Fundamental bottom seen at 9,700 for Sensex (Indian Market)

The fundamental bottom for the Sensex at 9,700. The next quarter might see the end of interest rate tightening. Expects to see troughs in the next and the last quarter of FY07.

It anticipates that oil prices to come down after July-August '06. July-August may be the worst phase for economic fundamentals.

F&O froth is already out of the market. Return on Equity (ROE) on the Sensex should be 15%, which implies PE of 15x.

On a sustainable basis, the Return on Equity (ROE) of the Sensex should be at least 15% odd, which translates to a PE of 15x. The current forecast of Sensex EPS for '07 translates to a fundamental bottom roughly of around 9,700 on the Index. Obviously, that doesn't mean that it will reach there, it could be slightly above or below that level. From now till then, is the time when one has to do serious buying.

We are ticking at about 20% per annum roughly. So you just take a 20% cut and in-between there will be volatility. But basically it is 20% YoY growth.

I think the previous quarter and the next quarter will be the trough in terms of economic fundamentals. One must remember that stock markets always discount the future. So the best time to buy is obviously when it is at a trough because then, one is discounting the future.
The interest tightening cycle globally will end in the next few months and you will see it topping over, so the worst is right now. As regards interest rates, always remember that the 20% of GDP growth to the US is housing, so the interest rates cannot freak out too much. So the next 3-4 months will see major tightening and the end of the tightening cycle.

Oil prices start falling when it actually hits demand. Last month, the International Energy Agency (IEA) warned that it has started to hit demand and so probably in the next few months again, oil prices would start falling.

The third important factor are the monsoons. Roughly towards the middle of July, we will get a clear idea of the monsoons. Monsoon normally does not affect the Indian GDP growth unless there is drought. But it mostly affects the political cycle. Usually in the second year of the political cycle, the government takes some initiatives and actions, so we are particularly vulnerable in this period. Therefore, July-August will be the worst in terms of economic fundamentals. The point to note is that one thinks that since India is the least vulnerable country among all other emerging markets as it is not linked to commodities, it is domestic based, there is consumption growth etc, it is not going to crash out.

The basic hypothesis is that there is no recession because oil prices will start falling and if you believe that, then the world powers will continue to throw money at the problem and not take drastic measures.

If that is so, then the only way to throw money at the problem is through managed currency regimes, which means more liquidity and which in turn means that liquidity will come back. In a rising interest rate scenario, equity is preferably more attractive compared to bonds and other assets. Second, one must remember that most of the froth has been cleaned out in terms of F&O positions.

As regards to margin pressures, whether it is wage cost or interest cost, whether it is a service or manufacturing industry or whether it is competition, the worst is some time now. If one believes that the topping over of bad economic fundamentals will happen sometime now, then this quarter and the previous quarter could be the worst because we are going to be hit by margin pressures throughout and it is across the board.

The question is, so far, the volumes have offset the margin pressures in most industries and the key to note is where it will continue to offset and where it may not.

Last, the economics and market cycles are related but they are independent of each other. On the way down, you roughly have four stages; the first stage is the unwinding of positions, which has already happened. The next stage, when you have greed buying is the time when you are looking at prices where the market was at 12,500 and people say that this was very low compared to that. The third stage is when there is a slight re-allocation of portfolio where one feels that one should not invest too much in equities, in fact, withdraw a bit out of equities. The last stage is what I call apathy, where people say what can they lose now.

So what happened in the last two months is Stage 1 and 2, we are currently in Stage 3 and slowly getting into Stage 4. So, this could be the worst and the stock markets discount the futures, so one cannot wait for the bottom. Nobody would know the duration and extent of the bottom. But when volumes continue to grow, when we are cost competitive etc, is roughly the time for long-term investments.

India deserves probably 1.5 times the PE that we currently have. If politics were to get into huge reforms, for example PSU divestments were to happen, then it would wipe out the entire fiscal deficit. So politics in a positive sense, in terms of making PE 1.5 times is something that people are not even forecasting or it is not even in the price. The question is the negative part of politics.

Normally, a failure of monsoon triggers political headedness and that is the real concern. In this year, if there is problem in politics; we are not saying that something great could happen, but even if PSU disinvestments do not happen, still India can clip on because one must remember that our investment growth is at a capacity utilisation of 80-90% plus and that is not going to go away.

In the whole view, politics gets jaundiced by the short-term. So if nothing gets done in the medium-term, that is the real issue in politics in terms of hindrances to corporate life.

It is something that one should do; this is a normal stage of the market cycle. I am not recommending that you reduce your portfolio exposure to equities. What I am saying is that when we released this strategy report called 'Froth Cleaned', long-term investors could start buying; this was a couple of weeks back when the Sensex was at 10,000 odd.

In the report, we said that there is a stratified strategy, which is an absolute return strategy and a relative return strategy. Normally funds managers are forced to do a sector wise diversification. But what they really do is time diversification like short, medium, long-tem diversification and so on. So at that point, normally over higher short-term focus, we have more stocks, which have more visible growth in 2007.

Now as we move on to the trough of the economic fundamentals, you get into absolute return portfolios; where in the short-term, you have higher risk, for long-term, you have much higher risk-reward ratio. So what I am advocating is to move now from relative return strategy because that has actually worked out. We recommended like the IT sector, Larsen and Toubro, infrastructure etc, those have already happened, it has already moved up. Now this is a stage to get into absolute returns, which are the deep discount sectors.

According to our report, another 25 bps interest rate hike is likely. We expect that in another 3-6 months interest rates will start falling or at least begin stabilizing. The danger in any economic parameter for India is when it affects volumes. When it affects margins, it is not so much of a danger because across most industries, volumes offset margins and in certain industries, where volumes get hit, it is going to be a bit of a concern.