Signs of recovery
There are many signs of recovery across industries indicating that the earnings outlook for the economy is likely to improve over the next few quarters. Some key sectors like cement, passenger cars, two-wheelers and durables have recovered sufficiently. Index of Industrial Products indicates that industrial activity for the first four months of 2009 has expanded by three per cent compared to the same in 2008 and 7.6 percent over the year 2007 inspite of the global recession and the recent credit crunch. The trends in IIP constituents reveal that the process of recovery is linked to three factors. One, the sectors that rely purely on domestic consumers fared much better than those that depend on industrial and export demand. Second, sectors that rely on rural and semi-urban demand were more resilient than city-focused firms. Thirdly, the three rounds of fiscal stimulus which gave a pre-election push to project completion might have boosted demand for sectors such as cement, steel, power and engineering.
How long will it last?
Having recognized that there is a recovery, can investors expect it to last? A prediction of medium term is a little difficult to make. However, the indicators of industrial output states that this recovery will sustain over the next couple of months. For instance, the Purchasing Managers Index (PMI) of a leading bank moved into positive territory and improved further in May. This indicates that purchase managers are quite optimistic about output and employment driven by new domestic orders, though export orders remain weak. The index of core infrastructure industries has delivered better-than -expected growth over the past two months. Key triggers for sustained growth may come from accelerated public spending on infrastructure and reduction in interest rates. If the forthcoming budget managers to keep up the tempo of government spending, sectors like engineering, capital goods and construction may see their fortune revive.
Consumer-oriented sectors are well placed to sustain a recovery, because of higher incomes (credit goes to the 6th Pay Commission for this) and lower retail lending rates. Sustainability of rural demand may hinge on continued public spending in rural employment and infrastructure and better access to agricultural credit. The only risk to the ongoing recovery stems from the possibility of the developed economies slipping back into recession - throwing the services sector into a poor pace of implementation in public projects.
Impact on the Stock Market
Having recognized that there is a recovery, the stock market has reacted positively to the same. FMCG stocks’ valuations are attractive based on their recent earning momentum. Some of the firms have seen summer sales of their seasonal products zoom. However, the poor rainfall / delayed monsoon may cause sale slippage in the rural turf going forward. FMCG companies are sensitive to monsoons for both input cost and rural demand. The recent rally in the market is unprecedented. During the last 15 weeks the key indices have all moved upward. This rally is owing to the beaten down valuations, extreme pessimism, short positions in the market, huge cash on the sidelines, improved liquidity and reduced interest rates. A lot of stocks the in the above mentioned sectors are over-bought and run ahead of clear fundamentals though the prospects for cements still looks positive. Under these circumstances valuation will continue to remain at elevated levels over the next few quarters. I strongly believe that it is important today to stick to fundamentals and not to be carried away with the market momentum. Markets, as they start their correction, can fall by 10-20 per cent from the peak.