Why experts feel stock markets may tumble

The recent rally in Indian shares may not last long, according to market players.

While the fundamentals have not improved, the worries have increased due to a steep rise in crude oil prices, they say.

On Wednesday, the Bombay Stock Exchange Sensex went up by 9.1 per cent in March, its biggest monthly rise in six months. It rose 434 points to 19,696.

The Nifty closed 125.80 points up at 5911.50.

"FII (foreign institutional investor) money is coming back. But, a large portion of the recent inflows has been through ETFs (exchange-traded funds), which can be dumb at times, ignoring fundamentals," said the chief executive of an asset management company.

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Also, the near-term outlook on inflation and interest rates as well as the global political situation is not bright.

Saurabh Nanavati, chief executive, Religare Mutual Fund, says: "Macro headwinds continue.

"For instance, the crude oil price is higher than in mid-March and inflation is not coming down. We expect margin pressure to continue (for India Inc) in the next two quarters." The rally has been driven by global factors and FII inflows.

While key Asian and developed markets (barring China and Brazil) have risen 5-10 per cent between March 16 and April 8 due to FII inflows, the gain in commodities has been as much as 20 per cent.

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Amit Rathi, Managing Director, Anand Rathi Financial Services, says: "The recent rally is mainly on account of inflows into global equities, especially emerging markets.

"With US QE2 (quantitative easing-II) ending in June 2011 and no sign of a QE3, we expect the markets to reverse the gains of the last few weeks."

Experts say a weak dollar may be one reason for higher allocations to emerging markets. Of late, the rupee has gained 2.3 per cent against the dollar. However, crude oil, ruling at $120-125 a barrel, is a worry.

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Dharmesh Mehta, Managing Director, Institutional Equities, Enam Securities, said: "The undertone does not seem to be too bullish. The real impact of the rise in crude oil prices will be seen in the coming quarters, which is a major worry."

Most experts say that after the ongoing state elections, the government will increase fuel prices, putting an upward pressure on inflation.

Inflation, despite easing a bit, is still above the Reserve Bank of India's comfort level and may prompt it to increase rates further.

This, the market fears, will raise the borrowing costs of companies and put pressure on demand.

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Higher input costs (commodity prices) will also hit corporate earnings. In fact, the growth in earnings has been slowing for the last one-two quarters and is projected to fall further.

In a recent report, Morgan Stanley analysts estimated that the Sensex earnings would grow 19 per cent year-on-year in the March quarter as compared to 26 per cent in the December quarter.

According to a Dun & Bradstreet quarterly survey, India Inc is cautious.

"Although business optimism has continued to rise during the Q2 of 2011, some signs of cautiousness are visible...following increased concerns over rising inflation and interest rates.

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"High inflationary expectations seem to have tempered the exuberance regarding future demand conditions and profitability," said Kaushal Sampat, president and CEO, Dun & Bradstreet, India.

The macro concerns have already led analysts to downgrade their earning estimates. Clive McDonnell and Gautam Mehta of BNP Paribas Securities Asia wrote in a March 31 report: "Hit by the triple whammy of rising interest rates, higher input costs and execution slippages, India continues to be the worst hit by earning downgrades. Almost every sector in India saw an earning downgrade in March."

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Religare's Nanavati says: "If oil remains at these levels for a couple of months, we will be forced to cut our earning estimates.

"We have estimated earning per share growth of 14-15 per cent for Sensex companies, as against the market expectation of 18-19 per cent, as rising crude/higher raw material costs will eat into earnings."

Analysts at Motilal Oswal Securities echo the view.

"Our FY12 estimates suggest Sensex EPS growth of 19 per cent, a marginal downgrade over the past two quarters.

"If the current trend of rising commodity prices persists, the profit after tax mix will tilt in favour of global cyclicals rather than domestic plays.

"This will drive down the valuations of Indian equities."

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Most experts say there may be an improvement only in the second half of 2011.
Rathi expects the markets to turn bullish in the second half of the year.

However, views differ on the quantum of the correction (if any) and valuations. While some believe valuations are fair at current levels, others expect a correction of 5-10 per cent.

Adrian Mowat and Bharat Iyer of JP Morgan, who recently upgraded India to 'overweight', wrote in an April 5 report: "While concerns over high inflation and growth moderation are likely to continue over the near term, we believe these risks have largely been priced in.

"If global economic conditions, especially in West Asia, don't worsen, we believe Indian equities can deliver a healthy return into the second half of the year."