The markets touched new highs recently, but the risk of elections looms ahead. Here's how to negotiate this possible bump.
Even as the stock markets hit new highs recently, Rohit Karna grew more apprehensive. This Patna-based entrepreneur's portfolio has benefited from his allocation to equities. But Karna is now worried that the current rally may be driven more by hope than reality. "The earnings of companies did not improve so much in the last quarter as to warrant such an upswing," he says. He fears that after the elections, if investors' hopes are not realised, the markets may see a precipitous drop.
Sentiment-driven rally
The biggest driver of the current rally is indeed sentiment. Recent opinion polls have assigned a high probability to the BJP-led NDA (National Democratic Alliance) coalition forming a government at the centre. This has enthused investors, especially FIIs.
Second, strengthening FII inflows in recent weeks have driven the markets up. Once tapering started in January, the emerging markets witnessed a mini crisis. Many of them saw capital outflows and currency depreciation. Compared to other emerging market peers, India has emerged as a safe haven. India's current account deficit (CAD) is expected to come in at a benign 2-2.25% for 2013-14. In the recent vote on account, the Finance Minister managed to peg the fiscal deficit at 4.6%, thereby sticking to his promise. A recent report from Nomura Securities suggests that inflation may ease in the second half of 2014 owing to the base effect. All these factors have placed the Indian markets in a sweet spot, leading to higher FII inflows.
Key risks
The biggest risk before the markets is the possibility of the elections delivering a fractured mandate. Aditya Narain of Citi Research says in a recent report that if one looks at the track record of opinion polls in India, they have been "modest on reliability". The best that can be said about them is that they have captured accurately the shift in momentum as one got closer to the elections. Hence, despite the opinion polls suggesting a BJP victory, investors shouldn't treat it as a foregone conclusion and allow it to influence their investment decisions excessively. The second risk to the markets comes from the ongoing Fed tapering. It is currently in its third month. Since its onset in January, FII investments have weakened compared to the levels seen in 2013. As it continues, FII investments could dry up further.
Bi-polar valuations
The current consensus earnings per share (EPS) estimate for the Sensex is 1,344 for 2013-14 and 1,575 for 2014-15. At the current Sensex level of 21,856 (12 March closing) the market is trading at a one-year forward PE of 13.88, which is not high compared to the long-term average of 15.1. However, if the expected EPS growth of 17% does not materialise—downgrading of earnings estimates as the year progresses has been the norm in recent years—these levels would appear expensive. While frontline indexes like the Sensex and the Nifty have scaled new highs recently, sector valuations reveal the bi-polar nature of the markets. "While IT, FMCG, pharma and private banks are trading at high valuations, infrastructure and capital goods companies are languishing at single-digit PEs, and PSU banks have price to book value ratios of 0.5 or less," says Sanjay Sinha, founder, Citrus Advisors. Thus, some pockets of the market are still affordable. The key is to examine whether they also offer growth.
Sectors to invest in now
IT
With global growth reviving, prospects of the Indian IT sector remain robust. Both the US and European corporates are increasing their IT spends which they had reduced in the aftermath of the financial crisis. Currently US companies are sitting on record profits. They are also more confident about future demand and want to tap IT for efficiency and productivity gains to benefit from an improving economic outlook.
Technology shifts offer another opportunity area to Indian IT companies. Organisations are spending a considerable portion of their IT spends on making their IT infrastructure more mobile, more cloud-based, and more geared towards exploiting big data. In Europe, where the outsourcing trend is now catching on, Indian IT companies have begun to gain market share. Faced with the imperative to cut costs, European governments and companies are willing to outsource. They are replacing high-cost vendors with more cost-effective ones. The major threat to the sector comes from the US Immigration Bill which calls for the substitution of Indian workers with Americans. If passed in its current form, the Bill will translate into higher labour costs for Indian IT. Valuations of most IT stocks are high compared to historical levels. Besides large-caps, even mid- and small-caps have run up.
Pharma
The developed countries are adopting generic drugs to cut healthcare costs. This trend is the biggest contributor to Indian pharma's rapid growth. Over the last five years, more than $100 billion worth of drugs have gone off-patent in the US. With more than 100 US FDA approved plants in India and with Indian companies having the most number of product filings for this market (by non-US companies), they are well placed to tap this opportunity. The domestic pharma market has also been growing at 12-15%. The rupee's depreciation in 2013 will boost earnings in 2014. Indian companies' performance will depend on how fast they get approvals for their niche drugs in the US. The key threat comes from regulators turning stricter in the US and the UK. The sector is expected to grow at 17-18% annually over the next two years. Stocks are likely to perform in line with earnings growth.
