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| Stock up on select stocks |
| Devangshu Datta / New Delhi Oct 04, 2009, 00:56 IST |
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With debt not so attractive anymore, one can look at select sectors in equities.
Unnoticed amidst the excitement of the Nifty hitting 5,000, the wholesale price index (WPI) went into positive territory in September. The WPI had been registering negative year-on-year (YoY) returns since mid-June.
The trend switch confirms inflation is climbing. Consumer price indices say it is already at worrying levels. Most CPI series are at 12 per cent YoY, and official estimates suggest the WPI will be 6 per cent YoY by March.
High inflation during a period of lower growth is scary. But this is being driven by rising food prices and it cannot be mitigated by monetary policy. Therefore, whatever anti-inflationary measures are taken, interest rates and money supply should not be disturbed.
Unfortunately, the government and RBI alike have a knee-jerk response to inflation – squeeze money supply and hike rates. So there could be some northwards impetus to interest rates. Pressure on money supply will remain pronounced anyway, given the massive government borrowing.
So, rates will not come down, and they may go up, in the Oct-Dec quarter. This removes one possible driver from economic recovery. Higher rates also raise the bar in terms of acceptable equity valuations and make debt funds unattractive. (Most debt funds gave negative returns in August-September).
Current T-Bill yields are in the range of 4.5 per cent. If T-Bills are used as a proxy for risk-free returns, price-earnings ratios of 22-odd are about the maximum a prudent investor will accept. Investors using FD rates (ranging 7 per cent up) as benchmarks will be more wary, since FD rates suggest equity is fully-valued at 14-15 PE.
The Nifty is running close to 23 PE at current levels of 5080. Better earnings growth is expected across the board in July-September. So, Q2 2009-10 results will somewhat reduce PEs. However, 5000+ Nifty levels are still likely to be full-value. Nor can 22PEs be justified by growth projections. PEG ratios are likely to be above 1 in 2009-10 since average earnings growth is reckoned to be 15-20 per cent at the most.
This makes broad-spectrum passive investment look unexciting, despite accelerating recovery. To my mind, a correction must occur. It always does when valuations are out of line. The market could rise further in the near-term but the Nifty is very likely to be available at sub-5000 levels within the current fiscal.
Unfortunately, debt as we've pointed out earlier, is also not a very useful avenue in the current circumstances since rates could harden and are very unlikely to soften. Hence, investors will have to stick to equity. In the absence of compelling average valuations, they'll have to seek selective punts that may outperform the overall market.
Stocks from several industries could be worth investigation. Pharma stocks for example, have attracted quite a lot of buying in the last 10-15 sessions. If there is a full-scale turnaround in industry prospects, there could be a lot of upside left in pharma stocks.
This industry is a stock-picker's dream territory since there are several different business models and many minefields to negotiate in judging company-specific future prospects. Generics, contract-research and manufacture (CRAM), original IP, legal challenges abroad, development stages in various drugs; it takes detailed knowledge and analysis to make sense of pharma operations.
One way around this is to buy into industry-specific funds since several exist. Reliance Pharma is the leader in this speciality category. It has a one-year return of 60 per cent and it holds as much as 10 per cent of its corpus in Aventis. Franklin has also done fairly well.
Another play seems to be FMCG. The received wisdom here is that consumer demand is reviving faster than expected. Hence, the old faithfuls will see quicker growth in the next six months. FMCG shares could therefore, outperform the market.
The third potential outperformer consists of PSU-stocks. These are scattered across many sectors, of course. Successful IPOs of NHPC and OIL, show that the disinvestment programme is more or less on track. The focus on unlisted companies also translates into a focus on listed PSUs in say, banking, and in the BSE PSU Index. Valuations could rise here.
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