Sensex @ 12K: Experts advise what to do

The Sensex has touched 12,000 again, but under entirely different market conditions. The advice from market pundits is to stick to stocks with strong fundamentals.

If stock market sentiment rode on 'irrational exuberance' in the first journey of the Sensex to 12,000, this time around has crept with caution towards that milestone.

The number is the same, but there is a wide chasm between sentiment and forecast which makes it imperative that you realign your portfolio to the current market truths.

In May 2006, when the Sensex peaked at 12,671, the indices had made a habit of breaking records. Every addition of 500 points was quicker than the previous one, the Sensex overtook the Dow Jones Industrial Average and it seemed that the good times would be endless. The correction that came subsequently was quick and scathing.

It took the Sensex only 24 sessions to fall from its highest level to its lowest this calendar year. Most analysts expected the corrections to span over a longer period -- four to six months, at least. But the markets bounced back almost immediately and have been climbing steadily since July, leaving many as thrilled as they are surprised.

The difference this time

All said and done, 12,000 is 12,000 is 12,000, right? Turns out it's not really, when it comes to stock market dynamics. Despite the quick revival in the markets since the crash in May, the agony of seeing thousands of crores (billions) of market capitalisation wiped off in a single trading session and several stock prices plunging to their 52-week lows, has rendered investors cautious.

The intelligent investor is not getting lured by speculative movements in the stocks of smaller companies and obscure counters. The momentum in the market is largely due to frontline stocks.

To illustrate, in April, when the markets were reaching record highs almost every other day, total equity turnover at the BSE (Bombay Stock Exchange) was averaging Rs 5,400 crore (Rs 54 billion) a day. In May, when the Sensex reached its highest level of 12,671, the average turnover was still robust at Rs 4,500 crore (Rs 45 billion) daily.

This time around, the BSE is clocking an average of Rs 2,890 crore (Rs 28.90 billion) a day. This implies that though the broad indices are moving up steadily, overall buying and selling activity is still tepid. Investors, some of whom have not yet recovered from the shock of the sharp fall in May and June, are looking at stock prices very differently.

While the Sensex has gained 14 per cent and the BSE 200 over 10 per cent since the beginning of June, the BSE's Mid-cap index has lost 2 per cent and the Small-cap index has shed close to 7 per cent. These indices were all posting over 25 per cent gains between February and May, when the Sensex touched 12,000 for the first time.

This implies that the market movement this time around is limited to only a few stocks. The 'side counters', as non-frontline stocks are referred to, have only just begun attracting some buying interest.

"People have missed the bus on quality stocks again. The 'me-too' phenomenon will trigger people to get into bad stocks yet again. They should try to avoid this," cautions Rajesh Jain, Director and CEO, Pranav Securities.

In this scenario, despite the euphoria of the market returning to high levels, it would be advisable not to risk any purchases in companies and sectors whose fundamentals you are not certain of. Gains in the current rally are limited to very few counters.

There is room for diligently picked stocks that can give you strong returns, even at this level. However, equally importantly, stocks that are not backed by strong fundamentals should be avoided, even if they are on strong bull runs currently.

FII movement

There are no arguments over the fact that the great secular bull run in the Indian markets has been fuelled by foreign institutional investors. The revival of the markets since their slump in May and June can also be largely attributed to them. In August, FIIs brought in a huge $1 billion.

This is over 25 per cent of what they have invested in Indian stocks since January 2006.

With the uncertainty over US Fed's policy on interest rates abating a bit, dollar investments are confidently flowing into emerging markets, including India. What cues can you take from this?

The opinions of analysts are mixed. On one hand, this implies that strong players in Indian stocks have a positive view about the markets here. They would like to keep the market buoyant so that there are buyers for their stocks when they choose to exit and book profits.

On the other hand, some analysts caution that the current positive sentiment in the market is a mirage and large investors who were stuck without an exit option in May and June are creating artificial exuberance to make profitable exits now.

On a fundamental level, US consumer spending data has indicated a slowdown and there are concerns that the US economy could be heading towards a recession. Other Asian markets have begun slipping because of concerns that this raises, but our markets are yet to react.

Analysts caution that if a sell-off does ensue, it would be quick and scathing like the last time around. Whether the markets will recover from these corrections just as quickly is unpredictable.