FMCG
Analysts are neutral or negative on the sector's prospects. While earnings growth has declined below the peak levels witnessed in the years up to 2012-13, valuations remain high. "There is potential for valuations to correct," says Ritwik Rai, FMCG analyst, Kotak Securities. Earnings growth has slowed down because of slowing GDP growth, which has translated into lower income growth and lower consumption. The sector continues to enjoy high valuations due to the lack of other attractive investment options, and low risk appetite. If other sectors do well, or risk appetite improves, valuations would be hit. This government's redistribution initiatives led to strong rural demand in the past 5-6 years. If such initiatives slow down under a new government, demand would be affected. Rai's favourite picks are ITC and Marico.
Banking
The sector's prospects are tied to those of the economy. Currently growth has bottomed out but a revival is not visible. Asset-quality concerns are weighing heavily on banking stocks. These concerns have been aggravated by the lack of revival of the infrastructure sector, to which banks have lent heavily. PSU banks in particular have a significant NPA problem. They also suffer from the problem of low capital adequacy due to which they can't grow their loan books fast. If GDP growth recovers in 2014 or 2015, it will be positive for the sector. Interest rate cuts will be yet another positive. At present private banks enjoy better valuations than PSU banks as they are gaining market share over the latter. They have higher capital adequacy and lower asset-quality related concerns.
Auto
The auto sector's prospects will depend on a potential economic recovery. All the sub-segments within the automobile sector—four wheelers, two wheelers and commercial vehicles—have substantial pent-up demand.
The key risk to the sector is a fractured verdict in the elections. If the government that comes to power is perceived to be incapable of driving economic growth up, both business and consumer sentiment, and demand, will be hit. The high-inflationary environment is also a threat as it erodes discretionary spending. Currently valuations do not factor in a potential recovery in volumes. Gandhi's picks in this sector are Hero MotoCorp and Tata Motors among large-caps and Eicher Motors and TVS Motor among mid-caps.
Metals
Currently analysts are neutral on this sector. While they expect the demand for metals to recover, it will be slow. "The average historic demand growth for steel has been 8% whereas it is now expected to be only 4%. While there will be a recovery, it will not be a strong one because the investment cycle is still slow in India," says Prasad Baji, senior VP, Edelweiss Financial Services. Moreover, Chinese demand growth for steel is expected to slow down from 7-8% last year to 3% this year. The mining ban in Karnataka was lifted last year, but production has been slow to ramp up. The mining ban in Goa is still on. Some companies are trading at average valuations while other are trading at a discount. Baji's two favourite picks in the sector are Tata Steel and JSW Steel.
Oil & Gas
Analysts are gradually turning positive on the prospects of the oil and gas sector. This is because of the government undertaking price reforms in this sector—the 50 paise per litre hike in the price of diesel each month. This has helped to contain under-recoveries for players in the sector. It has also resulted in lower demand growth for diesel, which means potentially lower losses for players in the sector. According to a recent report from Religare Securities, if prices are hiked at the same pace, underrecoveries will be wiped out completely by the end of 2015-2016. If under-recoveries are lower, then the government could allow higher realisation for crude oil for companies like ONGC and Oil India. The approval by the Cabinet Committee on Economic Affairs of the revised formula for domestic natural gas prices will also lead to higher earnings for both these companies. According to Religare, the improving prospects of these PSU players in the oil and gas sector is not sufficiently factored into the price.
Realty
Analysts are either neutral or negative on this sector whose biggest headwind is lack of affordability. While prices have run up , salaries have not kept pace and inflation is eating into disposable incomes. Except Bangalore, prices have gone out of the reach of the middle class in most other metros. In Mumbai they are steady but demand has fallen while it remains strong in Bangalore. According to an analyst at Emkay Research, "DLF and Unitech are struggling because sales have dried up in the north. Prestige and Shobha, which enjoy sales visibility and have decent balance sheets, enjoy high valuations." He is currently recommending Oberoi Realty, Prestige Developers and Kolte Patil.
Telecom
Analysts currently have a neutral view on the telecom sector. Most of the opportunity lies in the data segment, whose revenue is growing 100% year-on-year, due to growing penetration of 3G mobile phones. The other opportunity will arise for stronger incumbents from reducing discounts in the voice segment as the industry consolidates. As for risks, Shobit Khare, VPResearch, Motilal Oswal Securities, says: "The launch of a well-funded player, Reliance Jio, will enhance competition. The markets may worry about possible over-bidding in the next round of spectrum auctions. The incumbents will also have to invest more on their data offerings. They may do so prematurely due to competition even though the business case may not be strong." Khare's favourite stock is Bharti Airtel.
