IN NOVEMBER 2006, when the BSE Sensex was stuck at 12000, ET Investor’s Guide had placed a March ’07 target of 13500-15000 for the Sensex. We were off by a couple of months, but largely, this rise has been in line with our predictions. But now, the big question for the retail investor is — what next?
    Will the market now go up or down? If it goes up, which companies/sectors will take it forward? Will the IT and auto sector continue to underperform? Will capital goods and cement continue to do well? What about mid caps? Cement, telecom and pharmaceutical companies have been the biggest contributors to the rise of the Sensex. So, which sector will don the mantle next?
    At a broader level, ET Investor’s Guide expects the Sensex to trade in a range of 15700-18300 during the rest of FY08. Our lower band is based on the assumption of a 20% growth in earnings, while the upper band for FY08 is 25%. So, is it Hello 18000 — next?

TARGET 18000

Based on our Sensex model of two-year forward earnings, we are introducing our target for May ’08 at 15700-18300. This is assuming that the Sensex earnings grow by 20% for FY08 and 16% for FY09. The lower end of our target range is based on an estimated 16x forward multiple and the upper end on a 25% earning growth and a 17x forward multiple.
    Historically, the Sensex has traded at an average forward multiple of 14x, but we expect it to trade at a multiple, given the higher growth. We have assumed a constant value of 16% earnings growth for FY09. The Sensex is currently trading at 19.5x FY08 earnings, which is quite above the historical average of 14x.
    Current brokerage estimates for FY08 Sensex earnings growth range from 16-25%. However, we feel that Sensex earnings growth is most likely to fall to 20% from the 30% seen during FY07.
    We must mention that the market is already trading close to our lower end target of 15657. Our lowest levels on the Sensex, assuming a 15% growth, is 13123 or close to a 13% downside from current levels.
UNLOCKING VALUE

It’s a term that the Indian corporates got familiar with after the conclusion of the Reliance saga, but here, we are referring to companies unlocking value by listing their subsidiaries. A good example is Mahindra & Mahindra (M&M), which has benefited from the listing of Mahindra Finance and Tech Mahindra.
    Many of the majors and some smaller companies may soon follow their lead. ICICI Bank, L&T, Bharti Airtel, Reliance Communications and State Bank of India (SBI) have all announced plans to list their subsidiaries. The total subsidiary valuations of Sensex companies now account for close to 20% of the total market capitalisation of the Sensex. This is only expected to rise in the future as nonearning assets, especially KG Basin gas assets, insurance subsidiaries and infrastructure assets start gaining traction.
THE BULGING MIDDLE

In March this year, ET Investor’s Guide had said that it is time for mid caps to shine again based on their P/E multiples and earnings growth. And they have. We have changed our view because the time is now right to shift from mid-cap stocks to large caps. This is because in March this year, the ET Midcap index was at a P/E multiple of 16.2 against a Sensex P/E of 19.4.
    However, the gap has now narrowed down to the stage where it is almost negligible. This is not sustainable because the biggest companies in any sector should get a premium over their smaller counterparts. Extending this hypothesis, the large-cap stocks should outperform the mid caps — barring big surprises on the earnings front.
TECHTONICS

Looking at the broad trends over the past one year, the IT sector looks like one good bet. IT majors, which account for about
one-sixth of the Sensex, have actually fallen in the past few months.
    The three IT majors, Infosys, Wipro and TCS, are all currently trading 15-20% below their levels in the beginning of February. The fall is due to the weaker US dollar against the Indian rupee, which is expected to hurt margins. Events like the fall of sub-prime lenders in the US, collapse of hedge funds and a slowdown in the US property market have also led to fears that the US economy could witness a slowdown, leading to slower growth. However, the figures for the US economy are expected to improve by the end of this year. Also, these are solid and wellmanaged companies. In our view, this could be an opportunity for the contra investor.
A CAPITAL IDEA

