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Rama Krishna Vadlamudi, MUMBAI May 10, 2009

Contact: vrk_100@yahoo.co.in

The stock markets have, of late, been going through a period of purple patch. Since the early part
of March this year, stock markets around the world have rallied strongly giving positive returns of
30 to 50 per cent (yes you heard it right, that is an annualized return of between 180 and 300 per
cent!) depending on which part of the world you belong. The stock and commodity indices have
been evocative of the positive sentiments in the financial markets towards an economic recovery
that is expected to usher in much earlier than anticipated. The governments and central banks
have taken strong measures and pumped in huge liquidity into the financial system.

In India, BSE-Sensex has recorded a remarkable recovery of 46 per cent from its recent low of
early March 2009, reaching a level of 11,876 on May 8, 2009. A detailed analysis is given in the
following three tables for different time periods.

BSE-Sensex has given a phenomenal return


BSE INDICES - TABLE 1 of 46 per cent between the recent low of
% return since
recent low of March 9, 2009 and now, whereas real estate
INDEX 08.05.09 Mar.9, 2009 index, metal, bank and capital goods indices
SENSEX 11 876 46 have been top performing indices with returns
MIDCAP 3 770 48 of 81, 79, 65 and 56 returns. Defensive
BSE-200 1 403 46 sectors-IT, PSU, HC and FMCG have been at
TOP PERFORMERS: SECTORAL INDICES the bottom of the sectoral indices during this
REALTY 2 356 81 period. It may be recalled that the top
METAL 7 950 79 performing sectors, like, real estate, metal,
BANKEX 6 007 65 bank and capital goods were among the worst
CAP. GOODS 8 507 56 performing sectors between the peak of Jan.
BOTTOM PERFORMERS: SECTORAL INDICES 08 and the recent low on March 9, 2009 (see
FMCG 2 093 16 Table 2). Due to their gross
HEALTHCARE 3 123 24 underperformance during that period, these
PSU 6 098 30 sectors have shown remarkable recovery
between the recent low of early March 2009
INF. TECH. 2 725 35 and now.

BSE-Sensex has fallen by 60 per cent


BSE INDICES - TABLE 2 between the peak of January 2008 and the
% return since recent low of early March 2009, whereas
INDEX 09.03.09 peak of Jan. 08
sectoral indices, like, real estate, metal, capital
SENSEX 8 160 - 60
goods and bank were among the worst
MIDCAP 2 553 - 74
performing sectors during the same period
BSE-200 963 - 64
losing 90, 78, 72 and 68 per cent respectively.
TOP PERFORMERS: SECTORAL INDICES
Defensive sectors, like, FMCG, HC and IT
FMCG 1 803 - 22
HEALTHCARE 2 519 - 43
were among the top performers between Jan.
AUTO 2 599 - 54
08 and early Mar. 09.
INF. TECH. 2 025 - 55
BOTTOM PERFORMERS: SECTORAL INDICES
REALTY 1 304 - 90
METAL 4 439 - 78
CAP. GOODS 5 453 - 72
BANKEX 3 633 - 68

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BSE INDICES - TABLE 3 Even though, BSE-Sensex has
% return since peak recovered 46 per cent (see Table 1) till
of Jan. 08 now from the recent low of March
INDEX 08.05.09
SENSEX 11 876 - 41
2009; it is still down 41 per cent from
its peak of Jan. 2008. From the recent
MIDCAP 3 770 - 61
lows of early March 2009, the real
BSE-200 1 403 - 47
estate, metal and capital goods have
TOP PERFORMERS: SECTORAL INDICES recorded a rise of 81, 79 and 56 per
FMCG 2 093 - 10 cent (see Table 1). The important thing
HEALTHCARE 3 123 - 29 to note is that they are still down 81, 60
AUTO 3 652 - 36 and 57 per cent between Jan. 08 and
OIL & GAS 8 469 - 36 now as can be seen in the Table 3.
BOTTOM PERFORMERS: SECTORAL INDICES Investors who invested during the peak
REALTY 2 356 - 81 of Jan. 08 have seen, even now, an
METAL 7 950 - 60 erosion of more than 80 per cent of
CAP. GOODS 8 507 - 57 their wealth from these real estate
POWER 2 176 - 52
stocks, like, DLF, Unitech, etc.

