Pension Funds: Their impact on Equity Market

Pension Funds constitute a pool of assets created by contributors to a pension plan for the exclusive purpose of pension plan benefits. In India only about 10% of the citizens are covered by the defined benefit plans like the Govt. servants. Pension funds serve as an important vehicle for social security of the people not covered by defined benefit plans.

Pension Funds worldwide are important shareholders of listed and private companies. According to analysts Pension funds have assets worth more than US$ 24 trillion wordwide. It is estimated that about 5% of this corpus is likely to be invested in Indian equity markets. In the US pension funds invests 70% of their corpus in equity related instruments. In October 2007 SEBI allowed pension funds to register as FII's. About 40 such funds have registered with SEBI during the past eight months. This includes 15 of the world's top 20 pension funds. Pension funds due to their large capital base and longer term investment horison, are more stable amidst market turmoils.

In India pension funds were initially not allowed to invest in equities. Pension Fund Regulatory & Development Authority (PFRDA) was established in 2003, and it launched its New Pension Scheme (NPS) in January 2004. The scheme has collected funds of around Rs. 3500 crores so far. Under the scheme upto 15% of the corpus can be invested in equities and the balance 85% in fixed income securities. The amount to be invested in equity may be hiked, depending upon the PFRDA bill which is likely to be tabled in the Lok Sabha in the winter session next month. State Bank of India, the country’s largest bank, has floated SBI Pension Funds Pvt Ltd (SBIPFPL) to manage investment of the contributions made by the employees of central and state governments who choose to join the scheme, SBIPFPL has got the maximum share among the fund managers and will manage some 55% of the corpus. Life Insurance Corporation of India and UTI Asset Management Company Pvt. Ltd are the other fund managers.

The impact of such large inflow into Indian equity markets will have a positive impact on the markets, and at the same time will lend a semblence of stability to our markets. The full impact of Pension fund investments will be seen in our markets from January 2009 onwards. If you beleive in this story, and its potential for our equity markets, do get ready to board the stock markets - but wait for the next correction to increase your commitments. The long term story of Indian equity markets is going to be written by the Pension Funds.

Current Economic Indicators: Is it a time for Euphoria?

WPI inflation rate down to 12.40% from 12.63%, GDP growth for first quarter at 7.9% - greeted by the markets with euphoria, BSE Sensex up 516 points and Nifty up 146 points. What are the reasons for this optimism? Are the markets out of the woods?

Let us try to analyse the ground reality to try and find an answer to the above questions:

• Inflation Rate: The rate of WPI inflation for week ended 16.08.2008, has shown a marginal decline over the past week. The major reason for the decline is the decline in prices of non administered petroleum products like naphtha. But the statement from RBI chief are not assuring, calling for cautious optimism. The WPI which is heavily loaded with the weightage of manufactured articles, is not a better representative of inflation and often leads to misleading connotations. CPI (Consumer price index) is a better parameter, andthe effort on the part of authorities should be to track this index which has remained more stable as compared to WPI in the recent past. Any overoptimism on the part of RBI to furthen tighten interest rates may be catastrophic for the Economy.
• GDP growth: The GDP figures for the first quarter of this fiscal at 7.9% (as compared to 9.2% a year ago) are the lowest in the past 14 quarters, and call for a closer scrutiny. The break up of the GDP figures are (Figures in brackets are the figures for last year): Agriculture 3.0(4.3), Mining 1.7(4.8), Manufacturing 5.6(10.9), Electricity & gas 7.9(2.6), Construction 7.7(11.4), Services sector10.1%. There are some alarming signals too: Gross fixed capital formation has decelerated to 9% from 16.7% a year earlier. However private consumption expenditure has remained stable at around 8%. Slowing of capital expenditure does not auger well for the economy, as it is a negative on the supply side impact on inflation.
• Global Commodity prices: The decline in global commodity prices has been responsible for the euphoria in Indian Markets rather than our internal factors. Crude oil prices are in a range between 112-122 $/ barrel, which is considered positive for India. Indian equties are being seen as a good hedge against global commodity prices. This could lure FII's to India in the near term. The current uptrend is again going to be sustained on the back of foreign liquidity.

