Last Monday’s market gains of 17.34 per cent or 2,111 points on the BSE Sensex are not just historically significant due to the quantum, but it also signals the elimination of key political uncertainties surrounding India’s long-term growth story.
The clear mandate to the Congress-led UPA government suggests that it will now be able to undertake reforms in an unhindered manner, including some of the hard decisions it failed to implement due to the opposition from the Left.
Also, the Congress party now seems to have an improved its bargaining power with allies, which will provide stability as well as flexibility in decision making. The election outcome also suggests that voters have largely preferred those that are perceived to be effective administrators.
The cases of Delhi, Gujarat and Bihar are examples pointing to this trend. This in turn, indicates that the UPA will be under constant pressure to deliver up to the expectations of the people, including the markets. But, if the government is not able to live up to these expectations, it may prove difficult for markets to sustain current valuations.
The clear mandate to the Congress-led UPA government suggests that it will now be able to undertake reforms in an unhindered manner, including some of the hard decisions it failed to implement due to the opposition from the Left.
Also, the Congress party now seems to have an improved its bargaining power with allies, which will provide stability as well as flexibility in decision making. The election outcome also suggests that voters have largely preferred those that are perceived to be effective administrators.
The cases of Delhi, Gujarat and Bihar are examples pointing to this trend. This in turn, indicates that the UPA will be under constant pressure to deliver up to the expectations of the people, including the markets. But, if the government is not able to live up to these expectations, it may prove difficult for markets to sustain current valuations.
HIGH ON EXPECTATIONS Themes Expectations … … likely gainers Nuclear energy
& PowerIncreased participation of private players,
emphasis on faster project implementation L&T, Areva T&D, HCC,
Suzlon, Power Grid Disinvestment UPA is seen as pro-disinvestment, and with
pressure on the fiscal side, expect action on
this frontNTPC, Neyveli, PFC,
IOC, SCI, ONGC, NALCO, SAIL, REC Infrastructure Its manifesto emphasised on infra as priority
to tackle the current slowdown. Low interest
rates and funding availability are positivesGVK Power, GMR Infra, L&T, Reliance Infra, IRB Infra, IVRCL FDI Liberalised policy for retailing, aviation,
education and mediaPantaloon, ICICI Bank, Everron, Educomp Banking Consolidation, FDI in insurance ICICI Bank, HDFC, BoB Agriculture & Rural The govt is expected to put more emphasis
on these sectorsJain Irrigation, M&M, Hero Honda, SBI Real estate Indirect benefits from SEZ policy, easing
liquidity and emphasis on low-cost housingHDIL, DLF, LIC Housing Telecom Speedier rollout of 3G licences Bharti, Idea, Rcom, TTML Oil & Gas De-control of retail fuel prices, NELP 8 RIL, ONGC, Oil Mktg Cos
Here, the market believes that the immediate focus would be on enhancing infrastructure spending and reforms, as by doing so the government could push up economic growth rates.
“The key macro-economic hope stemming from this election process is that Prime Minister Manmohan Singh will use the mandate to accelerate reforms. If so, this should help promote infrastructure and therefore investment spending. The election also raises the potential for a more responsible approach to India’s precarious fiscal situation. This in turn should help bring downward pressure on interest rates,” says Christopher Wood, equity strategist, CLSA.
The FDI limits in the insurance, retail and aviation sectors are also expected to be increased, thereby providing the required capital for growth.
Says Rajeev Malik, associate director and head-India and Asian Economics, Macquarie Securities, “The erstwhile government had already taken positive steps in FDI liberalisation and, with the Left out of the picture we expect the momentum to continue. Key areas in focus will be insurance, retail, and private and state-owned banks.”
In the banking space, the government is also expected to push for consolidation within public sector banks (PSB) by merging weaker banks into larger ones.
Besides, the market is also hopeful of some relaxation in government ownership (voting rights) in PSBs. The banking sector, as a whole, is also seen benefiting from a pick-up in economic growth.