India as an emerging market

When the markets tumbled this year, it was in response to tremors that were felt in all emerging markets. The view that domestic bourses were vulnerable to global factors and would increasingly behave in a synchronised manner with world markets, especially emerging ones, was strengthened.

In the resurgence since June 2006, however, Indian markets have raced ahead of emerging markets. While the Jakarta composite recovered over 8 per cent, others, including Korea and Malaysia, have appreciated only by over 3 per cent. In fact, among the BRIC countries (Brazil, Russia, India and China), India is the only one that is trading with positive returns.

China has lost 0.65 per cent and Brazil has shed over 1.5 per cent since June. This indicates that FIIs have overbought in India currently. If they start selling, our markets are likely to be the worst hit, according to analysts.

Be especially careful if you are buying stocks for the short or medium term. Only commit to funds that you can live without, so that if the markets slump, you are not forced to book losses in order to free up your funds.

Triggers

The market will take cues about its future direction from several triggers. For one, interest rates would continue to spook sentiment. Though there is relief in this regard from the US for now, global interest rates remain a question mark.

Analysts are closely watching the European Central Bank and the Bank of Japan. Any announcement on possible future actions could affect Indian equities.

Results in the next quarter will show how correct the projected growth figures are. Current expectations are that these would not be contrary to market forecasts. However, there is a cloud of doubt over Q3 results.

Fluctuation in oil prices, slowdown in the US economy and political uncertainties could also sharply move the markets upwards or downwards.

Market outlook

The general sentiment about the market is different from that of the broad indices. While analysts are confident of the Sensex reaching even 13,500 this calendar year, all stocks are not expected to grow at the same rate.

Some sectors have seen strong rallies in the past month. Select stocks in steel, cement, automobiles and banking have moved up. However, with the cycle of commodities turning, several industries are likely to come under margin pressure.

For instance, steel prices are on their way up, so steel stocks are buoyant. In the last month alone, BSE's Metal index has gained 11 per cent. Consequently, the auto industry's margins are getting squeezed and these stocks might see some profit booking.

Whether their reasons for having faith in the bull run continuing are fundamental or technical, the fact remains that no one sees a problem in Indian equities in the long run. In the short and medium term, a correction is not only anticipated, it is even welcomed. Analysts are, however, largely of the view that the corrections may not be as sharp as the last one. These could spread over a longer period of time, they guess.

With the markets running up significantly again, the outlook on the valuations of certain sectors is raising concerns. Infrastructure and construction have been big themes this year, but are becoming areas of excessive speculation.

Companies in these sectors are highly overvalued, with projections of explosive demand growth. Several dubious companies are now trying to change their names and add 'construction', 'infrastructure' or 'real estate' and thereby cash in on the frenzy that has been generated in these sectors.

You must make sure the credentials of the company you are investing in are sound. The biggest IPO due to hit the market, that of DLF, has also been put on hold. Market analysts say the company is reworking its valuation and the offer, when it comes, would be substantially lower than the earlier figure.

With two successful IPOs in August, Tech Mahindra and GMR, the confidence of issuers has increased. In the two previous bull runs in our markets, gullible investors have fallen victims to IPO mania and lost their money, so be judicious this time around.

Your strategy

All factors considered, your investment strategy should be driven by caution. There certainly are 'buy' opportunities, even in what is slowly being felt is an overheated market. But these should be restricted to frontline counters, in companies that are soundly managed.

"The markets could give 5 per cent upside in the next month on good stocks," says Jain.

If your investments in smaller stocks are currently trading in the positive zone, it would be wise to book profits on them. There has not been much traction in small- and mid-cap counters in this rally and the risk of continued holding may not be worth the return.

It would be prudent to consider exiting some of the stocks that have not seen any positive news flows or price movements, even at a loss. Brokers are telling investors to ensure stop loss levels and adhere to them. With likely corrections around the corner, these stocks may slip further.

"Even though the markets are likely to move up to 12,700 and beyond this calendar year, individual companies must be analysed before their stocks are bought. If you stick to the top 50 or 100 companies, then your risks are that much lower," says Roop Chand Betala of Betala Stock Broking. If you are not, watch your fingers, the fire could get you!

Triggers for the Market

• Interest rates, especially in Europe and Japan.
• Q2 results.
• Oil price.
• Slowdown in the US economy.
• Political uncertainty.