Business Today

Bull Charge or Bear Hug?

After being range-bound for the past 10 months, the markets seem poised for a big move-but could go either way.

Nitya Varadarajan and Rajiv Bhuva         Print Edition: September 5, 2010

A "sucker rally" is how A.K. Prabhakar brutally describes the current crawl in stock market indices. The Chennai-based independent advisor to local and overseas securities houses points to the charts to explain what he means - the National Stock Exchange's benchmark index, the Nifty 50, has inched up by four per cent since the beginning of 2010, from 5,201 to 5,420 points (as of August 10). The Bombay Stock Exchange's 30-share Sensex mirrors that pattern, gaining slightly less than four per cent over the past seven and a half months.

Also known as a "bull trap" or more colourfully a "dead cat bounce", a sucker rally isn't backed by fundamentals and lasts just long enough for the "suckers" to clamber on board, before petering out. In fact, Prabhakar doesn't just feel that the current upward movement will peter out; he believes it marks the onset of a bear market. And the techno-fundamentalist and economist pulls out some data from the past to back his claim. "Almost every two years since 2000, there has been a 20-25 per cent correction.

This year, too, I expect one. I've noticed that when there has been excessive market growth in a year, the next year has been flat or even negative." (See Time for a Fall?) In 2009, the Indian markets rose by 84 per cent. Now, if you go by Prabhakar's pattern, there's a crushing bear hug ahead.

Cut to Sandip Sabharwal, Head of the Portfolio Management Services at Mumbai-headquartered brokerage Prabhudas Lilladher. Sabharwal expects the Sensex to hit 20,500 by December, a 13 per cent jump from current levels, and 17 per cent higher than at the beginning of the year. He's bullish because he expects flows from foreign institutional investors, or FIIs, to get even more robust. In 2010, the FIIs have so far poured $11.5 billion (Rs 52,900 crore) into Indian equities, $3.55 billion (Rs 16,330 crore) of that coming in July. And he isn't fazed by the dip in corporate profits in the April-June quarter. "When companies are recovering from a slowdown, they will focus on volume growth. Margins will stabilise as they go forward," says Sabharwal.

This isn't an exercise to suggest that Mumbaikars are more optimistic than their southern brethren. Rather, these divergent views on the outlook for equities are a reflection of the perplexity that exists on The Street today as stock market gurus, investors and punters wrestle with that billion-dollar imponderable: Which way will the indices go?

Hello, Good Buys
D. Subbarao has of late emerged as an unlikely poster boy on Dalal Street. And that's because of the bullish sound bytes of the Reserve Bank of India (RBI) Governor during the July preview of the monetary policy. "The recovery process has consolidated and become more broadbased since April 2010," he said. "The strength of the recovery is also reflected in the sales and profitability growth of the corporate sector, with more investment intentions being translated into action across a range of sectors."

Subbarao also believes that better farm prospects should lead to a pick-up in rural demand, thanks to a monsoon that appears better than the previous year's. Such slivers of good tidings culminated in the apex bank revising its projection for real GDP growth for 2010-11 to 8.5 per cent, up from its April projection of eight per cent.

Even the RBI's moves to rein in inflation by hiking the repo rate (the rate at which banks borrow from it) and reverse repo rate (the rate at which banks park their surplus liquidity with it) augur well for the stock markets. "Rising real policy rates in India are almost always accompanied by a rising stock market, unless global risk aversion increases dramatically," says Ritika Mankar, Economist with Execution Noble, a Mumbai-based investment bank.

Real policy rate is the dif ference between the reverse repo rate and the annual wholesale price index (WPI) inflation. Between April and October 2007, points out Mankar, the stock markets spurted by 51 per cent as the real policy interest rate rose from zero to three per cent. Similarly, between January and April 2006, they rose by 26 per cent as the real policy rate rose from 0.8 to 1.6 per cent. And once again, between May and August 2005, the markets headed northwards by 27 per cent as real policy rates rose from -0.5 to 1.3 per cent. The only notable exception was the 33 per cent decline between September 2008 and March 2009, despite rising real policy interest rates - an exceptional period of global turmoil on the back of the credit crisis and the ensuing risk aversion.

What's keeping the bears awake at night are the forward price-earnings multiples (P/Es): 15.5 based on earnings projections for the 2010-11 financial year and 13.1 for the subsequent year, according to a July report put out by Religare Securities. "(These multiples) …would look meaningful if India can sustain a 20 per cent earnings growth," say the analysts in that report. In the first quarter of 2010-11, earnings of 2,687 listed companies were 8.9 per cent lower than a year ago; in the second quarter, the picture may be brighter, but 20 per cent growth may elude quite a few companies.

The key to robust earnings will be how commodity prices pan out over the next nine months, say the Religare analysts. As of today, the scenario looks subdued, with prices of aluminium, zinc, steel and iron ore down by approximately 20 per cent from the highs they reached in January and March this year. Meantime, the projections keep pouring in - most of them coated with caution and doing few favours to either bear or bull.

Says D.D. Sharma, Senior Vice President of Anand Rathi Securities: "A correction is a possibility, but I am not bearish." Adds Ajay Parmar, Institutional Head for Equities at Emkay Global Financial Services: "If there is a rally, it will be liquidity-based and based less on fundamentals…It is wise to book profits now." Pipes in Hemang Jani, Head of Equities at "I expect consolidation to take place now but the next bull run will happen in 2011-12."

Clearly, the chances of a spectacular crash are remote, as are the chances of a gung-ho bull charge. Ridham Desai, Morgan Stanley's India Strategist and Head of India Research, summed it up best when he wrote in an August research note: "The market is likely to reach higher levels before a sell-off happens. History tells us that we may have to wait another year or for another 50 per cent rise in index levels before tail risks play out."

Translation: Be a bull or a bear, but you don't need to be chicken either, driven more by fear than greed. Yet, the worst animal on the farm at such a time could well be the pig, or a high-risk greedy punter. For, as the adage goes: Bulls make money, bears make money, but pigs just get slaughtered.

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