Wednesday, May 22, 2013

Take shelter as the tornado passes by

Many equity markets world over (with the notable exception of China) have mostly recouped their losses of past five years. The same however cannot be said about the macroeconomic data. In fact there are little signs, despite near zero interest rates and persistently low inflation in developed economies, of economic growth stabilizing even at lowest levels or employment conditions improving in any helpful measure.

This is leading many, including InvesTrekk, to believe that the extant equity rally may be purely technical and hence should not be considered as beginning of a secular bull market. In exclusive Indian context, the rally has certainly outpaced macroeconomic and corporate fundamentals and valuations in select pockets are already flirting with bubble like conditions.

A normal monsoon, complete government post next general elections (hopefully!), lower rate, benign consumer prices and massive election spend may support higher consumption demand and hence justify expensive consumer sector valuations. Passenger vehicle may also gain. But many pharma, banking and metal companies would need to correct over 25% to deserve an investment consideration.

Second tier IT could be one suitable shelter given their strong balance sheets, stable businesses and cheaper valuations. Though growth there may still remain muted for another year or so, favorable resolution of US VISA uncertainties may cause a rally there.

Similarly, the valuation gap between top 3 cement companies and the rest is probably at historic high. A revival in infrastructure spending next year post election aided by lower rates could be trigger there.
There is a strong buzz around PSU oil marketing companies (OMCs). The cheap valuations relative to their replacement value is the primary investment argument, duly supported by recent fuel pricing reforms. In our view, these companies are worst examples of corporate governance. The majority shareholder (government) has consistently and blatantly oppressed the minority shareholders in these companies – by not allowing them to fix the prices of their products, raise capital when required, make investments where and when desirable and disallowing the managements to restructure their costs (especially employee cost) during downturns. Moreover, there is no legal guarantee that the current fuel pricing mechanism will continue for, say next 5years.

Insofar as the global rally is concerned, consider the following three data points are worth considering:

1.       The most-indebted U.S. companies are rallying more than any time in almost four years compared with the rest of the stock market.

2.       China’s trade surplus is contested to be one-tenth the official $61 billion reported so far this year after accounting for fake transactions used to disguise hot-money inflows.

3.   Imports of refined copper by China, the biggest user, declined in April to the lowest level since June 2011, while exports fell for the first time in 8months.

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