Sensex and Nifty: What Next? - Part 2

My two cents

Predicting the direction of market is like driving a car blindfolded taking directions from a man who is looking out of the rear window. Nevertheless, I am willing to stick my neck out and say that the chances of Sensex touching 20,000 again in 2008 is limited. I also expect the markets to remain volatile through the remaining part of the year, even as crude wreaks havoc on the earnings card of index stocks. The rationale:

Earnings may remain under pressure

Investors value a stock (and in turn the index) based on future earning expectations and not the trailing earnings growth. An analysis of Sensex companies indicate that the top-line and bottom-line growth of these stocks may decelerate over the next few quarters:

• Revenue of software firms, Infosys, Satyam, TCS and Wipro, are likely to take a hit as US economy is struggling with a slew of things including a housing slump, a mortgage crisis, job losses and a possible downturn. The recent change in the rupee-dollar parity (Rupee has lost about 7-8% against the dollar in the last few weeks and is currently trading at Rs 42.8 per dollar) may offset this a bit
• The possibility of an increase in interest rate and Cash Reserve Ratio, on the back of higher inflation that is set to touch 9%, also don’t augur well for banks; credit disbursements, and in turn the revenue, of SBI, ICICI Bank and HDFC Bank may get impacted. Higher interest rates also don’t bode well for realty companies such as DLF, as homebuyers in India predominantly buy through housing loans. It is worth noting that interest rate on housing loans has climbed 4 to 5 percentage points in four years
• Higher input costs will also be a cause for concern for several corporates. With crude marching its way towards $150 a barrel (it is currently trading at $135 a barrel), the margins and in turn the earnings may come under pressure. The demand for crude and the subsequent price surge may not abate in the near term, as China may consume more to rebuild itself from its worst natural disaster in the recent times. The recent hike in gasoline price is likely to act as a dampener on the sales of automobile manufacturers, Tata Motors, Mahindra & Mahindra and Maruti Suzuki.
• The price of coal, the key input for cement, steel and power companies, also has more than doubled in the last one-year. Jaiprakash Associates, ACC, Ambuja Cement and Tata Steel, may find it difficult to pass on these increase costs to the customers as the Government has requested not to hike the price of key commodities such as Cement and Steel

FII flows may diminish

WL Ross, a FII, recently told a television channel that they are net buyers in the Indian equity market. Exceptions such as these are very rare, as FII’s remain net sellers in 2008. According to SEBI, FIIs have sold (net) $4.5 billion worth of securities as of 9^th June. Ben Bernanke, the chairman of the Federal Reserve, recently said that the risk of a substantial economic downturn has diminished. This perhaps is an indication that further rate cuts are limited. In turn, this may also lower purchases by FIIs in the Indian markets.

Conclusion

As negative global cues continue to depress investors’ sentiment, markets are likely to remain volatile. It would be interesting to see the next two quarters earnings card as they would determine the course of the market. If Sensex touches 20,000 again in 2008 without a clear visibility or a strong earnings support, it would be another case of irrational exuberance.

Madhan Gopalan

The author, who is currently based at Chennai, India, is an independent Investment Management consultant. The views expressed here are his own. He can be reached at gmadhan72@yahoo.com