Udayan Mukherjee: Riding Past The Speedbreakers

Udayan Mukherjee is Managing Editor of CNBC-TV18.
His Call: The stock market is structurally bullish. Corrections will come but won't change the big picture.
His Big Investment Idea: Look beyond index heavyweights. 2010 could be the year of midcap stocks.

Bullish but confused, that sums up my perspective for stock markets in 2010. Confused because it is beyond the grasp of my little mind to comprehend how economies and markets may shape up next year and bullish on the knowledge that India’s outstanding growth fabric will ensure that even if we slide on global panic like 2008, the fall will be temporary and most likely - buying opportunities for investors.

2010 is, in many senses, an absolutely pivotal year. Sceptics and doomsayers have their knives out predicting that the liquidity steroid-fuelled rally of 2009 will peter out; rising inflation will force policy makers to retract monetary stimuli which will expose the fragile nature of the recovery, bringing stocks down to their knees again. This scenario is certainly not implausible so should not be scoffed at outright. My own sense is that these concerns will lead to at least one or more sharp selloffs in 2010. I would be surprised though if it manages to break the market’s back.

Udayan Mukherjee, Managing Editor, CNBC-TV18

A repeat of 2008, in 2010, is in my eyes, a very low probability outcome. If this is a true bull market, bears will be wrong more often — as bulls were through 2008, and selloffs predicted to be the end of the bull run will be shortlived. Having said that, 2010 is a more difficult year to call than 2009 as this year was the classic first year of a bull market. Too much pessimism, improving fundamentals and tonnes of liquidity: the perfect cradle on which a bull market is born.

Year two is always more challenging, not least because valuations have priced in quite a bit of the good news already, perhaps the reason why the Sensex has been labouring through the last quarter of the year, unable to forge ahead.

So what are the key walls of worry that the markets will need to scale in 2010? At the top is a global breakdown. This is the part which is most difficult to analyse or predict, on account of it’s sheer complexity. The US Federal Reserve may not tighten its monetary policy any time soon, but growth could start waning. The dollar could stage a sharp comeback and reverse some of the easy liquidity which has led emerging market stock prices higher this year. Accidents could happen: Dubai may have come and gone but other sovereign blow-ups could provide a Lehman-like trigger for overextended markets.

These are all clear risks but if this is indeed a multi-year structural bull market, these shocks will only be speedbreakers.

There are India-specific risks as well. Interest rates will start heading up soon. Yet, if we have GDP growth of 8 percent next year which isn’t unlikely, markets may not correct significantly even in the face of rising interest rates. Remember the lessons of history. From December 2006 to December 2007, the RBI tightened monetary policy six times, the Nifty in this period moved from 3700 to 6100, a gain of 60 percent. Then there is the question of earnings growth itself. 2010 will probably see a gradual exit of some of the soft fiscal policies that spurred on growth this year.

There is consensus expectation of 20 percent earnings growth in 2011 which will have to swim against this tide. From current valuation levels, earnings disappointments will not go down well with stock prices. My own sense is that growth will not dry up significantly in 2010, and while stock prices may pause somewhat to let earnings come through they will be able to forge ahead. Also, the market may actually appreciate the trade off from a macro perspective, as our fiscal situation needs correction and that can only happen with a tighter fiscal policy. This is particularly relevant as the fisc remains the only fly in India’s macro ointment.

Global investors would have noted India’s growth resilience in 2008: our worst quarterly GDP growth number was 5.8 percent, at a time when the world was falling apart. So while we may fall with global markets whenever sharp corrections happen, smart money will be buying India as this is where the growth lies. That may not ensure near-term decoupling but has to lead to superior stock market performance over the medium term, else the laws of market economics are all wrong.

So yes, there are walls of worry but bull markets are supposed to climb them. It’s the volatility which has driven away local investors. When markets fall 60 percent in one year and double the next, investors just don’t get enough confidence to participate. This is perfectly understandable. Yet, if there is one lesson from the wild swings of the last two years, it is this: India has a strong and resilient growth story going, if you buy the market every time it trades around or below a PE of 12 and are prepared to hold for at least 18-24 months, you will make a lot of money. I oversimplify, of course. I could have said 10 PE but that implies catching panic bottoms which aren’t easy to do.

Illustration: Abhijeet Kini

Also, stock selection is important. Yet, even at a very basic Nifty index exposure level, this strategy should work. So, assuming we will see a Sensex EPS of around 1100 in FY11, and here I am deliberately not taking the most optimistic forecasts, any level around 13,500 Sensex or 4,000 Nifty would be good levels to accumulate stocks. It really doesn’t matter if there are overshoots on the way down, as long as you hold your nerve and buy more. There is of course the risk that you don’t even see these levels in 2010 and are left waiting in frustration. That may happen but I think you will get prices close to these levels sometime during the year, and those would be buying opportunities.

If you are more aggressively bullish, you could start buying earlier, at slightly higher levels. At some point in 2010, markets may realise that the world isn’t breaking down, the dollar is not out of the woods and emerging markets are where the growth lies. At that point, which is impossible to time, valuations may start expanding again, eventually heading to bull market levels of 17-18 times 2011-12 earnings. That may imply Sensex levels of 22,000 to 23,000 again, by the time the market exits 2010 and beginning to price in 2011-12 earnings.

If this is true and 2010 does turn out to be year two of the bull market, albeit with sharp knocks thrown in, then the bigger opportunities will lie in the broader market. It’s difficult to justify valuation expansion for index heavyweights like Reliance, Bharti, L&T, Infosys or BHEL, but there are many high quality midcaps and non-index large caps whose earnings growth will be over 25 percent and PE multiples are in low teens or lower double digits. 2010 could well be the year of midcaps.

Having said all of this, the strange thing about the market is that things change all the time. When things change, opinions need to change too; nothing is ever cast in stone. The world changed after Lehman and who could have seen it coming? With that caveat, I would enter 2010 with an opportunistic mindset, looking to capitalise on inevitable bouts of nervousness and keeping one’s powder dry for the rough patches, which will come. Just avoid overpriced IPOs and if you have to err, err on the side of bullishness.