Bulls in trouble

f/060908_01.htm">(Click here for tables)  Interest rate worries
One of the objectives of the monetary policy in India has been achieving price stability, which the RBI may try to achieve even at the cost of giving up growth. If inflation spirals, the RBI may also raise either the CRR (cash reserve ratio) or the repo rate, depending on the prevailing situation.  The RBI's comfort level for inflation rate is 5.50 per cent, whereas the current level is 8.24 per cent. As there are worries over the rising interest rates, the economist also predict higher interest rates, which along with other factors would shave off around 50-75 basis point from the GDP growth rate.  "It seems that the economy will slow down, closer to its long term average of around 6-7% for the next decade. Higher inflation and rising crude oil prices remain a risk to the Indian growth story," says Devendra Nevgi.  Earnings slowdown
The high interest rates along with the factors like inflation and higher commodity prices will hit India Inc negatively. The domestic cost of capital has already increased, with the prime lending rates having gone up by 175 basis points since the second half of 2006 to 12.5 per cent currently.  Also, the housing loans have become more expensive, while in many of the cases the banks are charging about 18-22 per cent for the two wheeler and personal loans. As a result of this, the bank credit growth has come down to about 24 per cent as against the recent high of over 30 per cent in January 2007.  This will not only hit the banks' income growth, but also hit the companies immediately, due to higher interest outgo and slow down in the consumer demand. The early sign of this is seen in the slow down in industrial production to 5.8 per cent during the quarter ended March 2008 compared to over 10 per cent a few months ago.  The lag effect is also felt by the companies. According to estimates, sales growth of a cluster of 1,524 companies, excluding oil and gas and finance companies, was 14 per cent year-on-year (YoY) during the quarter ended March 2008 as against the recent peak of 28.9 per cent YoY growth during the quarter ended September 2006.  Analysts expect this trend to continue going forward if the various issues, as mentioned above, remain.  "We think the Sensex earnings growth will slow down in FY09 mainly on account of margin pressure across the sectors led by input costs of power, coal and other raw materials. Also, higher interest rates and slower credit growth should pressure the banking sector," says Harendra Kumar, head research, Centrum Broking.  "Yes, moderation in earnings is quite visible. With increase in input costs (of materials, human resources and capital) margins are also under pressure. We have seen decline in margins of companies from the IT, automobiles, engineering, capital goods and logistics sectors" Says Bhavesh Shah, VP Research, Asit C Mehta Investment Intermediates.  Though not all sectors will witness a slowdown, certain sectors will be more vulnerable, such as financials and banking services, real estate, industrials, capital goods and auto, among a few others.  Analysts are also predicting a slowdown in the BSE Sensex earnings in the FY09 in the range of about 5-10 per cent.  "We expect Sensex EPS to be Rs 1,001 for FY09. We have revised this slightly lower (by one per cent) over the past couple of months from Rs 1,012, but do believe that the risk for further downward revisions does exist," says Ajay Loganadan, Head Investment Advisory Group, HSBC Private Banking.  Foreign capital
Considering these issues coupled with the slowdown in the earnings, market participants say that the Indian equity markets are relatively expensive as compared to other emerging markets. Also, this is cited as one of the reasons for the FIIs selling witnessed lately.  The depreciation of the rupee has lowered net returns (in dollar terms) for FIIs.  While sharing his view on the FII investments, Ajay Loganadan say, "FIIs have been net sellers of Indian equities to the tune of about $4.2 billion with about $1.2 billion of this selling coming in May.  Given the high levels of risk aversion and P/E contraction, we could expect flows to remain muted over the near term. Fund flow for the rest of the year will depend on global news flow and the perception of risk amongst foreign investors. Also, rising trade and fiscal deficits are not viewed very favourably by FIIs."  Global markets
Besides the FII flows the direction of the market will be determined by the global developments, which are not considered to be very favourable. "In our view, global markets are going to remain weak over the next 12 months.  US Housing data continues to get worse, record number of small businesses in the US are filing for bankruptcy (5,000 in April 2008 alone), debt of 174 large US companies is trading at distressed levels.  

In these circumstances, it is tough to make a case for stability in the US financial space," says Madhusudan Rajagopalan, Director, Aranca India Operations. Besides the instability and slow down in the US, analysts also see more risk due to the sub prime crisis.

So far, major banks and other financial institutions across the world have reported losses of approximately $380 billion. In a recent development, Lehman Brothers Holding, a top investment bank in the US is expected to raise approximately $4 billion to shore up its balance sheet after incurring losses due to the subprime crisis (S&Powngraded its ratings).  The rating agency also downgraded credit ratings of Merrill Lynch and Morgan Stanley, saying they may have to book more write-downs on devalued assets.  Outlook
For many, it is a bearish market due to the negative micro and macro factors that are affecting the markets, while for others it is the right time to invest and use the lower levels as an opportunity to invest for the long term. Considering that these issues remain, it also indicates that there are concerns for the market to rise from here in the near term.  A good monsoon, lower inflation rate along with the better global cues could be the positive triggers, which though seem some time away.  

MARC FABER ON INDIAN MARKETS

"I am somewhat surprised that Indian investors are as positive about their market as they are. Inflation is accelerating and will dampen consumption and the stock market is not particularly inexpensive. I would sell rallies and still expect the market to trade down to around 10,000 - 12,000. Developments in the international capital market, which are likely to be negative, will contrary to the belief of Indian investors, also affect the Indian stock market."