Cautious optimism

Market experts see more volaity in the new year

After a third bumper year for the stock markets in 2005, market participants continue to look at 2006 with cautious optimism. Crossing the previous high for most of the indices is virtually a given considering the current momentum, but will they sustain through the year?

The market has been partially driven by liquidity in 2005. FII inflows, which crossed $10 billion in 2005, have been the major driver for the rally in the stock markets.

Even acros s various emerging markets, India has attracted more inflows than most of its peers. This year, too, the market expects robust fund flows, as long as global interest rates do not shoot up.

But retail participation, which has barely been a fraction of foreign money, could also increase, say market experts. Retail holdings, in fact, have fallen to 11.9 per cent in the BSE 500 companies in September 2005 as compared to 14.1 per cent two years earlier.

While retail interest has been high in new issues of stocks and mutual funds, their secondary market participation could provide a leg-up to the stock market rally.

In terms of valuation, the Sensex is trading at a trailing 12-month P/E multiple of 18, which is not low. Some brokerage firms have put out sell reports on India in the past few months, as they find stocks overvalued.

The bull side expects strong growth and does not find the market expensive at FY07 estimated P/E of around 13 times. In the past, we have seen times of higher valuations, be it the bull market of 1999-2000 or the 1994-1995 markets.

The GDP growth is strong, companies are on an expansion drive to meet increasing demand, and some hike in interest rates is unlikely to cause damage.

We have seen some slowing down in the September 2005 revenues and profitability of Indian companies, and corporate performance in 2006 will have to improve to justify the current valuation.

The 2005 equity market rally was mainly driven by large-caps. Experts predict that mid-caps could come in the forefront again as the big stocks become expensive, and they add that there could be more volatility in 2006.

Metal sector: mixed fortunes

The metal sector is expected to see a wide divergence in its fortunes in 2006. The steel industry is expected to continue to reel under the impact of lower prices.

That's because global steel demand is expected to grow 4-5 per cent to 1,040-1,053 million tonnes in CY06, while steel production is expected to reach approximately 1,150 million tonnes in the new year.

This widening gap in steel demand-supply is largely due to the ramp-up in Chinese steel capacity "" steel production there was projected at 350 million tonnes in CY05 and this is expected to reach 400-425 million tonnes next t year.

Last week, Korea-based Posco had announced price cuts between 4-17 per cent for supplies in 2006 and there is growing consensus that steel prices will dip even further in the new year. Domestic hot-rolled coil prices are about $440 a tonne, and are about 25 per cent lower on a y-o-y basis.

Meanwhile, in the aluminium sector, global demand is expected to exceed supply by an estimated 200,000 tonnes in the new year. However, analysts point out that in key export markets for Indian players like the Middle East and elsewhere in Asia, demand is forecast to exceed supply by about 3.5 million tonnes in the new year, mainly because of the requirements of the booming transportation and housing sectors.

In addition, rising input costs like power and alumina for smelters in China, has resulted in global aluminium prices gaining almost 33 per cent over the past six months to $2,273 tonne at present. Analysts believe that aluminium prices will rise in the new year and this trend is no doubt expected to help domestic integrated players like Hindalco and Nalco.