This article appears in the latest issue (10Jan 2013)of Moneylife.
A RISKY PROPOSITION
The tail end of the year is seeing some heightened interest in equities. Starting the year at around 15500, the BSE Sensex added 3000 points by mid February. After this it went in to a range bound coma, with all economic indicators turning negative. What is interesting is the revival in the market momentum post mid November of this year, in anticipation of the UPA 2 waking up from its slumber and trying to push through a slew of reforms.
Whilst all the global indicators seem to indicate a kind of economic slowdown, the markets are indicating something quite contrary. Our markets seem to indicate that the worst of the economic slowdown is behind us and that corporate earnings are on the rebound track. Moodys, the global rating agency have upgraded the outlook from negative to stable. The sell side broking houses, are also saying that the worst is perhaps behind us and advise putting money in to the markets. In fact, of the various opinions I have seen, the ‘worst’ case seems to be a level of over 20,000 on the BSE Sensex for 2013!!
The rally of our markets in 2012 was bereft of domestic or retail participation. Amidst the global gloom, we had record inflows of FII money to the extent of nearly twenty billion dollars! And in the full year, we hardly had anyone telling us to buy. At best, in the beginning of the year, we all put a kind of fifteen to twenty percent gains, if any, on the indices with a low probability. And this gain happened in the first five to six weeks. After that, when UPA 2 decided to wake up from slumber, the market gathered momentum (just as we were all waiting for the BSE Sensex to go to 14000 or below so that we could buy) and is now threatening to enter in to new territory in 2013.
So, should we jump headlong in to the markets? I am not talking about things like “there are always some pickings in the markets if you look” kind of answers. I am wondering about whether the markets as a whole are buy worthy at this point and can one be sure that we are entering a bullish phase?
For me, there is a big disconnect between economic outlook and corporate performance expectations. One of them or both of them are wrong. Unless there is a strong recovery in the economy to be on a seven percent plus growth in FY 2012-13, the stock prices are clearly running ahead of expectations. Many people opined a few weeks ago that our markets were at their historically low “P/E” levels. Alas, they did not bother to figure this out in co-relation to the interest rate environment, which continues to be stubbornly high. Similarly, inflation refuses to budge, with the government doing nothing to improve supply.
The government announcement to move to direct cash transfers (which would in turn imply that subsidies to producers would go, letting them earn free market prices), reduce disparity in petrol and diesel prices, disinvestment (even if it to LIC), retail FDI ( a symbolism if anything), bringing back Mr Chidambaram to the Finance Ministry etc are all factors that have been influencing a bullish undertone. At the same time, people are saying ( I have no idea about the basis for these conclusions) that the worst in corporate earnings is behind us and that earnings are bound to go up from here, making the markets attractive.
As far as I am concerned, the markets are trading at close to 16 times FY 2012-13 earnings. Given that interest rates could fall by around one percent or one and a half percent in the next twelve months, this implies a corporate profit growth of over twenty percent each year over the next five to ten years. If I assume inflation to be at five percent, this implies a real earnings growth of fifteen percent and perhaps a top line growth that is equal. This implies a GDP growth rate that is higher than eight percent or so, assuming some earnings growth will come from fall in interest rates and some kind of productivity improvements.
We also have the paradox of consumer spending driven stocks (FMCG, Pharma etc) being at unaffordable valuations leaving no margin of safety and cyclical stocks in metals etc at interesting levels. Similarly infrastructure stocks are weak. Private sector banks are dear and PSU Bank stocks look interesting based on published numbers.
So, what should one do? My call is to go for now with the momentum with eyes open. However, unless we have a discipline to trade, I would keep away. In terms of discipline, it is important to keep what we call as ‘stop loss’ limits. These should be strictly adhered to. For me, this market is clearly not a convincing buy. However, I also believe that there is a trading opportunity given that coming February will be the last full budget by the UPA 2 and will go all out to please. There is also a high probability of the RBI being pushed to drop interest rates lower. So, there is a clear window of opportunity (with risk of losing money if not careful) to make some money if we trade with a lot of discipline. Clearly we are in unsafe zone and best to tread with caution.