Market Moves: It's time to exercise caution

It was around this time 2 years ago that our markets embarked upon the frenzied climb to Mount 21000 on the Sensex. And the end result was a steep fall to sub 8000 levels within 11 months from the highs created in January 2008. A majority of the analysts were talking of levels above 25000 at that time. Eversince the market touched 17000 on the Sensex (5000 on the Nifty) recently, these analysts are back to their old games. Investors are being advised to buy stocks at high prices, as if there is no tomorrow. Generally, the feeling of being 'Left out' lures retail investors to make the same mistakes repeatedly. Even Mutual Funds which were sitting on huge piles of cash when the markets were down in dumps, have invested heavily in the markets and their cash levels are down to between 5-10%. Agreed, that the economy is on a recovery path, but the process will be very slow and steady, and one should not expect the profits of the companies to rebound so soon to command such rich valuations. Foreign Institutional Investors have turned cautious at higher levels, and we may witness rounds of FII selling in the days to come. For retail investors, it is time to be patient. Generally, small investors who are worried about the safety of their principal investment should keep away from the markets at this juncture. Investment through SIP/STP may be continued, but do not get disturbed if the NAV of your fund temporarily dips below your average purchase price.

But this does not mean that there are no good opportunities to buy at this juncture. History tells us that every new bull run is made up of new market leaders, whereas the old winners fall by the wayside. At the current valuations most of the leaders of the last bull run like Reliance, L&T, BHEL, etc. look either fully priced or overpriced. On the other hand Auto and Realty sectors have had a fairly good run in the recent past, so they are also richly priced at current levels. If selective buying has to be considered, sectors like Retail (Pantaloon, Videocon, Geetanjali), Pharma & Healthcare (Ranbaxy, Fortis) etc. can be considered on dips.

But to reap  good returns from this market one must  have a minimum  investment horizon of 1-2 years, because that would be the time when corporate earnings catch up with the valuations. Yet, the market may surprise us on the upside because of the excess liquidity available in the system.

IPO Pricing & Listing Gains

Initial Public Offering (IPO) is as an exercise when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. For example, the recent Oil India IPO had both the above components. Subsequent issue of securities by an already listed company is referred to as Follow-on Public Offering (FPO). The IPO can be in the form of a fixed price option or in the form of a book building method. In India, currently the 'Book Building' pricing method is in vogue. This method provides an opportunity to the investors to decide a fair valuation of the issue through the 'Price Discovery mechanism'. In a book built issue allocation to Retail Individual Investors (RIIs), Non Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of 35: 15: 50 respectively.

There was a time when investors made a beeline for new issues for the sake of reaping decent 'listing gains'. After a lull in the IPO market due to the crash in secondary markets, the primary market is again buzzing with activity, with a large number of companies getting ready to tap the primary market through IPO's. But the poor post listing performance of a few prized IPO's (Adani Power & NHPC) has made the retail investors lose interest in the primary market. A retail investor refers to an investor who applies or bids for securities for a value up to Rs.1,00,000. For this reason the Oil India IPO received a less enthusiastic response from retail investors. However, qualified institutional buyers (QIBs), who invest with a long term perspective are quite bullish about the new issues hitting the markets. It seems there is ample liquidity to take care of the future IPO's getting a decent response from QIBs.

Small retail investors will have to be careful in choosing an IPO for investment, and not be guided by vested interests promoting the issues through media. Since most of the new issues are being priced aggressively, including the new issues by Public Sector companies, the chances for making listing gains are few. If one has to invest in a good IPO one should invest with a long term perspective and not merely for listing gains. SEBI has made rating of new issues an optional exercise, but a majority of the companies get their IPO's rated by rating agencies (CRISIL, ICRA, FITCH etc.). The grades assigned to companies are avilable on NSE's website. The highest rating is a 5-star rating. Amongst the recent IPO's, the issues of OIL India Ltd. and Mahindra Holidays and Resorts Limited have been awarded a 4-star rating by CRISIL & FITCH respectively. Before investing in any IPO, retail investors are advised to go through the Red herring prospestus (RHP) carefully, or seek the opinion of their Financial Advisor.

Beware of Accounting Jugglery!

