If January is any guide to the markets for the months that follow, 2010 can best be summed up as a year during which it will be extremely difficult for investors to make money. The year is going to witness the kind of volatility investors have just faced and might have many surprises in store. In 2009, when everybody was preparing for the worst, the markets rebounded with a bang and now, just as everybody started singing “Aal izz well…”, the hit song from 3 Idiots, the market has dealt them a nasty surprise.
The corporate sector’s better-than-expected results came as welcome relief for investors, reaffirming the sound fundamentals of the economy due to the fact that growth in net profits was supported by expansion in revenues – unlike the previous quarter when it was mainly driven by falling input costs. The sectors recording strong growth included sugar, auto and auto ancillaries, cement, consumer durables, IT and so on. Substantial decline in interest costs was also a significant reason for the corporate sector’s improved performance.
The domestic demand is likely to further prop up sectors like FMCG, automobiles, media, retail and financial services. The mega spending lined up for infrastructure by the government and private sector will not only boost the sectors with strong linkages but will also improve the productivity and competitiveness of Indian business globally. Also, due to the government’s policy initiatives, many new and innovative businesses are likely to emerge in sectors such as education, media, agriculture and finance. All this will ensure that India retains its leadership position among the fastest-growing economies.
However, despite strong quarterly results and other positives, the markets have fallen sharply – compelling analysts to look deeper into the challenges facing the nation and the world as also worries surrounding the markets. At current valuations, the markets appear to have discounted all the positives but not the negatives. The Nifty/ Sensex are trading at around 24 times the trailing 12 months EPS and 18 times the projected EPS for 2010-2011, which is way ahead of the historic average valuations. In view of the fact that the future outlook for corporate earnings does not look too bright due to the challenges facing the economy, the valuations appear risky.
The inflation for December 2009 was 7.3 per cent and analysts believe that it may even touch 10 per cent in a couple of months, which is much higher than the RBI’s fiscal year-end estimates of 6.5 per cent. Coupled with the fiscal deficit of around 10 per cent of GDP, the situation may require policymakers to use a combination of fiscal and monetary measures, including higher taxes, lowering of public spending, and higher interest rates. Such a policy will hurt demand growth in the economy and severely impact corporate borrowings, which in turn will negatively influence revenue and profitability. In fact, the next crisis facing major economies will be their inability to fund their deficits. Fiscal problems in Greece and Dubai are just the tip of the iceberg and are likely to be faced by the economies of the UK, Japan and even US.
In a bid to control capital inflows, the government may take steps such as reducing interest rates on NRI deposits, tightening ECB norms, withdrawal of fiscal stimulus, and rollback of excise and service tax relief. Investors may therefore face some anxiety till the forthcoming Union Budget makes the government’s fiscal stance clearer.
The number of IPOs and FPOs lined up for the year may suck substantial liquidity, putting further pressure on equity valuations. The days ahead may witness profit booking by FIIs, who are sitting on sizeable gains over 2009
The number of IPOs and FPOs lined up for the year may suck substantial liquidity, putting further pressure on equity valuations. The days ahead may witness profit booking by FIIs, who are sitting on sizeable gains over 2009. Moreover, apprehension of global difficulties might lead to flight of capital into US securities, strengthening the dollar while weakening the rupee and other currencies. However, the liquidity ensured by domestic financial institutions might limit the downside risk as the market rose on many days despite largescale selling resorted to by FIIs.
With the decoupling theory already discarded, the Indian economy is substantially dependent on exports, ECBs, FDI and its markets on FIIs. If the global economy falters – because of rising defaults in commercial real estate and credit card loans or because of a premature withdrawal of fiscal stimulus or raising of interest rates – India will be impacted, too. Even a modest slowdown can impact our markets, never mind some drastic policy pronouncements like the one made by US President Barack Obama to limit proprietary trading by banks or tighter monetary policy by China.
Investors are advised to adopt a stock-specific approach, concentrating on companies that have potential to register higher earnings growth with good managements. Companies deriving growth from domestic consumption or those likely to be impacted by reforms and disinvestment agenda of the government are likely to yield decent returns.
The author is retired as Professor from the University of Delhi in 2024. He is an alumnus of IIM Indore and holds a PhD from the Delhi School of Economics. An investor activist and former member of various SEBI committees. He taught Capital Markets and Investment Banking at leading business schools of India.
