Financial Daily from THE HINDU group of publications
Sunday, Mar 13, 2005
Financial Daily from THE HINDU group of publications Sunday, Mar 13, 2005 |
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Investment World
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Insight Markets - Stock Markets Mid-cap investing — Ride the sector wave right Krishnan Thiagarajan
But now it is all mid-cap mantra. With at least three mid-cap mutual fund public offers made or on the anvil from Kotak, SBI and Tata, apart from the launch of a host of multi-cap and flexi-cap funds, investors are being offered a plethora of opportunities. Significantly, a chunk of mid-cap stocks, both in the index and outside, have touched their 52-week highs or are close to them. Will the mid-caps hold? Is it time to turn bearish on the market? Not really, as the returns on the MidCap 200 Index continue to outpace the Nifty in the post-Budget rally, in line with the broad trend over the past two years; this trend, however, flagged in 2004 in the volatile phase in the market between January and May. The classic shift in trading patterns towards Nifty or Sensex stocks (called the "flight to safety") that happens whenever indices vault to new peaks is not visible at this stage. And though a correction is possible, there may be little need to fear a crash.
Fuelled by two rallies
The MidCap 200 Index scaled its new high in two long rallies of about seven months each between July 2003 and January 2004, and from August 2004 to date. Prima facie, both the rallies look similar, driven primarily by the expectations of an upturn in economic activity, but the underlying factors and sectoral themes that propelled them are different. Incidentally, between January and August 2004, there was another seven-month spell of volatility, first in the run-up to the Lok Sabha elections and, then, after the surprise verdict.
First mid-cap rally: July 2003 and January 2004 After the last bull-run, in mid-1999, several factors finally fell into place in the economy in early 2003 that helped the stock market price in a nascent recovery. Some of the key factors that dictated the surge in the market from 1000 points in July 2003 to 1800 points in January 2004 were:
The sector preferences were... Based on the returns delivered by the top 20 companies in the MidCap 200 Index, the sector focus was skewed towards pharma and software (global outsourcing story), banking (led by the decline in interest rates) and power (based on power reforms). Some of the prominent gainers during this period were Hexaware Technologies and iGate Global, CESC and KEC International, and IDBI Bank. Outside this, there were no consistent gainers among sectors. Individual stocks in sectors such as construction (Gammon India), textiles (Jindal Polyester), sugar (Bajaj Hindustan), steel/mining (Sesa Goa and Nava Bharat Ferro Alloys) and fertiliser (Gujarat State Fertiliser and Chemicals) figured in the top 20 list. Breaking up the run-up of the MidCap 200 Index into two legs, from 1000 to 1500 (July to November) and 1500 to 1800 (December to mid-January) reveals a different picture. In the first leg, stocks from engineering, power, textiles and construction figured in the top-20 list, probably reflecting the undervalued status of stocks in these sectors. But in the second leg, there was a clear switch in focus to banking, software and pharma. Second mid-cap rally: August 2004 to date In the run-up to the second rally, the market went through a painful phase of volatility, lasting nearly seven months, from January to July. This period proved to be the experimental phase for the market, where sectors and stocks caught investor fancy for a month or quarter, only to be dumped unceremoniously in the next few months. Following the mini-Budget in February, the market clearly favoured the economically sensitive sectors such as cement, retail, power and steel sectors in March and April. But in the homestretch to the elections, as the exit polls projected a hung Parliament and the China factor preyed the commodity market, the stock market turned defensive. Instead of chasing sectors, the market preferred undervalued, low volatile and news-driven stocks such as Himatsingka Seide, Colour Chem and Amtek Auto, and cigarette stocks such as Godfrey Philips and VST Industries. A similar trend was evident even in the post-election phase. By the time the sustained rally began in August, driving the index from 1700 to 2915 points in March 2005, the economy had consolidated on the incipient trends visible in 2003. Among these were:
And the sector preferences were... As economic growth gathered momentum, the sector focus changed dramatically. In different phases of the rally between August and March, among the top 20 stocks, there was concentrated buying in sectors such as construction (Gammon India, Hindustan Construction), chemicals/petrochemicals (Gujarat Alkalies, Finolex Industries), sugar (Bajaj Hindustan, Balrampur Chini) and textiles (Bombay Dyeing). As power sector reforms did not take any concrete shape, the interest in the stocks receded to a large extent, with some revival in interest post-Budget. Despite buoyant prospects for software sector, the re-rating happened quite quickly, leaving limited room for substantial capital appreciation. As the auto and auto-ancillary story played out strongly in the volatile phase of the market, it did not make much of a dent in this rally. Interestingly, in the first and second rallies, among the top 20 stocks, there were six common gainers: Sintex Industries, Pantaloon Retail, Sesa Goa, Gammon India, Bajaj Hindustan and Essar Oil. They were driven by acquisitions, strong expansion, order book and preferential allotment to FII/private equity investors, broadly reflective of the optimism in the economy.
It's a different market now
As the MidCap 200 Index waltzes merrily higher each day, it may be smart to bone up on the tunes to play the mid-cap theme. While sector themes will continue to dominate the market, the scope for momentum-based stock trading opportunities is drying up. A chunk of stocks is also trading at or close to their yearly highs. Relative valuation based on price-earnings multiples (PEs) may also be a dicey proposition. In this backdrop, the key will be specific stock selection in individual sectors using fundamental analysis that places emphasis on accounting information, management quality and earnings momentum. Picking stocks purely on preferential allotments or stock splits or bonus may no longer be desirable, as it is likely to leave investors with risky options. The pricing and terms of preferential allotments made to FIIs/private equity investors in 2005 will be qualitatively different from those of 2004. And the preferential allotment made to promoters at a price higher than the market price need not necessarily be a vote of confidence. Quite a few recent bonus offers and stock splits are settling at theoretical ex-bonus or stock split levels (sometimes even lower). Investing through mutual funds rather than direct investing is preferable. Even here, investing in established diversified equity funds with a good track record may be the better option than investing in mutual fund IPOs, especially at these index levels. The mutual fund route is preferable for three reasons. — One, the strategy of diversification will protect investors from any downside. — Two, as oil prices are ruling above $50 a barrel and commodity prices are also soaring, operating profit margins are sure to feel the impact. Mutual funds with a diversified portfolio that includes, say, software and pharma stocks may be able to reduce the risks for investors.
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