Capital goods companies have been powering the surging Sensex, with L&T alone gaining more than 4%, and Bhel moving up about 1.5%, on the back of the government’s decision to give a push to the power equipment manufacturing sector. L&T gained sharply last week, following two positive developments. The first was the recommendation by the National Manufacturing Competitiveness Council (NMCC) to consider L&T as the second most preferred power equipment supplier after Bhel.
    In view of the shortage in equipment manufacturing capacity, Bhel is consistently running an order backlog equivalent to nearly three years’ its sales. The move has greater relevance in view of the fact that L&T has already tied up with some of the global companies for a super-critical range of boilers and turbines.
    The company may gain immensely if it gets some orders for its new venture through the negotiated route, instead of going through competitive bids. L&T is also looking at unlocking value in the future through listing of its subsidiaries.
    Bhel has also gained significantly with the government’s focus on the sector. The company is already on an aggressive expansion plan to meet all its commitments. With enhanced efforts on the government’s part to meet generation capacity addition targets, it’s expected to sustain its current growth rate.
METAL MANIA

The BSE Metal index has been underperforming the Sensex for the past couple of weeks. Even the year-on-year performance has been rather weak. Concern over metal prices was among the chief precipitating factor in the last market crash. The pricing scenario for metals has remained gloomy since then and the trend is likely to continue. Steel, in particular, has seen two rounds of price cuts in the past one month. Aluminium prices have also slipped.
    The metal sector, which comprises one of the primary sectors of the economy, has a lot of clout in the stock market. At the same time, being an old economy sector, it generally has a steady rate of growth. As a result, in a boom period, the sector typically underperforms the overall economy, as other sectors hog the limelight.
    The metal index has appreciated by 24% over the past one year vis-à-vis the Sensex returns of 36% over the same period. However, the index has been particularly lagging behind for the past one-and-a-half month. Among companies, Steel Authority of India (SAIL) has gained just 1%, whereas Hindalco has lost 8% in the past one week. The earlier rally of Hindalco stock, on takeover talk, had led to an overpricing of the stock.
VROOM DOOM OR BOOM?

Thanks to negative growth in commercial vehicles and motorcycles and a slowdown in passenger cars, automobile stocks are currently out of favour. Most of the leading stocks in the sector are currently ruling at a discount to their 52-week high.
    While there doesn’t seem to be any sign of a turnaround in the sector’s fortunes in the immediate future, many executives are expecting a better performance in the second half of FY08. If it materialises and auto stocks appreciate, it will be a bonus for the Sensex, which has a fair representation from the sector.
A FIRM SET

In the recent past, cement companies have been one of biggest contributors to the the earnings growth of the Sensex. Though the sector outlook for the current year doesn’t look as bright as it was a year ago, no one is expecting a bad year either. A 15-20% growth in earnings looks highly plausible and this will be enough for the sector to maintain its contribution to the bull run.
    Most of the stocks in the sector, which have declined by 40-50% following the mayhem in February, have already retraced 80-90% of their decline and seem all set to touch new highs in the coming months.
SMELL OF MONEY

At this point, liquidity continues to be the key driver for many emerging markets. Excess liquidity seems to be driving valuations. For instance, historical forward earnings for the benchmark index have been around the 14.5 mark. Currently, one-year forward P/E of the Nifty is around 18 levels.
    India is one of the most expensive emerging markets. Still, market players do not consider the market to be overvalued. The reason — excess liquidity. With abundant money supply, demand continues to drive up premiums. Add to it the continued stable India growth story and the equity market may continue to look attractive.
    Fresh money, primarily from Japanese investors, is pushing up the Indian equity market currently. That’s a good sign. However, Japanese investors are also considered to be late entrants in the equity markets when markets are almost fully valued.
    On the other hand, many market experts have started hitting out the source of liquidity as a bubble sign. But similar bubble talk has been heard in the past and thus far, there have been no conclusive signs of this being a reality.

They Came, They Saw, They Conquered

HERE’S TRACKING the journey to 15K right from the very beginning from 3000. And here’s to all the winners — the movers that have ensured the secular structural bull run:
• Cement has led the bull charge from the front, contributing as much as 20% to the rally constantly from 6000 to 12000
• The information technology (IT) sector seems to have nearly missed the bull run, halving its share from the first 3000-point rally, thanks to a falling dollar
• The auto sector, too, seems to have been smoked out towards the last leg, with rising interest rates and input costs keeping investors away
• Telecom is the star debutant, accounting for nearly 5% of the index gains — quite an achievement, considering that it was nowhere there at 3000 levels