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S. Vaidya Nathan

The auto and engineering sectors continue to exhibit buoyancy. But the worrisome trend in the monsoon, stiff oil prices, a possible rise in interest rates and FII flows that have slowed over the past two months are negatives that may lead to a modest year for equities.

THE key factors that drive equity prices seem to be missing this year. This is in contrast to 2003, when the favourable indicators were so strong as to propel equities to new highs.

Stocks appear set to trade in a narrow range as they have over the past several months and provide, at best, modest returns this year. For them to even end the year in positive territory would be a big story. A look at the key trends:

Auto overdrive: Buoyancy in the auto sector was a dominant theme in 2003. The cars and commercial vehicles segments notched up growth rates of nearly 30 per cent. This story still appears to have some steam, despite a sluggish May.

Sales of commercial vehicles — Tata Motors and Ashok Leyland dominate this space — show signs of at least matching up to 2003 levels. Growth rate in cars has slowed compared to last year. The 25 per cent growth rate in June, however, suggests that one more year of strength may be in the offing.

In the two-wheeler space, Hero Honda Motors still reports impressive growth; Bajaj Auto's performance is modest, while TVS Motor's fortunes have been on a decline. Overall, the auto story has a positive bias with favourable implications for auto ancillary stocks as well.

Monsoon clouds: Despite predictions of a normal monsoon in terms of quantum and spatial distribution, the weather gods have played truant. The South-West monsoon lasts till September; but the longer the ongoing break lasts, the more intense would be the negative impact as kharif sowing levels, patterns and early-stage management could be affected.

The information available so far suggests that there is a high risk of poor spatial distribution. This could be bad news for consumer product companies such as Hindustan Lever and ITC, which have not reaped any benefit from last year's bountiful monsoon.

A deficient and poorly distributed monsoon can neutralise the gains in the agriculture sector over the past year. It may also diminish the effects of the focus on agriculture in this Budget.

Sticky oil prices: If the crude price prevails at high levels, which appears likely, it could cut into profitability across several sectors. Its potential to spike inflation to higher levels, directly and indirectly, through higher prices for a mass of other products is a big risk.

Oil companies may have a larger burden, as price increases are not passed on to consumers. The flat trend in the consumption of petro-products in June is also a cause for worry. If petro-product prices continue upwards, they could put brakes on the impressive growth story in the auto sector.

Interest rate risk: Declining interest rates and windfall incomes for banks are a closed chapter. The threat of a steep rise in interest rates is remote, unless oil prices go through the roof.

A rise of 0.5-1 percentage point appears likely. Banks that reported handsome earnings growth last year will be hard-pressed to do an encore.

Credit-driven growth may not deliver the magnitude of gains that treasury incomes provided to banks over the past couple of years. A rise in interest rates may also require banks to mark down their debt portfolios.

FII flows slow down : There are distinct signs that foreign institutional investors are in a cautious mode. Over the past two months, their net investment has been close to nil; but they continue to trade aggressively.

At $3.5 billion, net inflows for this year so far are still behind the record flows of $7.6 billion last year.

There is the possibility of FII flows staying lukewarm, especially with rising interest rates in the developed countries and profit booking in emerging markets.

Sector-specific pointers: Engineering, the other dominant theme of the bull market of 2003, continues to pack a punch. The likes of ABB, BHEL, Siemens, LMW and Larsen & Toubro appear set to spearhead another buoyant year.

The slowdown in cement demand and high steel prices are, however, cause for concern. IT and mid-cap companies in the pharmaceutical sector are likely to turn in smart earnings growth.

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