Our internals will take some time to improve. So don't be mislead by the euphoria so soon. It may not be the right time for fresh equity investments, but it certainly will be a profit booking opportunity if the markets go up by another 10%.

Inflation:What lies beyond the figures!

In a layman's language inflation is a situation arising out of too much money chasing too few goods, leading to a rise in price level. Runaway inflation is detrimental for the consumers, especially the weaker sections of the society. The dilemma before the Govt/RBI is to strike a balance between growth and inflation. The frequent increases in CRR and REPO rates leads to hardening of interest rates across the board, which is detrimental for the producers leading to a slowing down of economic activity. If this situation continues for long, ultimately the consumers will have to bear the cost of the economic slowdown.

How far are our monetary authorities justified in sacrificing growth for the sake of controlling inflation, can be gauged by looking beneath the inflation figures released on a weekly basis. There are two kinds of inflation indeces in use in India: i) Wholesale Price Index (WPI), released on a weekly basis by the Ministry of Industry. ii) Consumer Price Index (CPI), declared on a monthly basis by the Ministry of Statistics and Programme implementaion (MoSPI). The figures that capture the headlines are the figures for WPI, which has reached a level of 12.6% for the week ended 9th August 2008. The latest available figures for the CPI for June 2008 are 7.3%, a good 5% lower than the WPI. Why this huge difference? The composition of WPI is Primary articles (22%), Fuel, Power. Light etc (14%), and Manufactured products (64%). Primary articles account for more than 50% weightage in the CPI. Another anomaly is in the calculation of point to point inflation. WPI shows the movement of prices on a Year on year (YOY) basis. A higher base effect reduces the figure while a lower base effect inflates the WPI. This is exactly what has been responsible for the unprecedented rise in WPI since May 2008.

How far is the Govt. responsible for this situation and what is the solution? The Govt. itself is to be blamed for the situation to a large extent. It cannot merely pass the entire blame of the rising prices on International commodity prices. The figures for WPI inflation are highly inflated because of the low base effect. In its endeavour to keep the inflation below the 5% level, Govt. kept the prices of petroleum products at depressed levels, even reducing the prices of petro products twice during the past year. It is now reflected in the higher WPI. Infact, in most of the countries CPI is considered to be a better representative of the price levels. MoSPI is in the process of revamping the CPI for Urban Workers, which is likely to replace the WPI as a broad measure of inflation by the middle of next year.

The International commodity prices including crude oil have started softening, therefore, there is little need for the RBI to pursue further tightening measures, which is likely to stifle growth rate.

Once the base effect blows over, WPI inflation will fall to single digits by the end of the year. The growth of Indian Economy remains intact despite the global slowdown. Investors with a long term perspective (minimum 12 months) can hold, even fresh buying can be initiated at lower levels.

A slowing economy: Who bears the cost?

It's from the horses mouth! Prime Minister's Economic Advisory council (EAC) has projected the GDP growth rate at 7.7% for Fiscal 08-09. What is more disturbing is the projection of a higher inflation rate. Other concerns are on the deficit front: current account deficit is expected to mount to 3.2% of GDP as compared to 1.5% for the last year, off balance sheet(budget) liabilities are estimated at 5% of GDP. On the top of it their no let up in the hawkish stance of RBI, pointing to further tightening of strings, maybe leading to another round of interest rate hikes. All this does not auger well for the equity markets.

The cost of the economic slowdown will be borne by companies with high capex plans having good exposure to debt, and short sighted investors, who do not invest with a long term view. However, with the higher pay packets for govt. employees, and soon to be followed by PSU employees, consumption driven growth will be robust. Companies in the consumption space will continue to grow, provided they are able to reduce their costs, because most of the growth will be volume driven.

In such circumstances we have to rely on fundamental analysis. Most analysts have downgraded the growth in profits for fiscal 08-09 for sensex companies to under 15%. This broadly translates into a sensex EPS of around 950, and on a reasonable PE multiple of 15-16, this translates into a sensex number of 14250-15200. In a more pessimistic environment the PE multiple can go down to 12, and in a very optimistic environment (provided inflation stabilises at under 7% and crude oil stabilises in the 80-90 $/ barrel range) it may go up to 20. There is every possibility of the sensex going to 12500 levels again, which I feel will be a good time for long term investors to enter, provided you keep your aspirations at a reasonable level of gains at around 20% for one year. Do invest through good equity oriented mutual fund schemes at these levels.

