The Sensex’s sharp 41% fall from its January highs to the depths it plumbed in July is quite in keeping with what happened during the tech wreck in 2000, when the benchmark index lost 43% between its high in February 2000 and low in October, except that the fall this time has occurred more rapidly. But while attention has been focused on the magnitude of the fall, it’s worth remembering how long it took for the market to rebound in the early 2000s. As late as end-April 2003, three years and two months after it reached a high of 6,150 in February 2000, the Sensex was at 2,959. Even the pessimists are currently saying it will take another 12-18 months before the markets start to rise. If the last downturn is a guide, it may take longer.
Also, from a valuation perspective, the Sensex is now at around 18.4 times trailing earnings, about the same level it was at, during the correction in 2006. The economic outlook was far more buoyant during that time. On the other hand, the Sensex’s valuation is still much higher than where it has historically been at the bottom of previous major market downturns. For instance, during the last crash, the trailing price-earnings (P-E) multiple bottomed at around 12.6 at the end of September 2002. Earlier, after the domestic economic downturn caused by high interest rates in the mid-1990s, the Sensex’s trailing P-E multiple fell to a low of 9.83 at the end of October 1999.
Perhaps the changes in the economy since the 1990s and early 2000s will ensure this time the compression in P-E levels will not be so severe. A research note by Morgan Stanley points out that the P-E is determined by several factors: the risk-free rate, or the government bond yields, which are dependent on inflation; the equity risk premium, which is dependent on global risk appetite and thus on capital inflows; and the domestic growth outlook. Their conclusion: “Market participants should expect the market’s trailing P-E to fall in the coming months.”
What does that mean for investors? Says Morgan Stanley: “The conclusion at the portfolio level is to avoid stocks and sectors that are most susceptible to a fall in P-E. This includes stocks and sectors where the P-E is trading well above average and where the P-E has risen a lot over the past five years. The sectors that best fit this description are industrials, financials, and utilities.”
Ashok Leyland shares defy fundamentals
Shares of Ashok Leyland Ltd have risen by at least 16% since August, at a time when the markets have been practically flat. But this has nothing to do with positive developments at the company. On the contrary, things have been getting worse for the commercial vehicle maker. Auto analysts are perplexed at the rise in the shares in the past month.
After reporting a decent volume growth of about 10% in the past two months, sales plummeted in August. Total volumes fell by at least 20%, but more importantly, sales of medium and heavy commercial vehicles (M&HCV) in the goods segment fell by 28% in the domestic market.
What’s more, unsold stock has been on the rise. The company has produced 6,900 more vehicles than it was able to sell to dealers so far this year. During the same period last year, the unsold stock was exactly half. Goods carriers in the M&HCV segment accounted for most of this. A decline in the sales to dealers and the pile-up in inventory clearly point to lacklustre secondary demand. Soon, the company would have to adjust production to factor this in, which in turn would impact economies of scale and margins.
That this comes at a time when the company is in the midst of a major capacity expansion means that while core profits could be on the decline, interest and depreciation costs would be on the rise. The outlook for net profit, therefore, is rather bleak. In fact, keeping the slowdown in the M&HCV segment in mind and the rising debt levels at the company, rating agency Fitch recently revised its outlook on the company from “stable” to “negative”. With that backdrop, the rise in the shares is indeed baffling.
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