The Hindu Business Line : Stock prices: Watered down by drought

THE effect of a widespread drought may start getting reflected in the earnings numbers that are due this week on. This may cap any sharp upside in stocks. The effect of the drought has been priced in to some extent, but there is room for negative surprises. War, dominant theme now: War-related uncertainties have now taken centrestage. The past week saw the return of some buoyancy with the war appearing to go the US way and set for a quick finish. But it may be early days to take a call on this.

Quite a few other factors, beyond the war, that could impinge valuation levels in the next six to twelve months and merit a close look.

Bad monsoon effect: More accurate reports have started to emerge on the size of the kharif and rabi crops for 2002-03. These offer a clearer picture of the effects of a failed monsoon. A 28 million tonne (13.2 per cent) decline in foodgrain output tells the tale. This cannot but have a deleterious effect on the rural purchasing power, which has been weak in the last three years.

Companies in the consumer products — with the exception of a couple of firms that have an urban-centric product basket — and the automobiles sectors may feel the pinch. A declining growth rate in two-wheelers in the last three months, a continuing sluggishness in tractors and a more modest growth rates in cars point to the possibility of pressures on the auto sector.

Key themes falter: The auto sector, which has been the consistent positive driver in the markets in the 18 months, is beginning to stutter. Disinvestment may well be a theme that has to be put in cold storage with HPCL as the exception. The only theme that is still strong is the re-rating in the finance sector. Here too, stocks in the past few weeks have only recovered the value shed in a bout of profit-booking.

Smart money clearly appears to be headed towards such stocks as Bank of India, Canara Bank, Punjab National Bank, HDFC and Bank of Baroda. The sustainability of this trend will depend on a continued improvement in credit offtake. In the last quarter, banking companies turned in impressive numbers, riding on improved credit offtake than trading gains. The numbers may look good for the January-March quarter as well.

The dent in the rural economy could affect the industrial growth rate. Also, it could have a negative bearing on the credit offtake and the valuation levels of banking stocks. In 2002-03, a strong showing by the manufacturing sector helped neutralise the effects of a sluggish rural economy. The sustainability of growth rates of about 7 per cent is a question mark with drought and war effects at play. What may help finance sector stocks in such a milieu is the trend towards better quality balance-sheets. It may well remain a sector where there may be growth opportunities despite likely near-term blips.

Good monsoon effect: Markets are likely to quickly adjust stock prices to the drought effect once the January-March numbers float in. Downside risks exist in consumer products, automobile and select commodity sectors. What may quickly erase this effect is the outlook for the next monsoon. The only caveat here may be a wait-and-watch approach rather than placing total reliance on forecasts by the India Meteorological Department (IMD). Last year, its initial outline of the monsoon trends turned out to be far removed from reality. Actual rainfall and its special dispersion — if good — may be the key factor. A clear direction on this may emerge in five-six months.

Other listless aspects: The key indicators too suggest a market moving in a narrow range:

FII flows have been extremely sluggish. The flows into equities of about $400 million are among the lowest for the January-March quarter.

Of this, 69 per cent came through in January. This has left February and March with inflow levels that are extremely low by trends of the past decade. These are usually good months for FII flows.

IT stock valuations may get affected by declining profit margins, possibility of lower IT spend at the global level and war-induced delays in ramping up volumes.

Commodity stocks have had a good run in the last 18 months. A steady improvement in demand may be needed to drive up commodity prices. Any faltering on this score can impart downside risks.

The signals from the US economy are none-too-encouraging. There was active consumer spending for much of 2002 and that helped prevent a sharper slowdown in the economy. But signs of the consumer spending slipping have been emerging. If this delays the US economic recovery, it may not augur well for stocks. It may be one more year of investors having to use sharp dips to take exposures from a one-to-two-year perspective and use any emerging uptrend to book profits.

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