When will the stock market recover?

May 31, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

For nearly nine weeks now, the market has been entertaining the bears with the Sensex dropping 1,456 points. That was not a delayed reaction to the Budget. On the contrary, the market had responded well with a 9 pct jump in March. Obviously, there were other things that went wrong.

For one, inflation was taking its toll. Perhaps in two ways. First, the rise in the raw material prices, salaries, etc squeezed profit margins. For instance, in the quarter ending March, profit after tax (PAT) was up a mere 7 pct; in the previous quarter growth had crossed 20 pct. Surely, additional costs will be passed on and growth in profits will be regained. But the dismal balance sheets brought out by some of the important companies including banks like the State Bank of India knocked down the market.

Secondly, the RBI reacted strongly to inflation and increased the repo rate by 50 bps taking a more aggressive stance. Possibly the governor has gone beyond the recommendations of the technical committee on the assumption that stability is a precondition to healthy growth. That stance is likely to continue until inflation is keyed down to about 5 pct.

FIIs added to the problem. With lower profits, stocks looked overpriced. On April 6, when the prices had crossed 20 times the earnings, there was temptation on the part of the FIIs to sell in India and buy in other emerging markets. In May, FIIs disinvested to the extent of 1,612 crore rupees (up to 30th). In most of the South East Asian countries, even Australia and New Zealand, the P/E is around 14. A higher ratio in India was earlier justified because of the higher growth.

That justification no longer held because profits were slow to grow and the high rate of interest is bound to slow down the economy and industry.  Even mutual funds lost the nerve and sold. Prices dropped to bring them in line with the PAT.

When will the market recover?

There are no strong triggers in sight. The U.S. economy is still very lethargic burdened by high unemployment. Europe is not better except possibly for Germany. Japan is getting into its third round of recession. Oil prices continue to hover above $100 and may even rise further with OPEC reluctant to increase production. No stimulus can come from outside.

A likely trigger can be a good monsoon. It may help slow down inflation which has until recently been largely coming from the agricultural sector.  But it looks like commercial crops like sugarcane and cotton may not show much improvement. Even with good cereal crops the fall in inflation may not be steep because of the minimum support prices.

It is therefore likely that the stock market will be in a stalemate for a while, possibly until July. It will be mainly the financial performance of the corporate sector that will pull it up. There are good chances that the April-June balance sheets should read better. But with P/E at 19, the recovery may not be too strong.

One comment

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This is the time folks, out of gold bang into stocks. You will be the winner. A strong monsoon (pray to God, real hard) and all will be singing. Else you’d be better off holding the Gold. I say, sell GOLD, BUY STOCKs. Anybody agrees, huh v!!!

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