Tuesday 25 September 2007

Valuations ahead of Fundamentals

Stock valuations have raced ahead of fundamentals, but bulls hit the Street again on Monday, driving up the Sensex by another 281.60 points. The benchmark index rose to a record high for the fourth straight session. A section of the market expects the upward momentum to continue, led by robust foreign inflows.

On Monday, the Sensex closed at 16,845.83 points, rising 1.70%; the Nifty ended 94.65 points or 1.96% higher at 4932.20 points. Since the cut in a key interest rate by the US Federal Reserve on September 18, both indices have risen roughly 7-8%.

“Our momentum indicators are still supportive, but our value indicators are increasingly suggesting that momentum is the main source of support. The ultimate sell signal would be a reversal in momentum. That, coupled with where valuations currently stand, would spell trouble,” Citigroup analysts said in the latest note to clients.

Most observers believe that the current momentum is unlikely to break soon, as the Fed rate cut has created more opportunities for carry trades. This involves investors borrowing money in countries with lower rates and investing in shares or high-yielding government paper in emerging markets like India for higher returns. Given that the US Fed is expected to cut rates further, brokers expect more foreign money to flow into India.

According to Almondz Global Securities technical analyst and derivative strategist Gurudatta Dhanokar, “The current move of the market is up and the open interest is increasing that will reinforce the trend. In the near future, when the market will turn, it will be very sharp. One of the best sectors looking at the charts in medium to long term is power. It will outperform the market and downside is limited. Stocks that look attractive are power and telecom. Overall the charts are suggesting good upside in medium to long term. The investors can avoid IT stocks as if the market corrects, crack will be more in IT stocks.”

Since the Fed rate cut, foreign funds have invested over Rs 5,000 crore in India. Prior to the rate cut, foreign institutions had net invested roughly Rs 4,800 crore in Indian shares in September. The strong foreign fund inflows pushed the rupee to a fresh nine year-high of 39.77 against the dollar on Monday.

The stronger rupee continued to weigh down sentiment in software shares, which fell roughly 1-3% on Monday. Since software exporters derive a major chunk of their revenues in dollars, a weaker dollar impacts their revenues and margins.

Stocks of both Mukesh and Anil Ambani group companies extended their dominance on Monday. Fund managers seemed slightly baffled by the kind of surge seen in most Reliance shares in the past 3-4 sessions. “It is true that Reliance shares are considered as one of the proxies for the Sensex.

But I am not sure whether this kind of euphoria in these shares is justified,” said the fund manager with a private mutual fund. Reliance Industries, Reliance Energy and Reliance Communications have gained 13-20% in the past four sessions against a 7% rise in the Sensex.