Post-Diwali trading

BEATING THE STREET

The post-Diwali surge in prices has been surprising. Post-Diwali trading often tends to the lacklustre and bearish. But this time round the FIIs have pumped in funds and even domestic punters have been happy to revalidate their faith in equity.

The optimism comes in the wake of a dip in global crude prices and a long-awaited hike in domestic petro-product prices. The dollar has been falling against the Euro ever since Bush's re-election.

It's a coincidence of positive events. A falling dollar makes FIIs look for havens abroad and rekindles growth in Indian export volumes. Lower crude prices lower the import burden and cool off domestic inflation. The domestic petro price hikes improve margins across the energy industry.

How long can this last? ICICI has raised its PLR and other banks will probably follow suit. The advent of northern winter means increased demand for fuel oil and so crude prices are likely to rise again. By December, most FIIs will be engaged in window- dressing annual results rather than taking new positions.

Could this rally thus prove the proverbial last kick of the dying cat? Current Sensex PE valuations are in the range of 18, which is "fully-priced" in the euphemistic terminology of equity analysis. After all, most analysts don't see fiscal 2005-06 as a year when year-on-year earnings growth will exceed 20 per cent on average.

Apart from anything else, results will have to beat the base effect created by an excellent 2004-05. That puts current PEs at the upper end of sustainability. Rising interest rates may well be enough of a trigger to cause a sell-off.

Of course, a PE of 18 with an expectation of EPS growth of 20 is hardly bubble valuation levels. There is room for pleasant surprises. Even an across-the-board correction might not push the market down drastically. Still, in these circumstances, it's very difficult to find stocks that offer enough value to inspire confidence in a long-term investor.

Is it time to enter debt markets again in a big way? Maybe not. Mutual funds dealing in debt will have new losses to absorb if rates go up. Indeed the entire financial sector is braced for portfolio losses if one goes by widespread provisioning in the banking sector.

And the vanilla FD investor would be foolish if he got locked into new instruments at the very start of an up-cycle in rates.

This seems to be one of those depressing moments when few concrete actions seem to be worth taking. However, refusing to participate in a market that's moving up is one of the most difficult things to do psychologically. There is always the lurking fear of being left behind as everyone else makes money.

The following actions appear commonsensical. Take profits if you hold stocks with uncertain growth prospects or inflated valuations. Wait for a correction before buying into more equity. Keep cash in short-term debt instruments and wait for another rate hike before committing to long-term debt.

Try and make a call about balancing off the effects of a falling dollar on exporters' bottomlines versus the new business volumes that a weak dollar might help generate. Maybe it's worthwhile investigating mutuals specialising in floating rate portfolios as well.