Outlook for Indian Stocks in 2014-VRK100-31Dec2013

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During the calendar year 2013, the S&P BSE Sensex 30 index clocked a return of 9 percent, while the NSE’s Nifty 50 index rose by 6.8 percent. But the BSE Dollex 30 index recorded a negative return of 3.5 percent due to steep depreciation, around 12 percent, of Indian rupee against the US dollar. Dollex 30 is dollar-linked version of Sensex. Let us see which sectors have come out winners and losers and what is in store for Indian stocks in 2014.

Sectoral performance:

Among the sectors that have done well are BSE IT index and Healthcare indices, with a gain of 60 and 23 percent respectively. Significantly, both these sectors have partly benefited from the rupee fall. Other things that benefited these sectors are strong export growth, investors’ bias towards companies with strong balance sheets and better corporate governance, good potential for growth and slight recovery in the US economy. Other sectors that have done well include FMCG and Automotive sectors.

Real estate and public sector companies continue to be among the worst-performing sectors in 2013. The BSE Realty and PSU indices showed a negative growth of 32 and 19 percent respectively.

Returns and Volatility:

The Sensex return of 9 percent in 2013 does not reflect the volatility of stock markets in 2013. The benchmark index started the year with 19,510 and reached a peak of 20,328 (intra-day) on 17May2013. But due to fears of Fed tapering, steep fall of rupee against dollar, high current account deficit and policy-related paralysis in India; the index fell to an intra-day low of 17,922 on 27Aug2013.

After the US Federal Reserve deferring the proposed tapering, Raghuram Rajan taking over the reins of Reserve Bank of India and return of FII portfolio inflows; the Indian stock markets recovered sharply with the Sensex reaching an intra-day high of 21,484 on 09Dec2013. By the end of December 2013, the index closed at 21,171. Between May and August 2013, the Sensex fell by 12 percent.

But between September and December 2013, the benchmark index rose by 18 percent, giving some cheer to scary and wary investors. During 2013, the FIIs have brought in USD 20 billion to Indian equity markets.

Why the Difference between Sensex and Nifty Returns?

While Sensex recorded a gain of 9 percent, the Nifty rose by 6.8 percent only. The difference is due to the fact that Sensex consists of 30 companies, while the Nifty reflects prices of 50 blue chip companies. Moreover, at the start of 2013, Nifty was concentrated toward banks and financial companies. During July and August 2013, banking sector lost heavily—though banking stocks recovered in the last four months.  For 2013, the BSE Bankex lost 9.4 percent—causing the difference between Sensex and Nifty returns.

BSE Market Capitalization:

Total Market Capitalisation of All BSE companies:
	Rs Crore	USD Billion	USD-INR
Dec.2007	71 69 985	1 818	39.41
Dec.2010	72 96 726	1 616	44.44
Dec.2013	70 44 258	1 125	61.80
Note: Figures are end of the month; USD-INR is US dollar-Indian rupee exchange rate

Some interesting facts come out when you look at the above table. The market cap of all BSE companies at the end of December 2007 was Rs 71.70 lakh crore, converted to USD 1,818 billlion. But the market cap slumped to USD 1,125 billion (a fall of 38 percent) by the end of December 2013, though in rupee terms it fell by only 2 percent.

Two factors contributed to the steep fall in market cap, in dollar terms, of all BSE companies. One is the steep depreciation of rupee against the dollar. Another factor is the fact that broader indices themselves have fallen. For example, BSE 200 index lost 4.7 percent between December 2007 and December 2013.

Performance Chart for 2013:

Indices	31-Dec-13	31-Dec-12	% change
BSE Sensex	21 171	19 427	9.0
BSE DOLLEX 30	2 816	2 917	(3.5)
BSE 200	2 531	2 424	4.4
BSE Mid Cap	6 706	7 113	(5.7)
BSE Small Cap	6 551	7 380	(11.2)
BSE Auto	12 259	11 426	7.3
BSE Bankex	13 002	14 345	(9.4)
BSE Capital Goods	10 264	10 868	(5.6)
BSE Consumer Durables	5 821	7 719	(24.6)
BSE FMCG	6 567	5 916	11.0
BSE Healthcare	9 966	8 132	22.6
BSE IT	9 082	5 684	59.8
BSE Metal	9 964	11 070	(10.0)
BSE Oil & Gas	8 834	8 519	3.7
BSE Power	1 701	1 991	(14.6)
BSE PSU	5 910	7 335	(19.4)
BSE Realty	1 433	2 111	(32.1)
BSE TECK	5 051	3 428	47.4
Nifty 50	6 304	5 905	6.8

As can be seen from the above table, the performance of Sensex, BSE Mid Cap and Small Cap indices differs widely—though select mid cap and small cap companies delivered good to decent returns in the latter half of 2013.

It is interesting to note that mid cap and small cap stocks did better than Sensex in 2012. Investors mood changes—some years they’re optimistic about large caps and in some years they shift their bias towards mid and small cap companies. In general, it’s difficult to predict the mood swings of investors.

What to Expect in 2014?

However, my sense is that small cap and mid cap companies may do well in 2014, subject to the caveat that 2014 general election will throw up a stable government and the Indian economy will fare well next year. Having said that, I would like to add that investors are required to be more diligent as far as small cap and mid cap companies are concerned. They’ve to be very careful about choosing their stock picks. If they’re not experienced, they better consult their financial advisors before investing.

