The year was the best in more than a decade. 2010 could churn out modest returns while being increasingly volatile.
Although the overall trend looks bullish, there are many challenges to overcome which suggest that 2010 may end up with modest returns.
The year 2009 saw the BSE Sensex gain 81 per cent, its best annual return since 1991 (when it recorded an 82.1 per cent gain). In fact, in 2009, the Indian markets returned the second best gains among major global markets, which was just a shade lower than Bovespa’s (Brazil) 82.66 per cent (as on December 30). The strong rally comes on the back of an extremely pessimistic environment of 2008 led by the global economic and credit crises.
What then changed in 2009? Since early March 2009, markets have sensed an improvement in both, the economic outlook as well as corporate earnings, consequent to the major stimulus packages –including excise duty cuts, increased liquidity, robust government spending, banks allowing corporate to restructure debt and so on, in India’s case. Such moves lead to the re-rating of equities supported by strong inflow of foreign investor money. But, for now, the key question is what is in store for 2010?
The answer is not simple, even though the broader trend looks bullish. For one, the Indian markets have now reached a juncture where valuations are not cheap and fundamentals are yet to catch up. To explain this: The markets fell in 2008 even before the fundamentals weakened. Likewise, in 2009, the markets have moved up in anticipation of an improvement in fundamentals—the trend in net profit growth of Sensex companies in the last four quarters continues to show a year-on-year decline, although the rate of decline is reducing. Also, analysts are estimating the Sensex EPS to grow by 3.5 per cent in 2009-10 to Rs 850 per share and further by 24 per cent to Rs 1,050 in 2010-11. So, unless earnings catch up with expectations and continue to show exuberance, it might become difficult for the markets to sustain at current valuations (P/E multiple of nearly 17 times based on 2010-11 earnings).
There are some concerns as well. With inflation seen heading up, central banks are likely to tighten the systemic liquidity leading to an increase in interest rates. Since equity markets and interest rates are negatively correlated, any significant increase in interest rates (ahead of market estimates) could prove negative for stocks. Then there is the risk of the dollar, which has lost significant ground against major currencies post the global crisis. Analysts now expect the dollar to rebound in the near-term given that the US economic fundamentals are improving. This could influence the flow of foreign funds into the markets. Obviously, emergence of any major sovereign risk (such as Dubai and Greece) could add to the pressure on emerging market assets, including India.
Lastly but not the least, it will also depend on how various governments withdraw the stimulus packages announced, which have been largely responsible for the recent economic recovery. It is believed that the governments will take a calibrated approach to withdrawal of stimulus measures such that they do not risk the nascent recovery.
On the positive side, if the Indian government surprises the markets on reforms (like implementation of GST and the new Direct Tax Code), divestment, FDI in certain sectors and insurance bill among others, it could help boost investors’ confidence.
Overall, though there are positives, there are a number of challenges to overcome as well. Hence, although the year 2009 was among the best in more than a decade, 2010 could churn out modest returns while being increasingly volatile. Investors wanting to outperform the broader markets, may have to look beyond the large caps – mid-cap valuations are still selectively reasonable. Experts suggest that a selective stock-picking approach could prove to be a rewarding proposition in the year ahead.
