Winter weakness

When the Sensex breached 17,000 in November, there was optimism that the highs of 2008 were within reach. And why not? Macro-economic news has been very heartening of late. The index of industrial production (IIP) has clocked impressive growth in the past two months. In September, the index grew 9.1% compared with 6% in September 2008. In August, it had grown by 11%.

On the face of it, this surge in industrial production should imply good times ahead for the economy. The corporate sector is upbeat and so are brokerages. Is this a good time to enter the markets? No, says UK-based research house Noble. It feels that it is too early to celebrate because the sharp upturn in industrial growth is due to the low base effect. “The near zero base for IIP growth in the second half of 2008-9 makes the headline numbers look good but could be masking the lack of underlying momentum in industrial activity,” says a recent note from the research house.

Noble points to the drop in the growth of the infrastructure sector to below 4% in September 2009. Infrastructure accounts for nearly 27% of the IIP. Similarly, the fast growth clocked by the capital goods sector in the past two years could peter out in the coming months. “It would be a challenge to maintain the momentum,” says another report from the research house.

Noble is not the only one feeling jittery. Kotak Securities has reduced its estimates of the Sensex EPS for 2009-10 by 2.9% to Rs 913 and for 2010-11 by 2.8% to Rs 1,098 on the back of the cut in earnings of Reliance, ONGC and the telecom sector.

There are other factors that point to a cautious approach. While industrial growth has shot up, nonfood credit growth has steadily declined in the past nine months. “There is cause for alarm as bank credit has been closely associated with industrial performance in the past,” says Noble. The gap between sanctions and disbursals indicates that projects are being delayed.

Also, inflation could bounce back with a vengeance. The drought has reduced this year’s kharif crop production by almost 18% compared with last year, forcing a sharp rise in food prices. Headline inflation could hit 6.5-7% by March 2010.

Then there is the policy squeeze, both on the fiscal and the monetary front. RBI has already started tightening the screws and there is talk of the stimulus package being rolled back. Noble expects a hike in the cash reserve ratio in January 2010, followed by hikes in other policy rates in April, resulting in a rise in interest rates.

So, what does this mean for investors? Kotak Securities feels the market is fairly priced and there is limited scope for an upward revision in EPS estimates. Therefore, it is advising clients not to rush in right now. Prudence could pay.

Poor Prospects:

• Sharp rise in IIP growth is on a low base and is likely to moderate in the coming months.
• Industrial production is up but bank credit growth is down. This means projects are being delayed.
• Inflation is rising, primarily due to food prices. An 18% decline in kharif production over last year could fuel this further.
• Policy squeeze could add to problems. Stimulus package may be rolled back next year.
• The CRR may be hiked in January 2010, and other policy rates in April, causing interest rates to rise.