World markets, particularly the US and Japanese, have done extremely well with S&P 500 rising by close to 30 percent and Nikkei 225 by 57 percent in calendar year 2013.

I always maintain that investors have to take care of their asset allocation first. After asset allocation, they’ve to take a portfolio approach towards their equity investments. At this point of time, my thinking goes like this. Suppose you have a stock portfolio with stocks from companies with strong balance sheets, robust cash flows and high perception of corporate governance. Such a portfolio may not outperform benchmark indices if the economy quickly makes a turnaround and interest rates start falling.

This is due to the fact that any sharp turnaround accompanied by falling interest rates will benefit highly-leveraged companies and where investors are highly pessimistic about prospects. (Readers have to take my views with a pinch of salt, because I may change my view quickly depending on market dynamics and outlook on economy).

Let me assume that around 70 percent of your money is currently invested in companies with strong cash flows, decent balance sheets, zero debt and high profit margins.

My feeling is that around 20% to 30% of your money can be allocated to companies with moderate debt (means debt-equity ratio of 0.4 to 0.8), strong corporate governance and managements, reasonable but not very high interest coverage ratios, low operating profit margins and with potential to increase capacity utilization in the next 12 to 18 months. (Many companies are at present struggling with low capacity utilization which negatively impacted their profit margins).

The idea is that if and when the expected turnaround happens, these companies with moderate debt will be highly benefited as compared to companies with strong balance sheets and rich valuations—that have already been discovered by the market. You may have observed this kind of churning actually happening to some extent in the market in the last two/three months—select stocks in auto ancillary, NBFC, capital goods and power equipment sectors have risen sharply.  

It goes without saying that higher risk is usually rewarded with higher returns, provided you do your homework properly—peppered with some luck.

Of course, in the long run (beyond three years), companies with strong balance sheets, robust cash flows, pricing power and competitive advantage will continue to perform well. For a long time, I have preferred companies with strong balance sheets, low debt-equity ratios, strong cash flows and high growth potential.

But now I am thinking that as long as around 70 to 80 percent of your money is invested in companies with strong balance sheets, competitive advantage, pricing power and strong profit margins; you can slightly tilt 20 to 30 percent of your money towards companies with moderate debt, strong managements, low interest coverage ratios and low profit margins. This churning can be done in the next six to nine months in a gradual manner—keeping in mind the changing market dynamics, electoral math and progress of India/world economy.

Select PSU stocks may offer some protection from any downside that is anticipated around the 2014 general elections.

This is not to say that India has no problems. As you are aware, India is currently bedeviled with persistently high inflation and moribund investment cycle—not to mention the high cost of subsidies and government policy/regulatory issues. The RBI has kept its option of raising interest rates open.

Government’s fiscal deficit is a problem as revenue collections have slowed down, while non-plan expenditure (mostly subsidies) shoots up. But unfortunately, plan expenditure is being cut according to several reports.

Global problems may continue to haunt the Indian markets going forward. The government’s divestment effort is making very slow progress.

Finance Minster P.Chidambaram has been trying to limit fiscal deficit to the budgeted 4.8 percent (of GDP), through some creative accounting and cut in plan expenditure. Current account deficit was controlled by imposing severe curbs on gold imports.

It is naïve to expect that government diktats can wean Indians away from the allure of gold. Once the gold import curbs are removed, the gold buying spree will come back with a vengeance. The government seems to have made no serious effort to increase and widen export basket and boost manufacturing sector.

Some headway is being made on the policy front, after years of policy logjam by the central government. Subsidies are cut partially in diesel, LPG and petrol. After a decade, Railway fares too have been increased though marginally. Tesco of the UK has announced FDI in multi-brand retail sector in partnership with the Tatas. Abu Dhabi-based Etihad Airways recently bought a 24 percent-stake in India’s Jet Airways. Air Asia of Malaysia is planning a joint venture with Tatas.

Share repurchases (buybacks) by listed companies are happening. Many foreign promoters—like, Unilever, Vodafone plc and Glaxo Pharma—have been increasing their stake in Indian subsidiaries.  In the last two to three years, foreigners seem to be more optimistic about the prospects of select Indian companies rather than Indian investors, who have been selling heavily. FIIs have pumped in USD 20 billion into Indian equities in 2013.

My sense is that BSE 200 broader index may give 15 to 20 percent return in 2014. My optimism stems from the fact that many Indian companies have been able to weather the storms and will be able to generate decent profits and robust cash flows in future also—despite the uncertainties surrounding the political, fiscal and external fronts.   

Notes:

BSE – Bombay Stock Exchange, FII – Foreign Institutional Investor, NSE – National Stock Exchange and PSU – Public Sector Undertakings.

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Disclaimer: The author is an investment analyst, equity investor and freelance writer. The author has a vested interest in the Indian stock markets. This write-up is for information purposes only and should not be taken as investment advice. Investors are advised to consult their financial advisor before taking any investment decisions. He blogs at:

http://ramakrishnavadlamudi.blogspot.in/

http://www.scribd.com/vrk100

Connect with him on twitter @vrk100