Upside Depends On A Pro-growth Budget

Stock markets showed great poise last week after two weeks of carnage selling. Stock prices are showing an upward bias as the pullback rally stretches into the next week, and as we are also heading into Budget season which usually is marked by high investor anticipation.

Savvy investors were bottom-fishing in beaten-down sectors like PSU banks. This calendar year, PSU banks dipped 50.2 per cent. Last week, they staged a nice recovery gaining 4.5 per cent, against the broad-based Nifty’s 3.1 per cent showing that investors are willing to give PSU banks the benefits of an undervalued sector.

At these prices, the banks are quite lowly priced. The bad-loan problem is being dealt with, and re-capitalising PSU banks is high on the government’s list. A further clean-up next quarter would more or less bring most of the stress in the banking sector out in the open, and adequate provisions could further strengthen the balance sheet. That should lead banks to focus on what is best for the economy – credit growth.

PSU banks are also quite inexpensive on valuations quoting at about 2-7 PE. Some consider these banks as a value trap as the entire bad loan problem is not out in the open, but nevertheless in the long run, credit growth has to pick up and PSU banks are a vital cog in the economy.

In the coming week, all eyes will be on the forthcoming Budget. Allocations to infrastructure could increase, so watch the cement, construction and infrastructure companies. The government could announce schemes for the rural sector, so FMCG and rural infrastructure companies could see an upward pointing ticker. Banks could get another round of capital infusions which will give this sector some more shine.

Third quarter results continued to disappoint, with earnings contracting in banking and metals. The outperforming sectors were private-sector banks, the mass media, autos and select infrastructure companies. In the fourth quarter, too, investors are not expecting a huge recovery in earnings as PSU banks and metals would continue to weigh down on earnings.

For FY16, Sensex earnings are expected to come in the range of Rs 1,400, while, for FY17, net earnings are likely to expand to around Rs 1,625 levels, up about 17 per cent. At these earnings, the markets are discounted at 16.5 and 14.5 times for FY16 and FY17 respectively, which is reasonable, and not particularly inexpensive.

Globally, markets are still choppy, with oil continuing to play spoilsport internationally. Part of the good news last week came from the US Fed, which signalled that it was willing to consider the global turmoil when it meets again in March 2016. This could mean a pause in rate hikes from the world’s largest economy.

A pull-back rally could take the markets higher this week, but a great degree of high churn and choppiness cannot be ruled out, for several reasons. Earnings growth in the broader economy has still to pick up. Sovereign wealth funds have not yet turned buyers in global markets. The rupee is perilously close to its all-time low, which could put pressure on domestic inflation.

Stay with the quality companies and do not dabble in stocks that have no earnings visibility. Investors could make the switch from many overvalued mid-cap counters into quality large-caps, which are likely to recover first when the markets start looking up. Stocks that have been beaten badly could rebound, but that will give investors a good chance to shuffle their portfolios on the superior side.

If you are the conservative investor, who has been worried about the losses in your portfolio, it’s good to average on the lower side. Keep a buffer of cash to buy on the lower side for the long haul i.e., three to five years. If your portfolio has duds, continue to clean them up and move to the better-managed, well-positioned companies which can carve out growth even in a wrenching slowdown and an uncertain set-up.

At the moment, there’s no good reason to be overly optimistic about stocks given the global turmoil and slacking domestic growth, nor is there a good reason to be too pessimistic either as stock prices are down to fair value levels. But a good budget that balances all the pros and cons could just be the catalyst that the market needs.