Artcle taken from TOI:http://timesofindia.indiatimes.com/...be-fearful-or-greedy/articleshow/32590897.cms
Even as the stock markets hit new highs recently, Rohit Karna grew more apprehensive. This Patna-based entrepreneur's portfolio has benefited from his allocation to equities. But Karna is now worried that the current rally may be driven more by hope than reality. "The earnings of companies did not improve so much in the last quarter as to warrant such an upswing," he says. He fears that after the elections, if investors' hopes are not realised, the markets may see a precipitous drop.
Sentiment-driven rally
The biggest driver of the current rally is indeed sentiment. Recent opinion polls have assigned a high probability to the BJP-led NDA (National Democratic Alliance) coalition forming a government at the centre. This has enthused investors, especially FIIs.
Second, strengthening FII inflows in recent weeks have driven the markets up. Once tapering started in January, the emerging markets witnessed a mini crisis. Many of them saw capital outflows and currency depreciation. Compared to other emerging market peers, India has emerged as a safe haven. India's current account deficit (CAD) is expected to come in at a benign 2-2.25% for 2013-14. In the recent vote on account, the Finance Minister managed to peg the fiscal deficit at 4.6%, thereby sticking to his promise. A recent report from Nomura Securities suggests that inflation may ease in the second half of 2014 owing to the base effect. All these factors have placed the Indian markets in a sweet spot, leading to higher FII inflows.
Key risks
The biggest risk before the markets is the possibility of the elections delivering a fractured mandate. Aditya Narain of Citi Research says in a recent report that if one looks at the track record of opinion polls in India, they have been "modest on reliability". The best that can be said about them is that they have captured accurately the shift in momentum as one got closer to the elections. Hence, despite the opinion polls suggesting a BJP victory, investors shouldn't treat it as a foregone conclusion and allow it to influence their investment decisions excessively. The second risk to the markets comes from the ongoing Fed tapering. It is currently in its third month. Since its onset in January, FII investments have weakened compared to the levels seen in 2013. As it continues, FII investments could dry up further.
Bi-polar valuations
The current consensus earnings per share (EPS) estimate for the Sensex is 1,344 for 2013-14 and 1,575 for 2014-15. At the current Sensex level of 21,856 (12 March closing) the market is trading at a one-year forward PE of 13.88, which is not high compared to the long-term average of 15.1. However, if the expected EPS growth of 17% does not materialise—downgrading of earnings estimates as the year progresses has been the norm in recent years—these levels would appear expensive. While frontline indexes like the Sensex and the Nifty have scaled new highs recently, sector valuations reveal the bi-polar nature of the markets. "While IT, FMCG, pharma and private banks are trading at high valuations, infrastructure and capital goods companies are languishing at single-digit PEs, and PSU banks have price to book value ratios of 0.5 or less," says Sanjay Sinha, founder, Citrus Advisors. Thus, some pockets of the market are still affordable. The key is to examine whether they also offer growth.
Sectors to invest in now
IT
With global growth reviving, prospects of the Indian IT sector remain robust. Both the US and European corporates are increasing their IT spends which they had reduced in the aftermath of the financial crisis. Currently US companies are sitting on record profits. They are also more confident about future demand and want to tap IT for efficiency and productivity gains to benefit from an improving economic outlook.
Technology shifts offer another opportunity area to Indian IT companies. Organisations are spending a considerable portion of their IT spends on making their IT infrastructure more mobile, more cloud-based, and more geared towards exploiting big data. In Europe, where the outsourcing trend is now catching on, Indian IT companies have begun to gain market share. Faced with the imperative to cut costs, European governments and companies are willing to outsource. They are replacing high-cost vendors with more cost-effective ones. The major threat to the sector comes from the US Immigration Bill which calls for the substitution of Indian workers with Americans. If passed in its current form, the Bill will translate into higher labour costs for Indian IT. Valuations of most IT stocks are high compared to historical levels. Besides large-caps, even mid- and small-caps have run up.
Pharma
The developed countries are adopting generic drugs to cut healthcare costs. This trend is the biggest contributor to Indian pharma's rapid growth. Over the last five years, more than $100 billion worth of drugs have gone off-patent in the US. With more than 100 US FDA approved plants in India and with Indian companies having the most number of product filings for this market (by non-US companies), they are well placed to tap this opportunity. The domestic pharma market has also been growing at 12-15%. The rupee's depreciation in 2013 will boost earnings in 2014. Indian companies' performance will depend on how fast they get approvals for their niche drugs in the US. The key threat comes from regulators turning stricter in the US and the UK. The sector is expected to grow at 17-18% annually over the next two years. Stocks are likely to perform in line with earnings growth.
