THE SENSITIVE INDEX (Sensex) and Nifty are at their 30-month highs and look expensive at the price-to-earnings (P/E) multiple of 22 time for 12 months earnings till June 30, 2010. At current prices, the indices are trading around 17 times FY11 forward earnings. Automobile, banking, technology and fast moving consumer goods (FMCG) companies drove the benchmark indices to this level at a time when oil and gas, telecom and realty were struggling to return to the black.
The Sensex’s ride to current levels has been backed by the foreign institutional investors (FIIs), who have been net buyers of equity worth over $13 billion in the current calendar year so far. By contrast, they pulled out over $20 billion in just five months after the January 2008 collapse. A relatively stable United Progressive Alliance government in its second stint lifted sagging market confidence.
The market is certainly more stable than it was two and a half years ago. In January 2008, stock futures open interest was at an all-time high —nearly four times the open interest on index options — implying high leverage. Now the market is being driven by options, which are less risky because they are fully funded when they are bought or sold – unlike stocks futures for which investors pay a percentage of the value of the contract (known as margin money). Margins can fluctuate widely so any sharp losses can create considerable market panic.
A question mark, however, hovers over corporate performance. The sharp rise in interest costs in the last two years, on the back of heavy borrowing by India Inc, is one major concern. The Sensex Earnings Per Share (EPS) estimate was lowered for FY11 and the overall earnings revisions has turned negative for the first time since May 2009. Mega IPOs, such as Coal India, are expected to hit the market around October and that could be the real test.
Leading world markets are still languishing 10 to 20 per cent off their 52-week highs, but 20 to 40 per cent above the 52-week lows. The developed world may see a slowdown in the second half. The US Federal Reserve has hinted that it may take further action such as announcing another stimulus if growth does not pick up. Most leading indicators globally are hinting at tapering growth.
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