How far will this correction go?

 The Supreme Court's ruling on the privatisation of petroleum companies may have lowered the boom, but most market analysts were relieved to see the indices losing ground last week.

 Reason: The spectre of a market soaring out of control was scaring the daylights out of everybody.

 After a rapid-fire 1,500-point rise in the Sensex, the 300-point drop from the peak Sensex level has been welcomed as a healthy correction, something that will strengthen the long-term bull run in equities.

 Most research houses are predicting a Sensex value upwards of 5,000 within the next 12 months. While Kotak Securities is forecasting a level of 4,900, CLSA is forecasting a more modest 4,800.

 More bullish are Enam, Merrill Lynch and Salomon Smith Barney. While Enam and Merrill Lynch expect the market to pierce the 5,000 barrier, Salomon Smith Barney is talking of 5,300.

 However, the near-term reality is a technical correction. How far down will the correction take the Sensex?

 Last Friday, the index closed at 4134, and most participants, including the bullish brokers mentioned above, are expecting to plunge to continue - may be even below 4,000.

 The most pessimistic forecasts take the Sensex down to 3,700. Nothing catastrophic.

 The supporting arguments for dismissing last week's correction as a mere blip on the road to Sensex 5,000 remain pretty much the same as before.

 The macro-economic picture is looking good, with GDP growth set to recover on the back of good rainfall. Infrastructure spending is likely to keep demand for commodities like cement and steel buoyant.

 So is the boom in consumer credit which will hold up demand for consumer durables and automobiles.

 Then, the outsourcing story continues to reverberate, pushing up prospects for companies in the IT and IT-enabled services space, as well as auto and auto ancillaries, pharma and textiles.

 The picture on the corporate side, too, is bright. Many corporates have restructured themselves thoroughly to become competitive on a global basis.

 India Inc's return on equity has improved significantly over the last couple of years. The EVA (economic value added, which calculate profits after adjusting for cost of capital) of India Inc has turned positive for the first time in the history.

 Analysts say there is reason to believe that these companies will be able to perform significantly better in the coming quarters as the economic climate is likely to improve further.

 Also, many listed companies have achieved record high profits while their market-cap is still below their historic highs. The Sensex currently trades at 15 times earnings on a trailing basis and 12.8 times on a one-year forward basis.

 In contrast, the current yield on risk-free debt translates into a price-multiple of 18. This, analysts feel, leaves enough scope for further appreciation.

 More importantly, this time around there is ample liquidity in the system to support equities.

 While foreign institutional investors have already poured in over Rs 13,000 crore this year, domestic mutual funds have been witnessing positive flows in the last two months.

 So domestic mutual funds, too, have been net buyers in the markets during the period.

 The Smart Investor spoke to four experts - an economist, two equity strategists and our own technical analyst - to get a feel for how the market looks from three levels - the macro or economy level, the micro or corporate level, and the technical level.

 Subir Gokarn, chief economist at the country's top debt-rating agency Crisil, is bullish on the economy. "I expect the economy to grow by around 6.5 to 7 per cent for this fiscal. The two drivers for this are housing and roads, basically construction-related sectors" he says.

 However, Gokarn is quick to point out that the current stock markets do not fully reflect the growth in the economy over the last decade.

 "The main reason here is that the sectors that have grown are not a part of the markets, except IT and automobiles. Service sectors like entertainment and security (agencies) have grown tremendously but there has not been enough representation until recently. The dynamics of the growing sectors are not reflected in the markets."

 Falling interest rates will also impact positively on the corporate sector, he says.

 Jyotivardan Jaipuria, head of research, DSP Merrill Lynch, lives up to his organisation's baseline: "Be bullish." Given today's operating conditions, his prognosis is that the Sensex will touch 5,000 over the next one year.

 "We forecast an earnings growth of 17 per cent for FY04 and 15 per cent for FY05. Though we do not expect any significant re-rating over the next year from current levels, our earnings growth projections drive our index target of 5,000," he explains.

 Ajay Bhatia, head of research at Enam, says the current rally is different from rallies in the last decade because it is the result of a structural change in the corporate sector.

 "Since we are primarily betting on structural shifts in the economy, our favourite sector picks are automobiles and auto ancillaries, cement, banks and media - all of which are seeing structural changes." He thinks valuations in the technology sector still look stretched.

 Our technical analyst says that it isn't over-optimistic to expect the markets to move up till a peak of 5300-5500 Sensex and for the bull run to last till around July 2004. However, a possible dip to 3700 is on cards based on a 50 per cent retracement of the recent upmove.

 What will drive the Sensex up

 

 

India Inc has become EVA positive; stage set for secular bull run

P/E multiple for debt is around 18x while that for equities is 12x one-year forward earnings

Structural shifts in industries like automobiles, cement, banking and media mean further upside for stocks

Technical indicators suggest a peak of 5300-5500 by July 2004.

 What will drag it down

 

 

Fibonacci retracement of 50 per cent means a possible dip to around 3700

Risk of political upheavals