The government’s push for divestment in some public sector companies is not without reason. Such a move could provide the government with the much needed cash, which it could use to either reduce its fiscal deficit or for further pump-priming the economy through an increase in spending towards infrastructure.
Optimism renewed
The results of election have proved to be an icing on the cake. It has provided a sentiment boost to the markets, which in some measure was already rejoicing the scattered signs of improving fundamentals in the domestic and global economies, popularly called “green shoots”.
Put together, these recent events have led to many economists and research houses raising or at least, putting on positive watch, their estimates for India’s GDP and earnings for 2009-10. For instance, Morgan Stanley in its recent report has increased its GDP estimates for India to 5.8 per cent for 2009-10 as compared to its earlier estimate of 4.4 per cent.
“It is not just the elections, which has improved the overall short and medium term GDP outlook for India. We have already seen a pick up in some of the core sector activities. Recent high-frequency indicators on consumers and investment spending are already showing signs of improvement. The lending rates have come down and corporate borrowing would have increased by that time,” says Sailesh K Jha, senior regional economist, Barclays Capital.
The good part of all this is that the market is expecting growth rates to look up going ahead, and liquidity-related issues should also ease.
Earnings revision
The increasing confidence over the macro fundamentals has also proved to be positive for the earnings outlook of India Inc. Many research houses have already raised their earnings’ estimates, albeit marginally, for a host of companies, while a few others are yet to do so but feel that there is room for upward revision in earnings’ estimates.
Says Rajat Rajgarhia, head of research, Motilal Oswal Securities, “Till now, earnings have not been revised, but the chances are high of an earnings’ upgrade in the near future as the business environment and the confidence increase.”
In March 2008, analysts were projecting Sensex earnings for 2009-10 at about Rs 1,200, which was later downgraded to between Rs 800-850 due to concerns over economic growth and corporate profits. But now, the downgrades have stopped and some are expecting higher earnings of about Rs 880-900.
Justifying the earnings upgrades, Sailesh Jha, Barclays Capital says, “From the second half of the calendar year we will see some significant upgrades happening in the corporate earnings, because by that time analysts would have factored in an upward revision in GDP growth.”
According to a Morgan Stanley report on India strategy, the election result creates room for better earnings growth (through policy action).
“Thus, we are raising our earnings estimates. In our base case, we think earnings growth for the BSE Sensex constituents on an aggregate basis will likely be 2.5 per cent and 12.5 per cent for 2009-10 and 2010-11, respectively (up from our previous forecast of -10 per cent and 11 per cent). Consequently, the fair value estimate for the BSE Sensex rises to 13,201,” says the report.
Some others also believe that availability of capital to the corporate sector (including FDI) has led to the increased optimism over future earnings growth. Keeping these developments in perspective, research houses have already raised their Sensex targets of 13,000-16,000.
Additionally, some analysts see a growing willingness towards assigning higher valuation to Indian markets. “Post elections, with the expected stability in policy making and the hope that earnings will improve due to business environment, investors are ready to give higher price-to-earnings (PE) multiple,” says Jignesh Shah, head equity, ABN Amro Private Banking India.
But, with the Sensex now trading at 13,900 levels (15-16 times its estimated earnings for 2009-10 as compared to 10-11 times earlier), which is almost equal to the medium-term target of most research houses, most of the positive factors have already been factored into current valuations.
Risk appetite returning
Meanwhile, even as the valuations are not cheap, experts do not expect the markets to fall significantly from current levels except for any unforeseen events like global factors, including concerns over the US economy.
Among global factors, says Cameron Brandt, global markets analyst, EPFR, “Have the banks really come clean? There is still some real concern that the US and European financial majors continue to fudge the full extent of their liabilities in the hope that a global recovery will spare them the necessity of writing them off.”
Additionally, the risk could also arise from the inability of the new Indian government to live up to the expectations with regards to the reforms and its strategy to contain the fiscal deficit. Thus, the markets will be keeping a close watch on the budget for further cues on the direction of policies and reforms.
Barring these concerns, the fact that many investors, including small and big, who were left out in the recent rally are looking for an opportunity to buy Indian equities. This could act as a support in any significant correction in the share prices going forward.