Better than expected first quarter results have brought cheer to the Indian stock markets. A prima facie analysis of the overall financial performance of India Inc. may have been enough to convince the bulls that the Indian economy is finally out of the 'Recession blues'. However, the quarterly results of a few companies are a result of some financial jugglery, and thus should be taken with a pinch of salt. As per the notification issued by Ministry of Corporate affairs (MCA) in April 2009, provisions of AS11 have been suspended for a period of 2 years effective March 2009. As per AS11 companies are required to mark to market (MTM) their Forex assets and book gains/ losses in their Profit & Loss account on QOQ basis.

Taking advantage of this notification, quite a few companies have changed their accounting policies w.e.f June'09 quarter thus increasing their profits. For example, Tata Motors reported a net profit of Rs.514 cr. for quarter June'09, which reflects an increase of 57% over corresponding quarter last year, despite a drop of 8% in its sales. A foot note to the results says that last year profit would have been Rs.502 cr. as per the amended AS11. Another company Moser Baer has reported a net profit of Rs.43 cr., which is higher by Rs.146 cr. due to the amendment in AS11. In real terms the company would have suffered a loss of Rs.103 cr.

These are just two examples of accounting jugglery. Many more companies would have resorted to such accounting practices to boost their bottom line. But this makes comparison of company results a much more complex affair. Investors must take cognizance of the foot notes in the company balance sheet before taking a decision to invest, rather than being taken for a ride!

Affordable Housing: 'Panacea' for the Realty sector

After euphoric times 'Realty sector' seems to have hit a low in the past one year. There are very few takers for the super luxury apartments offered by the Realtors. Caught with severe cash crunch and falling sales most realty firms are busy selling their land banks to improve cash flows. The murmurs about 'Affordable housing' are now being heard in the Board rooms of the real estate developers. Those companies that have announced new affordable housing schemes have got a better response in the recent past, whereas those offering premium housing are still looking for clients.

According to research firm 'Knight Frank' there will be an additional demand for 45000 affordable housing units in NCR region alone in the next 2 years. The research also says: largest contributor to this demand would be the Rs.3-6 lac income group. The maximum affordability for a household is around 5 times its annual income, for example a household with an annual income of Rs.3 lacs can afford a house worth up to Rs.15 lacs. If households buy more expensive houses, the chances of default in repayment are higher. The unit area for a affordable housing project is between 600-1200 sq. ft. (average size of the apartment is around 850 sq. ft.). But many companies are still offering units above 1200 sq. ft. which are not really affordable. Real estate firms will have to catch with the ground realities and start offering real affordable housing. After all there is no dearth of demand by genuine buyers. The interest rate scenario points to a stability in interest rates in the near term, which is a great impetus to the dream of providing affordable housing to the people of India.

Prices will need to become more realistic if developers have to succeed in finding enough buyers. As land costs need to be sufficiently lower for an affordable housing project, most of the affordable housing projects are likely to come up in suburban areas, given the prohibitive cost of land in cities. There is also an urgent need to develop innovative ways to reduce construction costs without compromising on the quality of housing. There is also an urgent need to look at the use of newer, energy efficient, environment friendly materials and innovative construction technologies. This will help construction companies/ builders improve demand and will eventually help them improve their cash flows.

ULIPS made more attractive

Unit Linked Insurance Plans (ULIPs) are set to become attractive long term investment plans w.e.f 1st October, with the proposed changes announced by the regulator IRDA. IRDA believes that ULIPs are akin to Mutual Funds with an added insurance cover thrown in. Emphasising on the long term nature of ULIPs, IRDA proposes to increase the lock-in period in respect of ULIPs to 5 years as compared to the existing lock-in period of 3 years.

The regulator had earlier announced capping of fund management charges on all insurance contracts to 135 basis points. The other charges payable by the investors are: premium allocation charge, policy administration charge, mortality charge and charges for additional 'riders' included in the policy. The regulator proposed the overall charges on insurance contracts to be capped at 225 basis points for contracts over 10 years and 300 basis points for contracts up to 10 years. It implies that if the earning of the fund is 15% a minimum return of 12% must be payable to the policy holder. However, keeping in view the nature of an insurance contract, mortality charges have been left out of the overall ceilings announced. The mortality charge varies with the age of the client/investor - mortality charge is higher as the age increases.