Apart from equities, it will be prudent to invest some money in long term Bank deposits, as they will give you a decent real rate of return once the inflation falls to under 7% by March 2009, as expected by EAC.

Make Hay while the Sun Shines

The stock markets are in an intermediate uptrend. Is the trend likely to continue? What are the factors contributing to this uptrend? What should I do at this juncture? These are the questions uppermost in every investor's mind. Many of us may have seen huge erosion in our portfolio in the past. This intermediate uptrend has reduced those losses to a large extent. It will be prudent to book partial profits/losses at this juncture, because the immediate fundamental factors do not point towards a runaway bull run. Even technically, the best case scenario for the Nifty is 4950, and for the Sensex close to 16500.

Let us analyse the factors responsible for the current uptrend and their sustainability:

• Falling Commodity prices: The commodity prices have cooled off recently. Indian economy is largely dependent on imported crude and the fall in crude prices to around $115/ barrel augers well for our growth prospects. The same set of analysts who were projecting oil prices to zoom towards $200 are now predicting them to hit $90 per barrel very soon. Ultimately, global demand for oil will decide the course of oil prices. The demand from asian countries has not tapered off as yet, so oil can rebound towards the $140 mark, before heading back towards double digit mark, probably in the last quarter of calender 2008. The speculators would also fuel the bounce back for a safe exit from their speculative long positions in oil futures. The investors should take the current opportunity to book some profits in refinery/oil marketing companies.
• Interest rates: The interest rate sensitive sectors like banks, real estate, automotives have been leading the current uptrend, not because any change in fundamentals, but because they were extremely oversold. The interest rates have not yet peaked out. The PSU banks have cleansed their books of NPA's due to the farm waiver scheme, but have not made due provisioning in their books to reflect the loan waiver. It will be good for the banks in the long run, when the deffered payment is received by them during the next four years, but this fiscal will put a lot of pressure on their profitability. Real estate prices are in for a rude shock. The demand has slackened, and credit is not available, so many real estate players may find it difficult to complete their projects on time, posing a threat to their profitability. Any bounce in the Bank, Realty stocks should be used as an opportunity to exit.
• Political stability: Althuogh the govt is making a lot of noise about reforms, its ability to carry out big ticket reforms is limited. The season of agitation, dharnas, bandhs has already started, and will only escalate in the months to come, causing serious disruptions in economic activity. This situation is likely to have a negative impact on the profitabilty of companies and the markets.

The moral of the story is: 'Cash is King', so make hay while the sun shines.

Corporate Results: Impact on Markets

India Inc. has declared mixed results for the first quarter '08-09. The current uptrend in the markets has been largely fuelled by two factors: i) The perceived stability of the govt., and the positive expectation of economic reform process being revived, ii) Softening of global crude oil prices. Crude oil is currently trading at the lower end of the technical band $117-147/ barrel. Both these factors may be deceiving in the medium term: the govt. may not be able to push through the reform process freely, and the crude oil may be in for a technical bounce back towards the $147 mark. In this scenario the market may be driven by the results declared by the companies.

Let's analyse the 1st quarter results to find out how India Inc. has fared (YOY growth figures):

• Net sales are up 25% (sharply up due to inflationary effect, high input costs)
• Other income is up 12% ( sharply down from previous quarters, due to Rupee depreciation and MTM losses)
• Total expenses are up 27%
• Operating profit is up 15% ( A decelaration compared to previous quarters)
• Interst cost has gone up 62% (erosion in profitability of high debt companies is maximum)
• Net profit has grown 10% ( A sharp decline over previous quarters)

If we analyse these results it paints a gloomy picture. But the situation is likely to improve from 3rd quarter onwards, when inflation will start falling, interest rates will peak out, and the loss from MTM losses will be drastically cut. For investors it will be prudent to book profits in the range BSE 16000-16500 and Nifty 4800-5000, because the market is likely to react negatively once the positve impact of the other two factors mentioned above is realised by the market. A good buying opportunity will emerge in the sensex range of 12500-13500. If the sensex is able to make a higher bottom, signifiacntly above 12500 in the month of September-October 2008, it will signal a reversal of the bear market trend.