The Hindu Business Line : Market View

Strong fourth quarter GDP growth numbers and the advance tax data shows that there is no slow down in economy and corporate profitability in the near term. We expect that the revenue and profit growth numbers of corporates will continue to be robust for the quarter ending June 2006 also. Also given the demographics and large contribution by services sector to the overall GDP, the long-term attractiveness (sustainable GDP growth rates, with lower volatility) of India will continue to remain high. But, rising interest rates and rising inflation, local and global, can spoil the market sentiment in the short to medium term.

Kotak Mutual

In the Indian equity markets there is a strong out performance, which has occurred relative to the benchmark Nifty or Sensex indices. In fact up to 90 per cent of local equity funds have outperformed these indices on an annual basis over the past three years.

This strong positive skew has largely been achieved by "buying the mid-cap story". This exaggerates out performance relative to an index that is entirely made up of large-cap stocks.

Fund managers have therefore taken a higher degree of active risk against the index in their equity holdings. In general all funds have operated with a weighted market capitalization for stocks held which is far below the weighted average market capitalization for the Nifty or Sensex indices. Mid-caps have been the attractive growth sector of the equity markets and as a result fund manager out performance has been significant. Is it likely that this story of mid-cap out performance will continue? It may have done so in what was apparently secular bull run in the equity market. However, the gap between valuations on large-cap and mid-cap has reduced significantly.

The price-earnings ratios and price book value ratios of mid-caps have moved sharply higher than for large-caps, indicating a situation of mid-cap valuations running steeply ahead.

Therefore the risks of corrections in mid-cap stories, tend to become higher purely from an over valuation perspective. Also the ability of mid-caps to outperform large-caps reduces. If mid-cap out performance potential starts to decline, then the fund managers may adopt less active risk in their portfolios and thus out performance expectations must fall.

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