Sensex will touch 5,000 within next one year

HOW FAR WILL THIS CORRECTION GO?

Jyotivardhan Jaipuria is a management graduate from Indian Institute of Management, Ahmedabad. He has been with DSP Merrill Lynch for the last nine years. Prior to this he was with ICICI.

 On market outlook

After a sharp rally, the markets are likely to go through a phase of consolidation and correction. Over the past couple of weeks, we have already seen the markets starting to correct.

This is only a pause and the markets are looking at high levels on the Sensex over the next year. Our one-year target for the Sensex is 5000, after the formation of the new government.

Fundamentally, we are likely to see an improvement in the economy as well as better flows to the markets.

In terms of the economy, we expect agriculture growth to be strong following the good monsoons. This should drive GDP growth to 6.4 per cent for FY04.

On liquidity scenario

We believe domestic liquidity to the equity markets will be strong. Two important changes should likely be positive for domestic flows to equity markets:

Firstly, the UTI problem is behind us. Worries on UTI selling had been a constant drag on the markets over the past few years. With the UTI problem being over (by issue of tax-free bonds), the market is not worried about forced selling by any institutional player.

Secondly, bond markets are peaking out. After a sharp rally in the bond markets over the past two-three years, capital appreciation in bonds is likely to be limited.

Hence, for investors, returns in the bond market may reflect interest rates. Given that interest rates have fallen, we believe retail money on the margin will move to equity.

Remember that portfolios of investors have become totally risk averse with equities accounting for just 2-4 per cent of total savings versus over 10 per cent a decade ago.

FIIs continue to be positive on India. Our interaction with them indicate that India has been recognised as one of the fastest growing economies in the world.

Given the record inflows this year and the fact that India is one of the biggest overweight markets for FIIs in the GEM universe, we see weightage to India likely to be constant.

However, with emerging markets continuing to be the flavor, a shift in allocation from the developed to emerging markets should help India, too.

On corporate earnings and stock valuations

The fundamental scenario continues to be attractive on the back of good monsoons. This, we believe, could lead to a recovery in the economy starting December 2003 and help sustain a trend of earnings revision.

After a spell of earnings downgrades, earnings are again being marked up as the global economy performs better than expected and expectations of a bounce in the domestic economy are factored into earnings.

At a bottom up level, we forecast earnings growth of 17 per cent for FY04 and 15 per cent for FY05.

While the index has got re-rated over the past few months, it continues to be well below historic averages. We do not expect any significant re-rating over the next year from the current levels.

However, earnings growth of over 15 per cent drives our index target of 5000 over one year at a PE of 12.8x one-year forward, similar to the levels currently.

On sectors that are likely to outperfrom

We expect most sectors do to well going forward on the back of a general pick-up in the economy. Specific stock stories will be more in demand.

Overall, however, we would be bullish on sectors that benefit from the improvement in the economy. I would favor heavy commercial vehicles segment that would benefit from the highway project.

We believe the shift from rail to road traffic would get accelerated due to the highway projects that would boost the demand for trucks. Within the auto sector, we see a gradual improvement in the health of the tractor segment due to good monsoons.

However, this may not be reflected in sales immediately since the inventory in the system was running at high levels. I would also favor infrastructure plays especially in the power equipment space.

With the passage of the Electricity Bill we expect an improvement in the health of the state electricity boards (SEBs).

This coupled with the increased thrust on generation by the state-owned utility companies will lead to a sustained demand for power generating equipment companies.

Banking is another sector I continue to be bullish on given the likely structural changes in the lending profile as well as improvement in non-performing loans (NPLs).

Banks are successfully shifting their loan profile towards retail credit that has higher margin.

NPLs are likely to fall given the recovery in the economy, especially in sectors like steel. Foreclosure norms will provide a further boost to the banks in recovering their dues.

On how news flows will impact markets

Markets always react to events in the near term but focuses back on fundamentals as the initial surprise or shock wears off.

Over the past few weeks we have seen some examples in the form of the tragic bomb blasts in Mumbai or the shock over the Supreme Court judgment on the privatisation of oil companies. After the initial disappointment, markets recovered quickly.

In the near term, we believe corporate results next month will be a significant driver for the markets. Politics is another event the markets may focus on near term, especially with five Assembly elections likely over next few weeks.

On risks associated with markets in election years

Historically, election years (2004 will be one) have been good for the markets with economic reforms moving smoother in the absence of electoral considerations.

This partly reflects the fact that irrespective of the nature and shape of the government, reforms are accelerated as electoral considerations evaporate.

Typically, the first two to three years of the five-year tenure of the government will see maximum reforms.