Pages

Sunday, January 9, 2011

Sensex plunges on concerns over rate hike, earnings squeeze

Fears that the Indian central bank will hike rates sharply to fight high inflation and a growing risk that earnings growth might disappoint in the coming quarters because of higher raw material costs pulled down the benchmark sensitive index of the Bombay Stock Exchange.

The Sensex slumped 492.93 points on Friday, the sharpest fall in 16 months, weeks before the Reserve Bank of India (RBI) is to announce its quarterly review of monetary policy on 24 January.

Weak global cues and heavy selling after the index dropped below the psychologically important 20,000 level exacerbated the extent of the fall in late trading hours, and the 30-stock Sensex closed at 19,691.81, losing 2.44% on a day when most Asian markets ended in the red. The 50-stock Nifty dropped 2.38% to 5,904.60.

The MSCI Asia (ex-Japan) index rose by seven basis points. A basis point is one-hundredth of a percentage point.

The four-day losing streak comes just ahead of the earnings season that will be kicked off by bellwether Infosys Technologies Ltd on 13 January.

 
Companies are expected to announce high sales growth numbers for the December quarter, but relatively muted profit growth because of a rise in raw material costs.

“There is a risk that earnings growth falls short of expectations as rising raw material prices squeeze margins,“ said Tirthankar Patnaik, strategist at Religare Capital Management Ltd. “The spike in commodity prices means that the manufacturing sector would face a tough time in the coming quarters as well, and there is a risk that we fall short of the consensus earnings growth estimate of 20% for the current fiscal as well as for the next year.

The Sensex is currently trading at nearly 15.5 times its consensus earnings estimate for the fiscal ending March 2012, at a 30% premium to the MSCI Emerging Markets Index.

Persistently high inflation and a spike in the prices of commodities, including crude oil, remain the key concerns for most investors even as this raises the chance of sharp monetary tightening, affecting margins and valuations of companies.
Food inflation for the week ended 25 December accelerated sharply to a 23-week high of 18.32% from 14.44% in the week before. “The food inflation level has been worryingly high,“ RBI deputy governor Subir Gokarn said on Thursday.

The International Monetary Fund has advised the central bank to keep hiking rates to tame inflation. The fund has projected inflation at 6.5% at the end of the fiscal, one percentage point higher than RBI's forecast, and warned that core inflation (excluding food and fuel prices that tend to be more volatile) has been rising rapidly.

“Inflation continues to be a concern with the recent up tick in food inflation while the wid- ening current account deficit is being funded by volatile port- folio flows”, said a 6 January note by Parul J. Saini, a Singa- pore-based Royal Bank of Scot- land analyst. The macroeconomic environment remains tough and “high crude oil prices will likely further pressure the current account and fiscal deficits“, Saini added.

Friday's fall was further accentuated when the Sensex dropped below the 20,000 level, analysts said.

“There is definitely some panic selling when a psycho- logical barrier is breached or stop-loss mechanisms are triggered”, said Vinod Sharma, head of wealth management at HDFC Securities Ltd.

Bank stocks have been the worst affected this week as their profitability will be hit in a rising interest rate scenario, with net interest margin, or the difference between their cost of funds and earnings on loans, being squeezed. Be- sides, when bond yields rise or prices fall, they book mark-to- market (MTM) losses.
MTM is an accounting practice of valuing a financial asset in line with market value and not at the cost of acquisition.

Macroeconomic concerns over high inflation, widening deficits and delays in government spending on key investments such as roads and other infrastructure as well as political uncertainties in a year that is set to witness five state elections has clouded the outlook for Indian markets.

India, which outperformed its Bric (Brazil, Russia, India, and China) peers for most of last year, has seen its stock market underperforming over the past two months, with foreign in- flows slowing.

Since its recent closing high of 21,005 on 5 November, the Sensex has dropped 5.7%, underperforming Brazil (down 3%) and Russia (up 9.6%). During the same period, China's market has fallen 8%.
In January thus far, foreign institutional investors have made a net purchase of Indian equities to the tune of $202 million (around `918 crore) after pumping in a record $28 billion in 2010. Foreign inflows dropped to $329 million in December against a monthly average of $2.4 billion last year.
Growing confidence in a global recovery has led most Asian strategists of brokerages such as Credit Suisse, Gold- man Sachs, BNP Paribas and Citi to favour developed market equities and export-orient ed economies of north Asia within emerging markets. The fact that they trade at relatively cheaper valuations over domestic demand-driven economies such as India and Indonesia makes them more attractive over the course of the year, analysts said.

According to most analysts, the results season will give direction to the market in the coming weeks as the impact of rising input costs on margins will be known.
Clarity on key policy issues such as taxation and initiatives on infrastructure projects would also help, analysts said. Finance minister Pranab Mukherjee will present the budget for fiscal 2012 at the end of February.