Says Wood, “The outcome of elections will see a surge of portfolio capital into the Indian stock market since many foreign investors had been wary of betting on India because of the sheer unpredictability of the electoral process. The foreigners have bought a net $1.8 billion worth of Indian stocks so far this year. Remember last year, foreigners sold a net $13 billion of Indian stocks after buying a massive $51 billion worth between the beginning of 2003 and the end of 2007.”
Additional proof of the likely increase in risk appetite towards emerging markets is the result of a survey conducted by Banc of America Securities Merrill Lynch Fund Managers in early May this year. The survey result shows that “A net 46 per cent of investors are overweight emerging market stocks, up from a net 26 percent in April.”
Exit defensives
Among investment themes, money managers are now turning more bullish on the cyclical and industrial sectors as against their earlier desire for defensive sectors. This is primarily on account of the expected recovery in the sectors, which are closely linked to the growth in GDP or are sensitive to the interest rates.
The availability of the credit at lower rates of interest, higher government spending, lower input prices and improving confidence are some critical inputs necessary for the revival of some of these beaten-down sectors. Little wonder, experts are now advising a move out of the defensives.
Additionally, “The defensives could underperform going forward for the reason that most of these companies are trading at higher valuations vis-a-vis their growth expectations. Also, defensive sectors are over owned at this point in time and the money could now flow to under-owned sectors,” says Jignesh Shah.
The Banc of America Securities Merrill Lynch Fund Managers Survey also indicates a shift from defensives globally. Its results suggest that for the first time since early 2005, panelists are underweight (net 2 per cent) their favourite recessionary sector, pharmaceuticals, compared with a net 21 per cent overweight in April 2009. Investors have also reduced holdings in staples, telecoms and utilities in favour of energy, materials and industrials.
Among broader investment themes, Rajeev Malik believes, “Improved global risk appetite, improved domestic INR and USD liquidity, lower interest rates, pick-up in capital inflows, and equity market revival are all positive to an earlier turnaround in the investment cycle.”
However, he also adds, that this will still take a few months to manifest itself. Sailesh Jha says, “The biggest beneficiary of this phase of turnaround in economy and investment cycle would be the banking and the capital goods sector.”
Among other themes, which offer better prospects and are linked to the reforms and UPA's policies, include the education and rural space.
Likewise, although there is uncertainty over the timing, investors can look at equipment manufacturers in the nuclear energy and power space. Besides, there is a reasonable chance of the government freeing the pricing of retail fuels, which could prove beneficial for oil marketing companies and producers like ONGC.
Selective approach
Experts say that investors will have to be selective in their investment approach. A case in point is to avoid export-oriented plays, given the global economic outlook which is still weak.
Also, during the recent market rally, many stocks, particularly the front line or large cap stocks have risen sharply. So, selectively considering smaller companies could also make sense.
“Today, finding value in the front line stocks has become more difficult. However, even after the recent run-up, many mid-cap stocks are still trading at 5-8 times forward earnings as compared to 18-20 times in the case of front line stocks,” says Gaurav Dua, head research, Sharekhan.
Adds Sangeetha Saranatham, analyst, India Infoline, “Improvement in credit availability should also reduce concerns on soaring financial costs, especially for mid-caps which have not benefited much from the reduction in interest rates during the past quarter.”
Within mid caps, too, analysts believe that the companies which are leveraged towards the rural thrust and infrastructure spending themes are likely to witness greater earnings upside and rerating in their share prices.
Overall, a healthy portfolio mix between large-cap and mid-cap companies, with sustainable leadership in their businesses, should prove helpful.
Last, but not the least, the situation hasn’t turned completely gung-ho and there are concerns which still persist. Should the environment, especially global, turn unfavourable, the current rally could peter out. It will be a few more months, may be 2-3 quarters, before there are clear signs of any economic turnaround. Hence, experts also advice to tread cautiously, keep a constant watch on key indicators and to buy ‘selectively’ only on dips.
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