Monday, September 20, 2021
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Markets at all-time high, but cyclicals have miles to go



As expected, the markets were exuberant on Monday following the Bharatiya Janata Party’s (BJP’s) gains in the assembly elections, results for which were announced on Sunday. Both the benchmark indices— S&P BSE Sensex and CNX Nifty—hit all-time highs of 21,483.74 and 6,415.25, respectively. The tricky question now is whether investors would book profits after the long wait or whether the rally will be sustained.


The first thing to note is that while the benchmark indices may have hit new highs, valuations are far from their peaks. The current trailing price-earnings (PE) ratio of the Sensex is around 18, way below PE multiples of 24 and 29 when the Sensex scaled similar highs in November 2010 and January 2008, respectively. Neither the economy nor corporate earnings growth is going to get better overnight or in the near future nor is it on the back of PE expansion that the market has to go up, with earnings playing catch-up later.


But, equity markets move on future outlook. BSE Sensex’s PE multiple for fiscal 2015 is at 14.5 times, which is not expensive. According to Manish Sonthalia, a fund manager at Motilal Oswal Asset Management Co. Ltd, “Sensex earnings per share, which was Rs.834 (reported) in 2008, is estimated to grow more than 50% to Rs.1,400 in fiscal 2014, while the Sensex is hovering around the same levels, even after the recent rally.” Not surprisingly, forecasts on the Street have been upbeat and the mood is much more upbeat.


But it would be silly to consider the valuation of the benchmark indices as a whole. Valuations vary widely between the defensives and the cyclicals. For instance, the S&P BSE FMCG (fast moving consumer goods) index has a trailing PE multiple of around 37, while the S&P BSE Auto index quotes at a trailing PE of around 15.


The texture of the rally is, therefore, likely to change. The last two years saw funds flowing into safer havens and defensives like information technology, FMCG, pharmaceuticals and health care appreciate. These delivered strong returns. For example, blue-chips like ITC Ltd and Hindustan Unilever Ltd (HUL) are up 85% and 76%, respectively, from the November 2010 high. Hence, in the near term, these may move at a slower pace or may see some rotation out of them. On the other hand, note that the State Bank of India stock trades at a 46% discount to earlier peak.


Beaten down sectors and stocks, mainly cyclicals like capital goods, realty and metals along with power, oil and gas and metals, will, therefore, start catching up now. The hope that a new government after the general elections will be able to turn the business cycle around and ensure a revival in investment demand, will be the triggers. The benchmark indices may have reached new highs, but the cyclicals are way below their 2008 and 2010 levels. For instance, Bharat Heavy Electricals Ltd (Bhel) and Larsen and Toubro Ltd (L&T), which represent the country’s infrastructure sector on the bourses, are still down 66% and 20%, respectively, from their levels in November 2010. Others in the sector are 40-50% below the previous peaks and lower than the historical average one-year forward PE multiple of 10-12 and 1.5 times the price/book value.


Of course, all this does not make a case for a unidirectional upward movement of the market. There are still many uncertainties on home ground, including political realignments, persistent inflation, tight monetary policy and a probable cutback in government spending. Among global factors, there could be hiccups in the rally following the quantitative easing tapering in the US. These factors are likely to keep markets choppy, punctuated by profit-booking at higher levels.



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