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Debashis Basu: One cheer for the bulls

Of the three factors that move the market - earnings, valuation and sentiment - only one is somewhat in favour going into 2012

Debashis Basu 

Where is the market headed in 2012? Year-end is an arbitrary point in time, which markets don’t respect. are mainly caused by one factor: corporate How much and how long a market move lasts depends on two other factors: the relative value of assets, and If we tot up the score on these three counts – earnings, value and sentiment, as we end 2011 – what do we get? It’s 1/3.

growth: poor
At the time of writing this piece, Indian companies are not showing much growth, nor are there too many factors that could accelerate that growth. And it has been so for quite a while. For much of early 2011, the consensus estimate of (extraordinarily overpaid) analysts for 2012 of the 30 stocks in was around Rs 1,250 per share. The more optimistic ones pencilled in Rs 1,280. From April onwards, I have been suggesting that this was too optimistic. In June 2011, I wondered on our website: “Big brokers are reluctantly lowering their growth target, leading to the belief that the market is undervalued. Is it based on false premises?”·

At that stage, there was little clarity among market participants about market Retail investors, who are denied sceptical voices by the media, were fed with persistent propaganda that the market was undervalued. The typical argument went as follows. “The for 2012 is Rs 1,250. The is currently at 18,500. This means a forward P/E of just 14.8 — an undervalued market.” The math looked attractive except that it didn’t in real life: nobody was buying. The market remained sideways for months. For instance, in November last year, the low was 18,954. In end-July, the high was 18,944. More importantly, every rally was being met with more selling. Analysts kept on reminding us that only on a few occasions in the past has the forward price-to-ratio (P/E) been about 14, and on those occasions, long-term buyers have swooped in. So why not this time? Because savvy investors probably didn’t believe the analysts’ bullish propaganda. There was an alternative math.

To start with, the 2012 estimate for per share (EPS) was abnormally bullish. In 2010-11, a robust period of recovery, the was perhaps Rs 1,013 (it is hard to agree on these figures because the Bombay Stock Exchange calculates them in its own way, as does each broking house.) In June, the Bloomberg consensus estimate was Rs 1,240. This meant an assumed rise in net profit of 22 per cent. Was that logical, given that in a great year (2010-11), the rose by 21 per cent? In fact, the performance of the companies in March 2011 was terrible. (And not surprisingly, the analysts had missed it by a mile. March quarter growth was flat, while the estimate was of 17 or 18 per cent growth!)

Even after this, the analysts made a half-hearted downgrade – just three or four per cent – to the 2011-12 estimate. Some estimates (Bank of America, Macquarie, and Citi) were ridiculously bullish at Rs 1,250. But even a estimate of Rs 1,200 meant assumed growth of 18 or 19 per cent. Since the companies had done badly in the March quarter without any plausible reason and warning, it was prudent to work with pessimistic assumptions, not optimistic ones.

One cheer for the bullsWe suggested an of Rs 1,150 for 2012, which did not make the look undervalued. In fact, at a likely profit growth of 10 per cent, would be Rs 1,120. If this came true, for the to have a forward P/E of 14, it would have to be around 16,000. Not surprisingly, that is where the is.

Valuation: low
That takes us to the second factor. At an of Rs 1,120 and of 15,500, the P/E is 13.8. This is undervalued territory. But there is a problem. At a P/E of 13.8, yield (the reverse of P/E) is 7.2 per cent. Safe fixed income instruments fetch nine per cent. Fixed income has to be less attractive for equities to be more attractive. This is precisely the reason US markets have done better than India’s over 2011. It may seem surprising but and S&P are actually up in 2011 despite all the problems in developed markets, and this is partly due to extremely low interest rate set by the US Fed.

Sentiment: poor
This is obvious now but market can turn on a dime. At any time, there are many more bulls than bears, and it takes only a little bit for them to herd together and charge ahead. But apparently, we have a deeper problem here. The poor is not just about corporate performance, but also about Delhi. Even seasoned investors are tired of “lack of reforms” and “poor governance”. But I am not sure this would be an impediment to a significant market rally in 2012. For instance, from early December 1996, the rallied more than 60 per cent till August 1997, on some hope or the other. It fell after the Asian crisis but rallied again 45 per cent from December 1998 to April 1999, on another set of misplaced hopes. After a deep decline, investors only need the flimsiest of excuses to buy.

To sum up, if seem to be improving and/or interest rates come down, we will have a significant rally. After all, it is not “reforms” or governance that caused the to rise 80 per cent in 2003. could improve if Delhi turns reformist — or worse, with fresh economic bad news.

Meanwhile, markets have always fooled those who soak up anecdotal evidence of doom or boom peddled by the popular media, and then try to link them to future market moves. Once something has been in the popular media for a while, it is no longer a surprise, and therefore loses the power to move markets. Market-moving signals, as usual, would again come out of one or more of these three factors mentioned above as 2012 unfolds. The rest would be noise.

The writer is the editor and publisher of