New heights to scale

Markets have their way of surprising both participants and observers. There was first the bull run till mid-May, then a sudden correction followed by uncertainty and even gloom, only for a fresh rally to wipe out most of the losses""without stocks looking quite so overvalued as they seemed one short quarter ago. Each turn of the wheel has surprised the unwary, and the obvious question is: what comes next? At the moment, the outlook certainly seems positive.

It is useful to recall that the US Fed's rate hike in May sparked off a run on non-ferrous metals and a sudden withdrawal of foreign institutional investors' (FIIs') funds, so that the Sensex declined by over 30 per cent between May 11 and June 14. This collapse resulted in company valuations that long-term investors found attractive, so the market moved sideways for a few weeks-those wanting to get out capped every mini-rally, and fresh money coming in propped up shares whenever they fell. Now sentiment has improved because foreign flows have improved, and the global outlook does not look quite so risk-ridden.

If the US Fed rate hike in May was the cause of turmoil then, US interest rates are the key driver of the rally this time. When the Federal Open Market Committee (FOMC) met ten days ago, it halted raising rates after 17 consecutive hikes since June 2004. Along with the status quo of the Fed rate at 5.25 per cent, the central bank also said prices would moderate over time. The markets read this event to be the end of interest rate hikes for the time being and, as a result, fund flows into emerging markets improved once again. After net sales of a substantial Rs 8,247 crore during May in the cash market, FII flows turned positive in June and July at around Rs 1,400 crore each. Till mid-August, they have pumped in another Rs 1141 crore.

An India-specific trigger has been corporate performance in the June 2006 quarter. In a study conducted by Business Standard Research Bureau, net sales of 2,487 companies went up by 27.48 per cent and net profit by 21.46 per cent in the June 2006 quarter. If oil companies, banks and non-banking financial companies are excluded, India Inc's performance in the first quarter is even more impressive""operating profit and net profit go up 29.48 per cent and 31.6 per cent, respectively. The operating profit margin has improved from 21.64 per cent in June 2005 to 22.25 per cent for these 2,151 companies. The net profit margin has gone up from 10.9 per cent to 11.39 per cent in the same period. With no indications of a slowdown in either sales growth or profitability, the first quarter results have encouraged fresh equity inflow. As a result, the markets have witnessed an all-round rally across large, medium and small capitalisations.

The Sensex is therefore at a three-month high, and the outlook for the stock market has changed from negative to positive. However, concerns about a global slowdown are not unwarranted even today as the US struggles to balance its current account deficit, and as China tries to follow a slower path to growth. The market has been helped, meanwhile, by the generally quiet response to negative news like terrorism in Mumbai and London. If global interest rates start falling and oil prices continue their drop of the last few days, fund flows into India could keep improving. The combined effect of improved liquidity flows and robust corporate fundamentals means that stock valuations, while high by the standards of other markets and in historical terms, look reasonable once again to most investors. If the manufacturing and service sectors lead the charge for a fourth year of 8 per cent GDP growth, the markets may continue to remain broadly bullish in the coming weeks.