On surer ground but...
The current stock market rally seems to be on a much stronger footing
than the one in fiscal 2008, but investors need to be vigilant, argues
Rashesh Shah.
The more things change, the more they remain the same. Clichd as it may sound, it is true for a lot of things in life, including the stock markets. With the Sensex comfortably staying above the 20,000 mark for a while now, and, in fact, even having closed above the 21,000 level on the opening day of Samvat 2067, there is plenty of excitement on the streets. One cannot blame anyone for this; however, there is an unmistakable sense of dj vu as well. These are territories where the markets have been before and it is hard not to draw parallels between what happened three years ago and the rise in indices today.
Like it happened then, even today it is the money, pumped in by foreign institutional investors, or FIIs, that is chiefly responsible for the bull run. Yes, the amount has changed, with the inflows this year set to cross `100,000 crore. However, their contribution in driving the markets cannot be ignored. Apart from this, the strong earnings season was also a key reason for the good times for the investors, both in the financial year 2008 and now.
Nonetheless, there are differences as well in what we are witnessing now from what we saw before. Today, our repo rate stands at 6.25 per cent versus 7.75 per cent then. The difference of 150 bps makes me feel we are still in the early stages of the cycle. Also, retail participation in this rally is much lower. Today, equity markets continue to remain a place where retail investors hesitate to enter with the kind of confidence they do while investing in fixed deposits and bonds.
Let us take the argument forward. The GDP estimate for 2010-11 is `70 trillion, which is 40 per cent more than `49.5 trillion in 2007-08 at the current market rates. When you consider that the Sensex is at the same level for both these GDP numbers, one does get the feeling that we are on a much firmer footing now than we were earlier. Our GDP has grown by 42 per cent in the last three years while the total market capitalisation grew around eight per cent. So, on that metric, too, there is a lot more comfort now. Then, as stated earlier, earnings drove the markets both in 2007-08 and today. But in 2007, the price earnings, or P-E, ratio was 25x. Today, at the same index level, the P-E is 20x @2011 earnings.
Globally, there are some factors that could also determine how long this rally might last. While the western economies, including the United States and Europe, are still feeling the pangs of the global crisis, there are signs that the US in particular will continue with the quantitative easing measures for much longer. Even during the Fed meet in the first week of November, Ben Bernanke indicated little which suggests that the Fed will harden its key rates anytime soon. To put things in perspective, the yield on the 10-year treasury note in January 2008 was 3.8 per cent; today it stands at 2.5 per cent.
Moreover, in India, with inflation still a concern, there are no clear indications of whether we have seen the last of the rate hikes from Mint Road, although the Reserve Bank of India has hinted at a pause in the near term. With growth and interest rate differentials being high, we could see more inflows into emerging economies, especially India.
The widening current account deficit, or CAD, is another area of concern, rising by three times - to $13.7 billion in Q1, from $4.5 billion a year ago. As a result, foreign inflows are being welcomed by policymakers and, in fact, are required to offset the deficit. As a corollary to this, the policymakers would not prefer to use the option of imposing capital controls. As some countries continue to remain under stress and there are risks of exchange rate wars, I am sure our regulatory system is strong enough, as it has always been, to absorb shocks if any.
However, the markets are fully pricing in all this information and hence are not cheap anymore. Individual stocks can be cheap but the market is now priced for growth. So, risks of corrections are going to be there all the time - we believe an intermittent 5-10 per cent correction will be inevitable when markets are reasonably priced and growth expectations are high - as they are now. So, investors should use corrections to their advantage rather than be shaken out by them.
In a nutshell, this rally seems to be on a much stronger footing than the one we saw in financial year 2008, but investors need to be vigilant and not be complacent.
The author is Chairman & CEO of Edelweiss Capital
Like it happened then, even today it is the money, pumped in by foreign institutional investors, or FIIs, that is chiefly responsible for the bull run. Yes, the amount has changed, with the inflows this year set to cross `100,000 crore. However, their contribution in driving the markets cannot be ignored. Apart from this, the strong earnings season was also a key reason for the good times for the investors, both in the financial year 2008 and now.
Nonetheless, there are differences as well in what we are witnessing now from what we saw before. Today, our repo rate stands at 6.25 per cent versus 7.75 per cent then. The difference of 150 bps makes me feel we are still in the early stages of the cycle. Also, retail participation in this rally is much lower. Today, equity markets continue to remain a place where retail investors hesitate to enter with the kind of confidence they do while investing in fixed deposits and bonds.
| Rashesh Shah's take 1. Both in 2007-08 and now, FII money is chiefl y responsible for the bull run 2. Again, on both occasions, strong earnings season was a key reason for the good times for the investors 3. But in 2007, the P-E ratio was 25x. Today, at the same level of index, the PE is 20x @2011 earnings 4. Then the interest rate differential of 150 bps in India between 2008 and 2010 could mean we are still in the early stages of the cycle 5. The markets are fully pricing in all this information and hence are not cheap anymore 6. A correction will be inevitable and investors need to be vigilant, not complacent |
Globally, there are some factors that could also determine how long this rally might last. While the western economies, including the United States and Europe, are still feeling the pangs of the global crisis, there are signs that the US in particular will continue with the quantitative easing measures for much longer. Even during the Fed meet in the first week of November, Ben Bernanke indicated little which suggests that the Fed will harden its key rates anytime soon. To put things in perspective, the yield on the 10-year treasury note in January 2008 was 3.8 per cent; today it stands at 2.5 per cent.
Moreover, in India, with inflation still a concern, there are no clear indications of whether we have seen the last of the rate hikes from Mint Road, although the Reserve Bank of India has hinted at a pause in the near term. With growth and interest rate differentials being high, we could see more inflows into emerging economies, especially India.
The widening current account deficit, or CAD, is another area of concern, rising by three times - to $13.7 billion in Q1, from $4.5 billion a year ago. As a result, foreign inflows are being welcomed by policymakers and, in fact, are required to offset the deficit. As a corollary to this, the policymakers would not prefer to use the option of imposing capital controls. As some countries continue to remain under stress and there are risks of exchange rate wars, I am sure our regulatory system is strong enough, as it has always been, to absorb shocks if any.
However, the markets are fully pricing in all this information and hence are not cheap anymore. Individual stocks can be cheap but the market is now priced for growth. So, risks of corrections are going to be there all the time - we believe an intermittent 5-10 per cent correction will be inevitable when markets are reasonably priced and growth expectations are high - as they are now. So, investors should use corrections to their advantage rather than be shaken out by them.
In a nutshell, this rally seems to be on a much stronger footing than the one we saw in financial year 2008, but investors need to be vigilant and not be complacent.
The author is Chairman & CEO of Edelweiss Capital
