The Cycle Continues

Sentiment has improved significantly in the stock markets. And we believe that the positive bias would continue roughly through the next one month, at least until the budget.

Except for a small technical dip sometime this week, markets look poised for a gala time in February.

However, as the euphoria over the budget reaches a crescendo in late February, investors would be well advised to make an exit at higher levels, we feel.

The pick up in sentiment is the result of a number of factors. Primarily the huge FII buying on technology counters has triggered the current rally.

FIIs traditionally make large investments in the beginning of the year and this leads to a ramp up in stock prices. Interestingly, when FIIs are making the bulk of their purchases, stock prices do not move up in the initial stages. However, prices move up sharply after the lag of a few days and we see a big ramp up in prices. Take for instance, the FII buying since the start of this year. FIIs have been big buyers of equity since the beginning of the month.

However, stock prices did not move up for nearly three weeks and it was only last week, after FIIs had pumped in a good Rs 2000 crore, that buying started showing up in prices. Usually the bullish trend that thus starts lasts for a few weeks and initial investors sellout at higher levels. This trend was visible last year too in the crucial months of January and February. The important point to note is that FIIs made very large investments in equity in November and December 2009.

Although the market at that time was quite bullish, the huge ramp up in prices took place in January and February, 2010. However, FIIs invested merely $50 million in January when the indices were truly zooming. They were big sellers in March when the indices were touching a new high. Similarly, in April, 1999, just after the Vajpayee government fell, FIIs pumped in over Rs 1000 crore into equities and subsequently despite the Kargil war, stock prices moved up.

The short point is that we usually see an upward move in stock prices after large FII buying takes place. However, the upward move takes place with a lag, after the initial round of buying. Following this logic, we expect the prices to generally move up for the next few weeks.

We expect technology stocks to lead the rally. However, the ramp up in prices this time may not be as steep as it was last year and therefore investors should be cautious of entering at higher valuations later in the rally. Typically, all investors would make some money in the initial run up. They reinvest that money in other stocks subsequently, but forget that they are entering at higher prices.

Also the amount of exposure rises with every profitable deal. Therefore, when the markets fall investors lose money in one go. We largely expect the current rally to last a little over a month and advise caution while investing when indices rise more than 20 per cent from the present level.

It is expected that after the forthcoming rally, valuations for technology sector would settle in a more realistic range and a distinction would be drawn between good quality companies and the doubtful ones.

This does not imply that the fancy for technology companies would end or wane. We believe that software technology companies would continue to grow at a healthy pace and their fundamentals would be sound.

However, the stocks would move in step with individual corporate developments rather than as a group. Leading companies would become market performers while the laggards would under-perform the markets.

As a diversification to their technology portfolios, investors should look for well-known corporations where business models are being restructured, which could lead to a re-rating of the stock.

A very good example over the next year could be Grasim Industries, L&T and Hindustan Lever. All three are leading players in their respective fields.

Their growth rates have been bogged down due to the large and diversified nature of their businesses. And now their managements are in the process of restructuring businesses to make optimum use of resources.

This could lead not only to an increase in their profit growth rates but also to better valuations.

We are particularly hopeful of beneficial results in Grasim and Hindustan Lever, both top companies of the country.