Movers & Shakers

Tags: Stock Market

The vote on account can’t move the stock market for long, neither can the election verdict. FC Invest looks for triggers that can provide long-term momentum to domestic equities

Movers & Shakers
Swinging between hope and despair, the stock market has left investors clueless about what to look for next. Analysts claim stabilising macroeconomic factors, distorted stock valuations and corporate balancesheets hold cues.

After a good start to the calendar, the market has gone into a kind of suspended animation. Reasons: shrinking industrial output, high interest rates stifling growth, sagging demand in key sectors of the economy, slowdown in government spending and a fluid political setting ahead of general election.

There is no quick fix to these issues. Monday’s vote-on-account, being a temporary arrangement, can do little to address them.

“We believe a meaningful recovery in private capex, government spending or private consumption will be difficult to achieve over the next six to 12 months while policymakers focus on improving macro indicators, such as inflation, current account deficit and the banking sector balancesheet,” reckon Chetan Ahya and Upasana Chachra of Morgan Stanley Asia.

The drop in inflation rate makes room for an interest rate cut, which can help the demand-starved consumption sectors to look up. A few sops in the vote-on-account for, say, industries like automobiles or an easing of gold import curbs for the gems and jewellery sector may provide some succour. But the market requires strong, steady and long-term support.

Politics adds another dimension. It’s anybody’s guess where the market will be headed if the general election throws up a hung parliament. A rag-tag coalition in power is the last thing the market can afford at this stage, as that can send the economic agenda haywire with diverse interests pulling strings from different sides.

R Sreesankar, head of institutional equities at Prabhudas Lilladher says any indication of a fractured mandate is likely to increase negative sentiments, sending the market lower. “The market may trade in a range between 5,700 and 6,400 in the near term,” he warns.

Even if a BJP-led NDA is voted to power, much like Dalal Street and industry yearn for, can it put the market on a sustained rally? Doubtful, as the key props of the economy have crumbled and it will require more than a mere sentimental boost for a genuine stocks rally to begin.

Dipen Shah, head of research at Kotak Securities, says the biggest dilemma for investors is that most defensive stocks are richly valued, whereas stocks with low valuations do not have adequate growth visibility. And key risks like a decline in foreign inflows, sharp currency depreciation, spike in oil prices or political uncertainty loom over the market.

This may make stock investment look like catching a falling knife. But stock markets are never devoid of opportunities for investors who have their fingers on the pulse of the economy and plenty of patience.

So where is the money?

Some analysts feel in the short-term the market will not be driven by earnings or GDP growth, but by sentiments. Ambit Capital’s Gaurav Mehta, Karan Khanna and Saurabh Mukherjea, who offered this argument, say in the near term Sensex price to earnings (PE) multiple will be influenced by factors such as short-term rates, the slope of the yield curve (the greater the slope, the greater the gap between short-and-long-term rates), US bond yields and gross fixed capital formation (and not GDP growth and earnings growth). PE is the price an investor is willing pay to earn Re 1 per share or per unit of an index.

“Most of these factors seem to be at a point of turnaround. Barring US bond yields, others have not staged a meaningful reversal yet, meaning we will likely see better times ahead,” the analysts said in a report last week. This means Sensex will rise or fall on the basis of broader market sentiments in the short term before domestic microeconomic factors catch up with it.

The three analysts have also advised investors to look for valuation gaps. In the medium term, “money is to be made from the reversion in polarisation from defensives to cyclicals, from largecaps to smallcaps and midcaps, and from growth stocks (high-quality, successful companies whose earnings are expected to keep growing all the time) to value stocks (companies with strong fundamentals but lower valuations).

According to them, the valuation premium of defensives to cyclicals is reverting from multi-year highs, creating conditions for a re-rating, and such a phase of cyclical outperformance usually tends to be a period of strong Sensex returns.

The brokerage assigns maximum weightage to banking and financial services in its own model portfolio, followed by auto and auto ancillary, metals, oil and gas, utilities and cement.

Prabhudas Lilladher’s Sreesankar expects auto and technology sectors to drive earnings growth of Nifty companies in FY14 and FY15, which he estimates at 12.1 per cent and 16.5 per cent, respectively. He projects cement (-17.3 per cent earnings growth year-on-year), engineering and power (-6.6 per cent), banking & financials (1.7 per cent) and oil & gas (5.4 per cent) to be the laggards.

Another medium-term market driver would be expansion in profit margins. Brokerage Morgan Stanley says the market is getting sanguine about a new margin cycle, as evident in valuations.

“The net margins of 1,200 companies have declined 490 basis points since 2008 to a decade’s low but slightly better than their worst in history. The margin decline has been driven by an overvalued currency, a rise in the external deficit, a drop in investments and a sharp fall in capital productivity. This may provide reason to believe that the worst for margins is over,” analysts Ridham Desai, Sheela Rathi and Utkarsh Khandelwal wrote in a report.

But they cautioned that the new cycle would hinge on the balance between restoration of public savings and a superior capital cycle – i.e., policy action, which would likely roll out after the elections.

“While consumer discretionary, industrials, telecom, materials, technology and utilities appear to have margin upside, they are inclined to back technology, telecom and consumer discretionary because of the idiosyncratic drivers in those sectors. For three other sectors – industrials, materials and utilities – a margin recovery is dependent on a better macro cycle, which we are unwilling to call right now thanks to the political uncertainty,” they said.

A rather delayed trigger for stocks would be capex revival. Indian companies have been sitting on their capex plans waiting to see the shape of the government after the April-May elections. The 100-odd projects cleared by the government over the past few months and many other new projects will take off once there is clarity on the new government, providing an additional boost to these stocks.

Among the risk factors, apart from a fractured election verdict, a rupee crash, sustained outflow of foreign investment, a fresh spike in inflation and global uncertainty can be biggest drags. .


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