Too early to party?

Krishnan Thiagarajan

THE sharp rally witnessed by stocks at the Bombay Stock Exchange (BSE) over the past two months has taken market analysts, observers and industry experts by surprise.

Buoyed by the sharp surge in the Nasdaq Composite Index representing the technology sector in the US, the BSE Sensex has marched up by nearly 28 per cent in just over two months, after touching its lowest level on September 21 (after the September 11 attacks on New York and Washington).

At the BSE, this rally has been spearheaded by stocks from the convergence triad of software, telecom and media. The dramatic run-up in stock values has followed a certain pattern. In the first round, the uptrend was driven by rock bottom valuations of second/third-rung software stocks. The heightened trading interest soon pervaded the second-rung telecom/media stocks and finally, the frontline software stocks joined the party.

And what a party it has turned out to be. Out of over Rs 1,15,000 crore added to the market capitalisation at the BSE, nearly 65 per cent of this increase is attributable to the rise in the ''convergence'' stocks, led primarily by the software stocks. Since most of the software stocks, specially the second-rung companies, were trading close to their 52-week lows, the upswing from those levels was fairly steep. For instance, second-rung companies such as Digital GlobalSoft, Silverline Technologies, NIIT, Polaris Software, SSI, Rolta India and MphasiS BFL had appreciated by over 100 per cent during this period. Frontline stocks such as Infosys, Wipro and Satyam Computers also notched substantial gains during this period.

However, the nagging question on everybody's mind is: Is this rally at Nasdaq, which has been the prime mover behind the uptrend in the BSE Sensex, a speculative or a sustainable one? From an Indian perspective, if the software stocks were the biggest driving force behind this rally, has the firm undertone in the market been supported by robust growth in ''offshore outsourcing'' opportunities and strong earnings visibility in the foreseeable future? Though the long-term prospects for the technology sector seem bright (starting probably with the second half of 2002), the near-term prospects for the economy in general, and the technology sector in particular, continue to remain uninspiring for the following reasons:

Unsustainable Nasdaq rally: The Nasdaq Composite Index has appreciated by over 30 per cent since touching a low on September 21, following the September 11 attacks on the US. This is the second time in the last six months that the Nasdaq has witnessed a rally of over 20 per cent. But this is an indication of the fact that technology stocks are in an oversold position and are poised to witness greater market volatility in the weeks and months to come. The ground reality seems to suggest that the recent upsurge at Nasdaq (and at the BSE on account of the strong correlation between the two indices) are clearly unsustainable. The current rally appears to have been driven purely by market sentiment, the feel-good factor over the success of the war in Afghanistan and the tenth round of rate cuts announced by the Federal Reserve in the second week of November. On a sustainable basis, there has hardly been any improvement in the underlying fundamentals of the US economy and most of the news from the economic front has been highly depressing.

Sector fundamentals remain dismal: Practically all the key sectors in the US technology environment, namely PCs, telecom carriers, storage, wireless and optical networking, are slated to remain depressed in the near term. None of these sectors is showing any concrete signals of recovery. In the US, all hopes are pinned on the PC industry. But as yet, there has been no lead indicators of a recovery through the semiconductor sector, specially from the likes of Taiwan Semiconductor Company and United Microelectronics. With the slowdown spreading to Europe and Japan, the telecom carriers and wireless majors such as Deutsche Telecom, British Telecom, France Telecom, Ericsson, Alcatel and Nokia are already in a restructuring mode. This seems to suggest that there may not be any near-term uptrend in spending from the telecom carrier, wireless and optical networking arena. Even the storage market, expected to be relatively insulated from the slowdown, has taken a huge beating in recent times.

Commoditisation and slowdown in tech spending: It is becoming clear that open standards and standardisation of systems/processes have shrunk the scope for customisation in different sectors. The possibility of greater commoditisation of different sectors may threaten the scope for margin growth for market leaders in different business segments. Moreover, it is becoming obvious that ''overinvestment'' in the technology sector had contributed heavily to the US economy slipping officially into a recession. Two inferences can be drawn from a statement of this kind. One, unless the economy shows signs of recovery, none of the technology sector majors will loosen their purse strings. And that is unlikely to happen before the first quarter of 2002. Two, the sharp fall in the technology sector clearly shows that in future, this sector may also become a cyclical play, like other old economy sectors. Key technology players, namely Sun Microsystems, Oracle, EMC, Cisco Systems, Nortel Networks, Dell, HP, Compaq and Intel, continue to reel under the economic downturn. Cisco Systems has indicated in its latest earnings announcement that because of limited visibility and differing economic projections, it is unable to provide guidance beyond the immediately forthcoming quarter. Most other companies are also suffering from lack of earnings visibility and lowered financial projections, going forward.

The Indian software sector, specially the medium-sized companies, have also suffered from the same lack of earnings visibility, with hardly any significant change in the underlying business fundamentals in the near term. The offshore outsourcing opportunities for Indian players are immense but they are likely to accrue slowly in the foreseeable future, especially for the second and third-rung software companies. Against this backdrop, it is probably time for small investors to exercise greater prudence in investments or even stay away from the markets.

maverick@thehindu.co.in

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