennium be just as lucky?
First let’s look at 2012. Gains on Dalal Street came from PROFIT—an acronym for Policy (pushing reforms), Revival (on Wall Street), Options (or the lack of them), FII (inflows), Industry (revival), Tipping (of inflation and interest rates). The October push to reforms by allowing FDI in multi-brand retail was a big catalyst of the upmove. It was sustained by the continuing rise in the US markets. As options, gold and precious metals have been peaking post a spectacular run. Real estate too, having witnessed a similar uptrend, is now seeing a reversal. Pockets of opportunity there lie in the extremely lower or higher segment. The former a positive outcome of growth in farm income and the latter a negative arising out of widening disparities in wealth distribution and parking of unaccounted wealth. FII inflows in excess of $20 billion have been the highest since 1993, barring 2010. They have also made the dollar cheaper by 3% and imports thereby more attractive. Revival in industrial growth is visible. October production figures of 8.2% vis-à-vis the forecast of 5% was a case in point. Corporate profits at record highs have been most encouraging. The double-digit inflation now hovers around 7%. An interest rate cut sooner than later is inevitable, anticipation of which is fuelling the uptrend. It would make bank deposits lesser attractive, improve margins of debt-laden companies, give a push to consumption of loan products and improve treasury operations of banks.
Will this continue and if so why? For one, valuations are attractive. Stock markets work on assessment more than investment and from that derive a price based on the earnings forecast. This price is a multiple of those future earnings which a buyer is willing to pay today. For the stocks with a large capital the average multiple over the last decade has been 14.6. Currently at 13.5, this allows for a possible upmove. For smaller companies too the ratio is favourable at 10.6 to 10.1. Don’t let the decimal fool you. It equates to upmove possibilities of FII inflows in excess of $20 billion have been the highest since 1993, barring 2010. They have also made the dollar cheaper by 3% and ports thereby more attractive. Revival in industrial growth is visible. October production figures of 8.2% vis-à-vis the forecast of 5% was a case in point. Corporate profits at record highs have been most encouraging. The double-digit inflation now hovers around 7%. An interest rate cut sooner than later is inevitable 8% for large and 5% for small caps. In case of the S&P 500 on Wall Street, it’s far higher at 16:12 allowing for a 33% gain. These, of course, are just historical numbers but they do tell a story and more importantly guide investors. Another favourite yardstick to measure valuations is vide multiples of the trading price per share versus that on the balance sheet. Here too the valuations today are lower than the historical average. Don’t forget, cyclical stocks have been underperforming and shall be the first to turnaround as the economy starts recovering. Theoretically, the best time to buy stocks is when they yield more than bonds. This happened last year when bond yields hit an all-time low provoking a buy into equities. Stock prices are still below their 2007 peak just before recession set in. Corporate profits however are much higher making a further upside realistic.
Trouble, if it does come, is most likely to be external, even though the outlook for China is improving. Europe continues to be a drag. Austerity measures and strong fiscal correctives may result in long-term solidity but immediate term problems. Opinions are divided on the US. Even though a 6-7% rise is likely on the S&P 500 basis corporate profit expectations, coming on the back of last year 20% hike endangers the possibility. Even the slightest disappointment on corporate bottomlines would see the markets slip. Then there is the massive $1 trillion annual deficit. Traditional Keynesian economics may say that big government deficit boosts growth but the sheer enormity leaves the Obama administration no choice but to prune deficit by raising taxes and lowering consumption. Both threaten to be a drag on the economy and thereby the equity markets. In India, current deficit in excess of 5% of GDP is now well beyond the 3% danger mark. The fiscal situation is no different and it will need some tough measures to control. To come from a fragile coalition shall make it only tougher. The good thing though is that oil prices are likely to be in check thanks to a rise in shale oil production and a fall in demand. Commodities generally are likely to be stable even if a global recovery is muted.
Now for the unaccountables. Let’s call them the “S” force—seasons, shocks and scams. Seasons and the vagaries of weather are important influencers on the capital markets, particularly India, two-thirds of whose population depends on farm income which in turn depends on the monsoon. A poor downpour could bring down the GDP by upto 2% and thereby shave 6% off the Sensex. Shocks arising from natural disasters (tsunamis and earthquakes) and manmade ones (terror and wars) hit stocks the hardest as oil prices spurt and money flows into the relatively secure bullion. However, the biggest fall in equities happen on account of fraud. Interestingly, they usually come to light when markets are close to their peak.With the Sensex just 8% short of its all-time high and the Indian media on an expose overdrive the word scam could just be the unsuspecting culprit.
On the policy side, disinvestment, grant of new banking licenses and GST implementation would become game changers. The Parthasarathi Shome panel recommendations on General Anti-avoidance Rules (GAAR) and exclusion of capital gains on equities would be a big boon for investors as would the scrapping of (Chidambaram initiated ) STT for traders. A few decisive measures by SEBI chairman UK Sinha, entering his final full year at the helm, on safety net for IPOs and direct plans for mutual funds would repose confidence in the small investor—a basic ingredient for the sustainability of a bull run. This would be furthered by a better check on corporate governance.
Globally, 2012 was the year of the central bankers—with interest rates garnering maximum interest. The year 2013 should belong to the policy makers—reforms in India, austerity in Europe, fiscal cliff in the US. Higher clarity and lower discord shall be pro market. Stocks look good when cheap but that’s usually in hindsight. As they start moving up, their attractiveness begins to move down. Bargains make the best gains.
They are cheapest when there is fear. They become dear (expensive) when they become dear (enthusiasm). The upcoming February budget is likely to be extremely market-friendly courtesy the “P” factor—P. Chidambaram (past perception), Polls (2014), and Policy (push to reforms). This makes for a Happy Holi with green being the most visible colour. A blast on Diwali, however, would be a challenge.
The upcoming February budget is likely to be extremely market-friendly courtesy the “P” factor –P. Chidambaram perspectives (past perception), Polls (2014), and Policy (push to reforms). This makes for a Happy Holi with green being the most visible colour. A blast on Diwali, however, would be a challenge.