As ULIP products directly compete with Mutual Fund schemes, the recent changes in the load structure on MFs (Entry load on MF schemes has been abolished from 1st August 2009) announced by SEBI has prompted IRDA in making the necessary changes in respect of ULIPs, positioning them as a long term investment alternative.

Model Direct Tax Code: Taxation Simplified

The Govt. recently unveiled the 'Model Direct Tax Code', which is likely to replace the Income Tax Act 1961, by 2011. This signals simplification of the tax system, improving efficiency of the system and expansion of the tax base. It is a step towards tax reforms in India and may grant independence to tax payers after 50 years of introduction of IT Act. The main architects of this code are:

• Pranab Mukherjee, Finance Minister, who has fulfilled his budget promise.
• P. Chidambaram, former Finance Minister, considered to be the brain behind the code.
• Arvind Modi, Jt. Secretary, Tax Policy & Legislation, CBDT.
• Anita Kapoor, Jt. Secretary, Foreign Taxation, CBDT.

The salient features of the Direct Tax code are:

• Liberalisation of Tax slabs - Up to Rs.10 lacs (10%), Rs.10-25 lacs (20%), beyond Rs.25 lacs (30%). The basic exemption limits to continue.
• Classification of Tax payers - The separate categorisation of Resident but not ordinarily resident (RNOR) to be abolished. This will lead to increase in number of tax payers.
• Introduction of EET regime - The exempt-exempt-tax (EET) method would entail tax on withdrawal of savings including PF. The existing savings in the funds up to 2011 will not be taxed.
• Increase in deductions - The limit for deductions (currently at Rs.1 lac under sec 80C) will go up to Rs.3 lacs, but deductions on repayment of Home loans will not be available.
• Allowances will be taxable - Allowances such as HRA, LTA etc. will be added to income and will become taxable. Interest paid on Home loans will not be exempt from taxes.
• Removal of Surcharge - The tax system will be simplified by removal of surcharge
• Revamp of Wealth tax - The current exemption limit of Rs.30 lacs will be enhanced to a whopping Rs.50 crores. Thereafter, wealth tax will be levied at a fixed rate of 0.25%.
• Corporate tax reduction - It it proposed to levy a uniform tax of 25% on domestic as well as foreign companies.
• Computation of MAT to be simplified - Basis of levying Minimum Alternate tax (MAT) will be shifted from profits to assets. Even loss making companies will be liable for tax.
• Long term & Short term Gains: The distinction between the two stand removed, tax on capital gains will be charged at normal rates. It will result in higher cost of investment transactions.

The code promises to usher in an era of greater transparency in taxation matters, and hopefully will make the life of Tax payers hassle free.

Market correction: An opportunity to buy for long term

Stock markets world over are being driven by excess liquidity, but the valuations seem to have been stretched too far at this point in time. But based on fundamental analysis, the 'Margin of Safety' for a large number of stocks, especially the front line stocks, is under threat. Is it the time to buy for long term? Serious long term investors can wait for markets to correct around 10-15% from current levels to buy for long term.

Incidentally, market participants have a tendency to factor in the good news immediately. The good news about a possible revival of World economy by early next year, good set of quarterly results, have already been factored into the stock prices. But the markets may still continue to rise in the short term because of the comfortable liquidity position. However, markets tend to ignore the negative news for a great length of time. 'Behavioral Finance' would tell us that people tend to be in a denial mode for long before bad news actually catches with them. Remember, the signals for an impending global crises were ignored by the markets in the early part of 2007, when the sub prime crises broke out in the US. The after effects and the magnitude of the crises are known to all of us now.

At this juncture Indian markets are ignoring 2 important factors which may have far reaching impact on Indian economy:

• Failure of Monsoon: It is almost certain now that we are heading towards a deficient monsoon year (the worst in past 8 years). The impact of this could lead to a decline of GDP by 0.5-1%, depending on the distribution of the rainfall in the remaining part of the monsoon season. The 'El Nino' factor could worsen things further. rural demand may suffer, which is bad news for FMCG and Auto companies.
• Spread of Swine Flu: The speed with which the cases of Swine flu are being reported is likely to create a panic like situation. Some sectors like Hotels and Aviation would become the necessary victims of the spread of swine flu.

We continue to be in a denial mode about the likely impact of these two events. However, whenever reality dawns on the markets, they will correct substantially from the current levels. That would be a great buying opportunity for long term (long term means a holding period over at least 2-3 years).