FMCG
Analysts are neutral or negative on the sector's prospects. While earnings growth has declined below the peak levels witnessed in the years up to 2012-13, valuations remain high. "There is potential for valuations to correct," says Ritwik Rai, FMCG analyst, Kotak Securities. Earnings growth has slowed down because of slowing GDP growth, which has translated into lower income growth and lower consumption. The sector continues to enjoy high valuations due to the lack of other attractive investment options, and low risk appetite. If other sectors do well, or risk appetite improves, valuations would be hit. This government's redistribution initiatives led to strong rural demand in the past 5-6 years. If such initiatives slow down under a new government, demand would be affected. Rai's favourite picks are ITC and Marico.
Banking
The sector's prospects are tied to those of the economy. Currently growth has bottomed out but a revival is not visible. Asset-quality concerns are weighing heavily on banking stocks. These concerns have been aggravated by the lack of revival of the infrastructure sector, to which banks have lent heavily. PSU banks in particular have a significant NPA problem. They also suffer from the problem of low capital adequacy due to which they can't grow their loan books fast. If GDP growth recovers in 2014 or 2015, it will be positive for the sector. Interest rate cuts will be yet another positive. At present private banks enjoy better valuations than PSU banks as they are gaining market share over the latter. They have higher capital adequacy and lower asset-quality related concerns.
Auto
The auto sector's prospects will depend on a potential economic recovery. All the sub-segments within the automobile sector—four wheelers, two wheelers and commercial vehicles—have substantial pent-up demand.
The key risk to the sector is a fractured verdict in the elections. If the government that comes to power is perceived to be incapable of driving economic growth up, both business and consumer sentiment, and demand, will be hit. The high-inflationary environment is also a threat as it erodes discretionary spending. Currently valuations do not factor in a potential recovery in volumes. Gandhi's picks in this sector are Hero MotoCorp and Tata Motors among large-caps and Eicher Motors and TVS Motor among mid-caps.
Metals
Currently analysts are neutral on this sector. While they expect the demand for metals to recover, it will be slow. "The average historic demand growth for steel has been 8% whereas it is now expected to be only 4%. While there will be a recovery, it will not be a strong one because the investment cycle is still slow in India," says Prasad Baji, senior VP, Edelweiss Financial Services. Moreover, Chinese demand growth for steel is expected to slow down from 7-8% last year to 3% this year. The mining ban in Karnataka was lifted last year, but production has been slow to ramp up. The mining ban in Goa is still on. Some companies are trading at average valuations while other are trading at a discount. Baji's two favourite picks in the sector are Tata Steel and JSW Steel.
Oil & Gas
Analysts are gradually turning positive on the prospects of the oil and gas sector. This is because of the government undertaking price reforms in this sector—the 50 paise per litre hike in the price of diesel each month. This has helped to contain under-recoveries for players in the sector. It has also resulted in lower demand growth for diesel, which means potentially lower losses for players in the sector. According to a recent report from Religare Securities, if prices are hiked at the same pace, underrecoveries will be wiped out completely by the end of 2015-2016. If under-recoveries are lower, then the government could allow higher realisation for crude oil for companies like ONGC and Oil India. The approval by the Cabinet Committee on Economic Affairs of the revised formula for domestic natural gas prices will also lead to higher earnings for both these companies. According to Religare, the improving prospects of these PSU players in the oil and gas sector is not sufficiently factored into the price.
Realty
Analysts are either neutral or negative on this sector whose biggest headwind is lack of affordability. While prices have run up , salaries have not kept pace and inflation is eating into disposable incomes. Except Bangalore, prices have gone out of the reach of the middle class in most other metros. In Mumbai they are steady but demand has fallen while it remains strong in Bangalore. According to an analyst at Emkay Research, "DLF and Unitech are struggling because sales have dried up in the north. Prestige and Shobha, which enjoy sales visibility and have decent balance sheets, enjoy high valuations." He is currently recommending Oberoi Realty, Prestige Developers and Kolte Patil.
Telecom
Analysts currently have a neutral view on the telecom sector. Most of the opportunity lies in the data segment, whose revenue is growing 100% year-on-year, due to growing penetration of 3G mobile phones. The other opportunity will arise for stronger incumbents from reducing discounts in the voice segment as the industry consolidates. As for risks, Shobit Khare, VPResearch, Motilal Oswal Securities, says: "The launch of a well-funded player, Reliance Jio, will enhance competition. The markets may worry about possible over-bidding in the next round of spectrum auctions. The incumbents will also have to invest more on their data offerings. They may do so prematurely due to competition even though the business case may not be strong." Khare's favourite stock is Bharti Airtel.
Artcle taken from TOI:http://timesofindia.indiatimes.com/...be-fearful-or-greedy/articleshow/32590897.cms
