Kotak Securities: Market Overview

In the past fortnight, global markets remained in the positive zone helped by easing concerns about economic growth in the developed world. The jobs data in the US turned out to be positive which helped markets sustain gains. The Sensex crossed its 32 month high mark aided by strong FII flows. Sector wise, Banking outperformed other sectoral indices. Developed world markets have been buoyant in September on expectations of economic recovery. Positive economic data has definitely helped sustain gains. The European Union raised its forecast for economic growth in the 16-nation euro zone, in part reflecting stronger-than-expected growth in the second quarter. The EU estimates gross domestic product will grow by 1.7%, up from its spring forecast of 1%. The EU also lifted its growth forecast for Great Britain, projecting 2010 GDP growth of 1.7%, up from its spring estimate of 1.2%. Chinese data released during the month reaffirmed market hopes for a soft-landing for the mainland economy and strengthened expectations of a delayed interest rate hike by the Chinese central bank. China’s industrial production rose 13.9% in August from a year earlier. Consumer prices jumped 3.5% the most in 22 months, as food costs climbed, and retail sales rose 18.4%. The Indian benchmarks continued to remain firm aided by sustained FII buying. Banking stocks rose as the new capital norms agreed by global regulators were less stringent than feared. The Basel Committee on Banking Supervision, representing regulators from 27 nations, more than doubled its capital requirements for banks, giving lenders as long as eight years to comply in full, as part of efforts to prevent financial crises. The new rules requiring higher capital levels for lenders are designed to provide a cushion to absorb losses and thus help prevent the kind of problems seen in the recent global financial crisis. Banks will be required to have a tier 1 capital ratio of 6%, up from the current 4% level. The key element of tier 1 capital is common shareholder funds and disclosed reserves or retained earnings, according to the Basel Committee. High beta metal and mining stocks rose on strong economic data from China, which is the world’s largest consumer of copper and aluminum. IT stocks rose as strong economic data in US and Asia helped soothe worries over the global economic recovery. The Index of Industrial Production for the month of July accelerated to 13.8%, far in excess of the consensus estimates. Mining, Manufacturing and Electricity sectors for the month of July 2010 grew at rates of 9.7%, 15% and 3.7% as compared to July 2009. The Capital Goods index was the strong performer notching gains of 63%. However, there has been skepticism over the buoyancy in IIP growth given that the six core industries that account for 27% of the output in IIP grew just 4% yoy and 0.3% mom in July. RBI in its first mid-quarter monetary policy review announced increase in reverse repo rate by 50 bps to 5% and repo rate by 25 bps to 6%. With this, since the beginning of rate normalization cycle, the reverse repo and repo rates have been raised by 175 bps and 125 bps respectively from the lows of 3.25% and 4.75%. With this action, RBI is near completion of its rate normalization exercise, we believe. However, current sticky inflation and buoyant growth do leave scope for further tightening needs. RBI may take some breather by pausing in its next policy review, though we continue to expect further 50 bps rate increase in the fiscal. We have been positive on the markets and have been advising in our previous notes that investors should buy into declines as the fundamentals of India economy has remained intact. This strategy has worked well for investors. Key macro indicators to be monitored would be the inflation, IIP, Valuations and global liquidity. India has been a major recipient of global liquidity (FII flows). Investors should be vigilant against any reversal in the same as it could cause significant corrections in the domestic market. The US Federal Reserve’s policy meeting is scheduled on Sep 21. In the meeting, it is expected that the Fed would leave the fed funds target rate unchanged at a range of zero to 0.25 percent. The big question is whether any additional quantitative easing measures will be announced. Any further quantitative easing would be mean greater liquidity into the global financial system and more funds for investment into emerging markets like India. At the current market valuation (19x FY11 consensus earnings), there is marginal upside based on FY11 numbers even as the longer-term picture is positive. At the current elevated levels of the Sensex, investors must remain vigilant against getting into weak counters (typically small and penny stocks). It could also be prudent to consider profit booking in mid cap stocks. The objective is to lock in some gains and keep cash ready for deployment if the markets correct.  As earlier, we prefer sectors with a strong domestic consumption theme. In fact, the consumption driven sectors like Financials, Auto and Consumer Durables have been major outperformers in the ongoing rally. Apart from this, we recommend select stocks in Infrastructure, autos, capital goods, Financial Services and large IT as our preferred picks.