It is a paradox that investors face the most difficult questions during the best of times. Following the recent dream run, investors are entering 2011 with questions that are typical of an exuberant market.
Are the markets at their peak levels? Is it better to stay away from stocks? Or, is there still a good buying opportunity? To answer these questions, one must look at the Indian stocks with respect to the global economy, world markets, valuations and the Indian corporate earnings outlook. These are the key variables, which will determine the course of the markets in 2011. Economy in a sweet spot:
Even though there are divergent views about the sustenance of the global economic recovery, there is a consensus on where the economy is headed.
is the IMF estimate for GDP growth for India in 2011, double the global average.
times valuation is the Sensex's current one-year forward earnings per share. In 2008, it was 10.7 times.
According to IMF estimates, the Indian economy is expected to grow at 8.4% in 2011. Since the world economy is estimated to grow at 4.2%, India would be growing at double the world average, an achievement expected to be matched only by China.
Strong urban consumption and increasing incomes of the rural population are expected to keep the economy humming for at least a couple of years. With the growth of 8.9% in the second quarter, analysts are busy revising their GDP estimates.
"We have upgraded our GDP growth forecast to 8.6% for 2010-11. Rebalancing of growth in India seems to be complete, with the resurgence in private consumption complementing the demand for investment," says Dharmakirti Joshi, chief economist, Crisil.
Faced with anaemic growth prospects in developed nations (advanced economies, including the US, Europe, Japan and the UK, are expected to grow at 2.2%), institutional investors will stay or increase investments in fast-growing economies.
"Strong growth in the next decade (likely to average over 8%) and the shift in its domestic consumption (from urban to rural) is the long-term argument for India," says Manoj Singla, co-head (research), Religare.Growing on a high base:
The focus in 2011 is going to be on sustenance of earnings growth. Boosted by government incentives, the corporates have fared well in the first half of 2010-11. According to estimates, Sensex companies are expected to report an EPS of Rs 1,065 in 2010-11 (a YoY growth of 28%).
The big question now is if they can continue with the robust earnings. According to analysts' estimates, the trend is likely to continue in the coming financial year. Motial Oswal expects the Sensex companies to deliver an EPS of Rs 1,275 (growth of 20%) in 2011-12, while analysts at Religare estimate the Sensex EPS to grow at 16%.
EPS growth is the main driver of returns from stocks. A study conducted by HSBC's equity strategist, Vivek Ranjan Misra, indicates that 73% of the growth in the Sensex's journey from 781 points to the 20,000 levels in 2008 was due to EPS growth. "In the past 10 years, however, re-rating has been a more significant driver of returns. EPS growth now accounts for 62% of index growth, PE expansion for 20%, and the combined effect of PE expansion and PE growth for 18%," says Misra.
Sensex may hit a new high:
| || We have upgraded our GDP growth forecast to 8.6 per cent for 2010-11 based on expectations of 8.4 per cent rise in consumption|
Chief Economist, Crisil
Indian markets are just short of crossing the historic high of 22,000 levels. Even though the topline growth for the corporates was 18-22%, high input costs and lack of capacities confined the profit growth to 13-18%. This resulted in lesser earnings upgrades in the last two quarters. However, this is likely to change in 2011.
Considering that most sectors (automobiles, consumer durables, metals, cement and capital goods) are busy expanding their capacities, benefits of economies of scale will come into effect. Also, most Indian companies went through a financial restructuring in 2010. Many have retired highcost debt and have raised fresh equity, the benefits of which will be seen from 2011 onwards.
Based on conservative estimates of 16% growth in 2011-12 corporate earnings, the Sensex is likely to hit the 24,000 levels by the end of 2011. This is at around 20% upside from the current levels. According to analysts at Religare, strong rural and urban consumption and a pick-up in investment climate are expected to help the Indian markets continue with their long-term growth.
"We believe that the favourable positioning that has helped India outperform so far will continue as long as the global risk appetite is supported by an extended pause in rates and the absence of a negative global macro-event (a Eurozone default)," says Singla.Strong fund inflows to contain downside:
If favourable corporate earnings are likely to act as positive cues, robust inflows from foreign investors are likely to provide a strong support for Indian stocks. "Investors need to catch up in allocations in emerging markets due to historic under-representation," says Sunandan Chaudhuri, lead analyst, Execution Noble.
Strong interest from FIIs will give a fillip to valuation multiples. This is expected to result in limited downside as investors would like to buy more stocks at lower prices. "Flows and currency moves in emerging economies are essentially sound and their stronger prospects and GDP growth differential will attract capital," adds Chaudhuri.Valuations:
At 20,000, the Indian markets are neither too cheap nor expensive. On a one-year forward EPS estimate (2011-12), Sensex is trading at a 10% premium to the historic 10-year long-term average PE of 14.4 times.
"While the valuations are not excessive, we believe that the data points matter, especially in the event of market extremes," says Rajat Rajgarhia, director (research), Motilal Oswal Securities. The Sensex is currently trading at 17.3 times one-year forward EPS multiples. During the 2008 downturn, the valuation multiples hit 10.7 times. However, what brings comfort is that valuations are nowhere close to historic highs. In the previous two bull markets of 2000 and 2007, the Sensex's one-year forward PE multiples peaked at 24.6 times.
Strong growth in the next decade and the shift in consumption from urban to rural is the long-term argument for India
Co-Head (Research), Religare
The key to investing in 2011 is picking the right stocks and not making calls on broad markets. Instead of buying at one go, investors are advised to make staggered purchases. "India is an interesting bottom-up market. Despite rich valuations, specific large-cap stocks in high-growth sectors hold the potential to deliver steady returns in the next 2-3 years," adds Rajgarhia.
Analysts suggest that investors have modest expectations in terms of returns. Rajmohan Krishnan, senior vice-president, Kotak Wealth Management, advises investors have a 2-3-year perspective on Indian stocks to gain the most from the corporate resurgence.
"Corporate earnings are expected to grow at 15-20% per annum over the next couple of years. This gives us a clear indication that Indian stocks will generate above-average returns. Over the next 2-3 years, investors can expect a return of 12-14% annum," says Krishnan.
On the top-down approach, analysts still prefer companies that are likely to benefit from increasing consumer spending, such as infrastructure, construction, capital goods and real estate firms. Increasing incomes are likely to result in greater sales for auto companies, consumer durable firms, banks and telecom firms in 2011.
The year that wasOn a High: In the muhurat trading on Diwali (5 November 2010), the Sensex touched 21,000, 35 months after it last reached the milestone in January 2008.
Foreign Aid: Net investment by FIIs in 2010 (till Dec 16) stood at Rs 1.3 lakh crore in the Indian equity markets.
The IPO Boom: As many as 72 initial public offers hit the market in 2010.