Fundamentals are deteriorating

SMARTSHARE

The current fall in the markets is largely being explained as a mere correction and fundamental analysts have used the oft-repeated phrase "there is no change in the fundamentals" several times in the past weeks.

Common sense, however, says things may have changed for the worse. A combination of domestic and global events is creating a scenario where rate of growth of earnings could slow down.

A classic case in point is the cement industry. Investors had climbed on to the cement bandwagon hoping that 2007 would be the year in which cement companies would have that rare opportunity in which the rising demand and stagnant capacities would give them the pricing power.

Dalal Street analysts tracking the sector had hoped for a price hike of 35 per cent in the year 2007. With the industry now having assured the government that they would not be raising prices, the investors' fate has been virtually sealed. With fresh capacities expected to come up, it will be difficult to even maintain the prices by March 2008; the question of increase does not arise.

Any change by the government in its stand could possibly change fortunes.

But unless that happens, cement stocks are headed for the cemetery.

I see a lot of cement money moving to the steel sector, where the game of "kho-kho" is just about to begin. With predators on the prowl, the valuations of the sector are about to improve.

The entry of Vodafone into the telecom arena, Dalal Street's most performing sector, would mean more competition. While the industry will continue to grow, average revenues may fall. Whatever market share Vodafone gains will not get reflected in the stock market indices as this entity is not listed.

Something similar happened to IT post-2000. While the industry continued to do well, the market share of the listed companies fell as more US companies set up shops in India for their business. The net profit of Infosys multiplied 13 times since 2000.

The stock, however, has appreciated just 20.8 per cent. Similarly, Wipro's profits jumped nine times in seven years but the stock depreciated 65 per cent. A mere increase in profit is not enough, it must grow at a higher rate than past years to enable the companies to get same or better discounting by the markets.

The big guns of the Sensex are busy investing in businesses that will be rewarding some years hence. These strategic decisions, which are good from the point of view of the promoters and long-term interest of the company, may not gel with the short-term goals of the investor.

Besides, capital market players will have to learn to live with the fact that the business of the government is to run the nation and the capital markets are a subset. So more steps that may be politically right and wrong from the market's point of view may be in the offing.

The issue of reservation in private sector jobs is just another bomb that is about to be dropped on the markets. Companies may want to set up shop outside the country if this is done, as this will deteriorate the quality if implemented.

The US, the world's largest economy, is likely to see a slowdown if not an outright recession, as the housing delinquencies rise.

As of the end of December 2006, 13.33 per cent of all sub-prime loans were in default, the highest level in five years, and foreclosures were the highest in 37 years. Housing prices could fall, following more foreclosures, which in turn could send prices still lower, which in turn would mean more defaults and the cycle goes on. Rising inflation and the need to attract foreign exchange may not allow the Fed to cut interest rates, which would make matters worse.

The biggest thing going for the markets, despite all the negatives, is that as long as the PN route is open and the rupee continues to appreciate against the dollar, money stashed abroad by corporate India by over-invoicing during the license-raj or that under the control of men in khadi, will continue to come in and support the markets at lower levels.