 "Misplaced enthusiasm on Dalal Street?")
Is exuberance back on Dalal Street? Analysts are asking this after the past three weeks saw the benchmarks indices on the two main stock exchanges, the S&P BSE Sensex and the National Stock Exchange’s Nifty rise 7.6 per cent and nearly eight per cent, respectively.
More surprisingly, the rally is being led by stocks and sectors which were laggards till recently, spoiling the good show by defensives and export-driven stocks. In comparison, the hitherto high-performing ones in fast growing sectors such as information technology (IT), pharmaceuticals and consumer staples (FMCG) are conspicuously absent from the current rally.
The biggest gainer in this rally has been capital goods stocks, followed by banks & financials and real estate companies. The BSE Capital goods index is up 18.3 per cent since the beginning of February; the BSE Bankex has rallied nearly 16 per cent in the past month. The BSE Realty index is up a little over 12 per cent in the period. This is baffling, as most companies in these sectors continue to suffer from a falling or stagnant order book, high indebtedness and below-par financial ratios such as return on equity and interest coverage ratio (NEW LEADERS AND LAGGARDS).
“The market has become highly polarised in the past few years, with most of the money flowing to low-beta and defensive sectors such as FMCG, IT and pharma, while cyclical stocks languished and their valuations hit new lows. If corporate earnings recover after elections as expected, there could be a valuation re-rating in cyclicals,” says J Venkatesan, fund manager, equity, at Sundaram Mutual Fund.
The tough part is to separate exuberance from genuine value buying, given a lack of operational or financial turnaround in most of the financially stressed sectors. For example, construction and infrastructure companies that are part of the BSE 200 index continue to suffer from a high debt to equity ratio, a low interest coverage (ICR) ratio and a low return on equity. The industry’s ICR declined to 2.4 times in the December 2013 quarter from 3.3 times during the year ending March 2013, signalling a lack of cash flow vis-à-vis interest obligations. The ratio would look worse if data for financially stronger companies such as Larsen & Toubro were excluded.
Capital goods makers reported negative to stagnant revenue and profit growth in the first nine months of FY14 and fresh order inflow remains weak. Ditto in the real estate sectors, where most leading companies reported a decline in net profits in the third quarter. In the banking sectors, non-performing assets continue to hobble public sector banks and the problems seem to have spread to private banks, too. Banks also face pressure from a rise in interest rates as the Reserve Bank tightens monetary policy in a bid to fight inflation.
Another worry is the large gap between market valuation and total debt for most heavily indebted firms, despite the recent rally. This rules out the possibility of companies tapping markets to raise fresh equity and, thus, deleverage their balance sheet, unless their stock doubles or triples from the current levels. Jaiprakash Associates’ market cap is still less than a quarter of its total debt; the GMR Infra market cap is only 17 per cent of its total debt liabilities.
This has led some analysts to describe the current rally as purely sentiment-driven, likely to fizzle out at the first whiff of bad news. “The market is in exuberance mode right now, with bulls betting on a favourable election outcome. But it cannot sustain, unless backed by acceleration in GDP growth and corporate earnings. We still remain overweight on defensives and export-driven stocks, and are staying away from cyclicals and high-beta stocks,” says Dhananjay Sinha, head, institutional equity, at Emkay Global Financial Services.
Others say the current rally has many legs and could sustain for some time. “Macro economic factors and global cues support a rally. Inflation is down, the current account deficit has come down, growth is likely to hold up in China and the US economy is recovering. The only worry is poor industrial growth and capex slowdown, which will be taken care by the next government,” says G Chokkalingam, founder, Equinomics Research & Advisory.
More surprisingly, the rally is being led by stocks and sectors which were laggards till recently, spoiling the good show by defensives and export-driven stocks. In comparison, the hitherto high-performing ones in fast growing sectors such as information technology (IT), pharmaceuticals and consumer staples (FMCG) are conspicuously absent from the current rally.
The biggest gainer in this rally has been capital goods stocks, followed by banks & financials and real estate companies. The BSE Capital goods index is up 18.3 per cent since the beginning of February; the BSE Bankex has rallied nearly 16 per cent in the past month. The BSE Realty index is up a little over 12 per cent in the period. This is baffling, as most companies in these sectors continue to suffer from a falling or stagnant order book, high indebtedness and below-par financial ratios such as return on equity and interest coverage ratio (NEW LEADERS AND LAGGARDS).
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On the losing side are IT stocks, pharma makers and FMCG companies. The BSE IT Index has remained flat in the period. The BSE FMCG gained only 1.5 per cent and the BSE healthcare index is up only 2.6 per cent. Analysts attribute all this to investors’ exuberance about a positive election outcome and its likely beneficial impact on cyclical and high-beta stocks in sectors such as banking & finance, capital goods, real estate and construction, and infrastructure.
“The market has become highly polarised in the past few years, with most of the money flowing to low-beta and defensive sectors such as FMCG, IT and pharma, while cyclical stocks languished and their valuations hit new lows. If corporate earnings recover after elections as expected, there could be a valuation re-rating in cyclicals,” says J Venkatesan, fund manager, equity, at Sundaram Mutual Fund.
The tough part is to separate exuberance from genuine value buying, given a lack of operational or financial turnaround in most of the financially stressed sectors. For example, construction and infrastructure companies that are part of the BSE 200 index continue to suffer from a high debt to equity ratio, a low interest coverage (ICR) ratio and a low return on equity. The industry’s ICR declined to 2.4 times in the December 2013 quarter from 3.3 times during the year ending March 2013, signalling a lack of cash flow vis-à-vis interest obligations. The ratio would look worse if data for financially stronger companies such as Larsen & Toubro were excluded.
Capital goods makers reported negative to stagnant revenue and profit growth in the first nine months of FY14 and fresh order inflow remains weak. Ditto in the real estate sectors, where most leading companies reported a decline in net profits in the third quarter. In the banking sectors, non-performing assets continue to hobble public sector banks and the problems seem to have spread to private banks, too. Banks also face pressure from a rise in interest rates as the Reserve Bank tightens monetary policy in a bid to fight inflation.
Another worry is the large gap between market valuation and total debt for most heavily indebted firms, despite the recent rally. This rules out the possibility of companies tapping markets to raise fresh equity and, thus, deleverage their balance sheet, unless their stock doubles or triples from the current levels. Jaiprakash Associates’ market cap is still less than a quarter of its total debt; the GMR Infra market cap is only 17 per cent of its total debt liabilities.
This has led some analysts to describe the current rally as purely sentiment-driven, likely to fizzle out at the first whiff of bad news. “The market is in exuberance mode right now, with bulls betting on a favourable election outcome. But it cannot sustain, unless backed by acceleration in GDP growth and corporate earnings. We still remain overweight on defensives and export-driven stocks, and are staying away from cyclicals and high-beta stocks,” says Dhananjay Sinha, head, institutional equity, at Emkay Global Financial Services.
Others say the current rally has many legs and could sustain for some time. “Macro economic factors and global cues support a rally. Inflation is down, the current account deficit has come down, growth is likely to hold up in China and the US economy is recovering. The only worry is poor industrial growth and capex slowdown, which will be taken care by the next government,” says G Chokkalingam, founder, Equinomics Research & Advisory.