As the celebrations of the festive season and the new year settle in matters in the investing area are getting clearer. The confusion that sets in at the year end with low activity and overseas investors tending to stay away has now faded away.
Investment professionals have now started to prognosticate and the overall reckoning is that of optimism. Analysts believe that the market is rich with valuations at the moment, but the earnings momentum is extremely strong and this would hold the Indian equity markets in good stead.
After two extreme years, 2008 and 2009, the Indian market is now trading at a premium to historical valuations, and looking for fresh triggers to decide the direction of its next move. Going forward, Navin Agarwal and Rajat Rajgarhia of Motilal Oswal Securities see the market direction being decided by the interplay of a new cycle in three aspects — earnings growth, capital raising and policy reforms.
Betting on earnings
In the last 18 years, the Indian markets have witnessed four distinct earnings cycles. We now see the beginning of new cycle of earnings growth. Based on a detailed bottom-up exercise, Agarwal and Rajgarhia expect the Sensex earnings per share have a compounded growth rate of 23% through 2014. However the growth rate would be higher in the initial years and they estimate that the it would be at 32% in 2010-11 followed by 20% compounded rate of from 2011 till 2014.
Analysts at Edelweiss Securities are of the opinion that India?s current valuation premium over emerging has been in line with the recent past. And that given the strong visibility of growth and political stability, there should not be any change or ‘de-rating’ in the premium over the near term. They expect earnings estimates for 2010-11 to grow further. ?Even if there is no further uptick in valuation multiples, Indian markets will keep moving up along with earnings upgrade.?
The house view at Religare Hichens Harrison is that the Sensex is trading at a price earnings of 16.7 times its estimated 2010-11 earnings and this is a premium to the 10-year average of 15 times. ?However, we are still below the highs of 22 times witnessed over the past decade. In our view, the current valuation multiple is sustainable on the back of strong earnings growth.?
Most of the analysts are therefore betting on earnings growth. The view at IIFL is, ?2010, the Year of The White Tiger, is unlikely to be as malignantly capricious as the eponymous protagonist of Aravind Adiga?s recent prize-winning book, but it will still be one in which delivery of growth expectations will be put to test.?
For investors clearly the ‘earnings growth’ would be phrase to look out for. Funds and monies are more likely to chase growth than look for value in the coming year.
The concerns
And while investment professionals are taking a bet on earnings, the concern clearly is about these expectations not being met. There are other concerns like the fiscal stimulus being pulled out being one the bigger concerns.
However, analysts at Edelweiss reckon that this would not have much of an impact as the country remains largely immune to the risk of any rollback in stimulus as the amount of the stimulus was miniscule at less than 1% of the GDP against around 15% of China. And this stimulus was targeted at the lower strata of the economy?in line with government’s ?inclusive growth? strategy.
Agarwal and Rajgarhia reckon that global ambitions of Indian corporates would be a deterrent. ?
In the last three years, Indian companies’ global ambitions have not been well received by the markets,? they mention in their report. They are also concerned about the aggressive initial public offer (IPO) valuations. ?Over the last three years, 70% of large IPOs have underperformed benchmark indices. Recurrence of this phenomenon will affect investor sentiment and market growth,? they believe.
And then there are concerns about the liquidity factor. Many overseas investors have been using the ‘dollar carry trade’ route, that is borrowing at low interest rates and investing these monies in emerging markets. Changes in interest rates could have a negative impact. This is something that traders would have to carefully watch out for. For long-term investors this would not have as much an impact reckon investment experts. Domestically, the fact that there could be a hike in cash reserve ratio and some amount of tightening has been factored in the market at the moment.
The portfolio approach
Clearly, focussing on equities is what experts recommend. According to analysts at ICICI Direct, equity as an asset class has outperformed other asset classes including gold in 2009. The out performance also sustained over a longer period of time (see charts alongside). Emerging equity markets have outpaced their developed counterparts in the last 10 years since 2001, indicating growing importance of developing economies as a preferred investment destination. Commodities, as represented by Reuters/Jefferies CRB Index, have performed well in phases but huge volatility makes them less attractive as compared to equities over a long period of time, they mention.
Arafat Saiyed of Shriram Wealth Advisors recommends buying into stocks on dips. ?We expect short?term volatility to continue. We have Sensex earnings estimate of Rs930 and Rs1,070 for 2009-10 and 2010-11 respectively. We expect BSE Sensex to trade in the 14,500? 21,000 band implying a P/E band of 13.6 times ? 19.6 times on 2010-11 estimated earnings.? Their conviction on infrastructure, power, capital goods, FMCG and auto.
?Given our positive stance on consumption, our portfolio strategy would be to overweight all sectors linked to the consumption chain. In addition, we overweight the software and pharma sectors, as earnings momentum remains strongly positive, with more upgrades to come,? say analysts at IIFL.
Agarwal and Rajgarhia say,?Our model portfolio is overweight on domestic plays like financials, infrastructure, cement, autos and telecom. The only global play we are overweight is ,etals, that too owing to volume growth rather than price hikes.?
So the overall focus would clearly be on the domestic consumption and infrastructure growth. The lesson that investors have learn from the global meltdown that domestic growth will always sustain as against global activities that could be influenced by several factors.
Here, analysts at Edelweiss point out, ?We believe key to out performance will be with bottom-up sector and stock selection.? They too prefer to play the India growth story through the infrastructure creation and end-consumption route.
So as the new year unfolds the immediate attention would be on how the earnings turnout and if they are not in line with high expectations there could be some correction. However, this too could be an opportunity to buy. The few weeks ahead could truly throw up several opportunities ? good time to watch out for them.