Buying opportunity

The last week has served to remind investors that there is no one-way bet on the stock market. When the global economy has been cooling down, and the financial sector in particular has been heading from one cold shower to the next, it was inevitable that stock markets around the world would start catching the chill. The way in which Asian stock prices responded last week to the fall of the Dow Jones and Nasdaq indices by 4 per cent, hitting a 10-month low, has also punctured a hole in the decoupling argument (which said Asia would not be hit by an America-based problem) that had become fashionable in recent weeks. Investors around the world have taken note of the fact that the broad-based S&P 500 index is at a 16-month low, along with European stocks. And investors seem to have little faith in the Bush rescue plan's ability to ward off a recession in the US. The Fed will almost certainly respond with sharp cuts in interest rates towards the end of the month, but the market has already discounted for that.

It is interesting that Indian markets were hit the most last week, among all Asian markets. This may have been because the correction in the overheated Chinese stock market began some weeks ago. Investors will also have noticed that the third-quarter corporate numbers show significant deceleration in both sales and profit growth, when compared to the same quarter a year earlier. When coupled with the data showing that the export target for the year will be missed by a wide margin, and that the industrial sector has suffered a sharp slowdown, it was inevitable that stock prices would have to come off their dizzy highs. What began with profit-booking and unwinding of long positions cascaded on Friday into a 3.5 per cent decline in the Sensex. Foreign institutional investors had moved to the sidelines in the secondary markets even earlier, and FIIs have been net sellers to the tune of Rs 2,200 crore in January. Also relevant was the Reliance Power IPO, which pulled in a record amount of application money (Rs 1,15,000 crore). Even if a third or a fourth of that was being garnered by sale of stocks, it is a large enough sum for the market to go into correction mode. On Friday, heavyweight Reliance Industries lost 6.6 per cent, a reaction also to its low petrochemical business margins, though its refinery margins were strong.

There is no doubt that valuations had become expensive. Even after the 10 per cent correction from the market's peak, the Sensex trades at a trailing P/E multiple of 24.5, which is not cheap in anyone's book. A global liquidity surplus had certainly contributed to momentum buying. The question is whether the correction that has occurred so far is enough for fresh buying to emerge, or whether a further fall is required before value-based buying starts. On a forward basis, the Sensex trades at an FY09 estimated P/E of 18. The floor therefore would probably be a Sensex level of 18,000 "" which would mean wiping out the gains of the past three months, no more. Provided the general economic and corporate news does not get worse than has already been anticipated, fresh buying cannot be very far away.