The Hindu Business Line : Positive drivers may boost market further

It is by now a familiar feeling — a sense of anticipation and jubilation tinged with caution — every time the Sensex touches a new high. And so it is now with the market barometer setting new highs on two consecutive trading days — Thursday and Friday. With the Sensex closing above 14,400 points on Friday, some of the questions passing through the minds of investors are: how far away is 15,000; is this the start of another sustainable rally; or is it merely a short burst of enthusiasm? These questions can be answered by looking at just what has caused the bullish sentiment now. There are at least three factors that seem to have combined to set off the sudden burst of optimism in the market. These are:

Electrifying Earnings

Corporate India appears to have had a rocking time in the third quarter, which clearly shows up in the results. It is not just the usual suspects from information technology and telecom that have declared excellent performances but also companies from industries such as cement, steel, non-ferrous metals and automobiles. Gujarat Ambuja, ACC, India Cements, SAIL, Tata Steel, Ashok Leyland and Hindalco, to name just a few, turned in stellar performances in the September-December 2006 quarter.The good earnings cards have come at a time when corporate foreheads were beginning to crease with worry lines about rising input costs and its impact on margins. The strong bottom-line of the major companies show that the strain on margins is not unmanageable, at least not yet. The bursting top-lines, in terms of sales volumes and realisations, prove the strong demand out there for most products and commodities, which by itself is an indicator of the economy's robustness.

Favourable RBI signal

Given the upward bias in interest rates in the economy in recent months, there was some nervousness in the market about the Credit Policy Review of the Reserve Bank of India on January 31. As it turned out, the 0.25 percentage point increase in repo rates (the rate at which the RBI lends to banks) was better than what the market expected, leading to a dose of positive sentiment. That the US Federal Reserve decided not to tinker with rates at a meeting around the same time only added to the relief of the market. An increase in rates by the Fed could have set off an outflow of FII funds from the Indian market.

Rating Upgrade

Standard & Poor's decision to upgrade India to investment grade was another positive factor though it was largely symbolic in nature. S&P's decision was certainly not a path-breaking discovery; the India growth story has been the subject of worldwide focus for at least a couple of years now.

Its impact may be felt, if at all, by companies when they borrow funds abroad as the investment grade rating could help reduce the cost of borrowing. The S&P move, however, combined with other positive news flowing in to set off a bullish sentiment in the market.

Start of another rally?

Traditionally, the run-up to the Budget has always seen the indices in strong territory and it is likely to be the case this year as well. The fourth quarter of this fiscal is likely to see an even stronger performance from Corporate India. Traditionally, the final quarter is a busy one when economic activity peaks and companies see a surge in sales.

A strong earnings performance will take the market into the first quarter of 2007-08 in a buoyant mood. However, there could be some uncertainty from thereon. There are a couple of factors that could subdue sentiment, not the least of which is the margin pressure that manufacturing companies are likely to face. To be sure, such margin pressure was already visible in the third quarter numbers of companies such as Hero Honda, Bajaj Auto and Tata Motors due to higher input costs and their inability to pass them on to customers a competitive market.

Assuming that prices of steel, cement and energy continue to be high, the margin pressure will only intensify. Buoyant revenues could help ease the pressure in the fourth quarter but the devil will manifest in the first quarter when business activity is relatively dull traditionally. Earnings growth could also be lower given the higher comparison base of last year.

Second, interest rates are, without doubt, set to rise further and the signal will be the end-April edition of the central bank's monetary policy. Higher borrowing costs combined with rising input costs could dent earnings of most manufacturing companies. Most major players are now expanding capacity, entailing capital investment and borrowings. Until such capacity begins to translate into revenues and earnings, margins could come under pressure.

Finally, it will be time to look heavenwards, to the monsoon. Though it no more plays as major a role in the economy as in the past, the monsoon impact on market sentiment cannot be underestimated.

Suffice it to say that while sentiment is likely to remain strong through this quarter, mid-summer blues could set in from the beginning of the next fiscal. That is assuming, of course, that the Budget does not throw up any nasty surprises. If it does, then the summer heat could set in early in the market!

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