The question that is now exercising the minds of investors is: whether the current rally in stock
market will sustain for long? While there are no easy and straight answers to the question,
experts have been circumspect about the medium term sustainability of the current rally,
described by some as a bear market rally.

GLOBAL MARKETS: The Down Jones has given a return of 31 per cent in the last two months,
whereas NASDAQ Composite and S&P 500 have shown a positive performance of 37 per cent
each. It is interesting to note that the yield on the benchmark 10-year US Treasury has gone up,
in the last few months, by more than 100 basis points to reach a level of 3.28% on May 8th. It is
reflective of the higher risk appetite for riskier assets like equities and commodities in the US as
well as other world markets.

FII FLOWS TO INDIA: The foreign institutional investors (FIIs) have brought in net investments of
st th
around Rs 10,650 crore or USD 2.14 billion between March 1 and May 8 . This massive inflows
from FIIs has helped the Indian stock market showing an almost 50 per cent recovery in the past
few months. Global risk appetite for equity markets has gone up substantially in the recent past.

IS IT TIME TO SELL AT EVERY RISE?

While it is difficult to predict the peaks and troughs in the financial markets, it is clear from the
currency rally that investors’ sentiments have been aroused by some positive factors, like,
positive results from corporate results in the US, strong policy actions from the central banks by
cutting interest rates aggressively and pumping in huge liquidity and the latest stress test results
which are perceived to be positive by the markets. Indian markets have seen a bit of profit
th th
booking on May 8 ahead of the elections results slated for May 16 .

So far, Indian markets have shown strong correlation to the world markets. The correlation may
prove to be less pronounced in the next two months due to our own domestic compulsions; like,
uncertainty about central government formation, huge government borrowing in the first half of
2009-10, concerns about weakness in exports, job losses in export-oriented sectors, weak
corporate performance, shortfall in tax collections, etc. At this point of time, risk-reward ratio in the
stock market is turning towards higher risk. It is always better to leave the last leg of rally to
professional traders. Downside risks from now are very much high in view of the fact that many
stocks have already rallied between 50 to 70 per cent in the last two months.

Sensex faces strong resistance at 12,600 level: During the May 2006 stock market crash,
Sensex plunged 30 per cent from a peak of 12,600 on 11.5.06, to 8,900 on 14.6.06 in just one
month – such is the severity of stock market crashes. It is always better to exit from
fundamentally weak stocks during every rally for one may not get any opportunity to sell such
weak stocks in the near future.

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WITHDRAWAL OF MONETARY ACCOMMODATION BY RBI? Effective from May 6th, RBI has
withdrawn conducting second Liquidity Adjustment Facility on a daily basis. It may be recalled
that RBI introduced second LAF on a daily basis with effect from September 17, 2008 during the
height of extremely tight liquidity conditions in India. In the last three weeks, inflation based on
WPI has inched up from 0.18% to 0.70% for the week ended 25.4.09. Inflation based on CPI is
still running high. It remains to be seen whether RBI will start rewinding its accommodative
policies pursued aggressively by them since mid-September 2008. The RBI has got huge
government borrowing in the next five months. The full-fledged budget is expected to be
presented once the Lok Sabha is convened in the first week of June 2009.

High crude oil prices: The country may incur higher current account deficit and the concomitant
rise in fiscal deficit due to higher crude oil bill, which accounts for more than 70 per cent of India’s
import bill. Nymex crude oil price has reached a six-month high of USD 58.50 a barrel on last
Friday. Higher crude oil price entails higher fiscal deficit for India.

Oil Marketing Companies: OMC stocks have shown resilience, due to subdued crude oil prices,
to stock market crashes in the last six to eight months. However, with crude oil prices rising by
almost 20 per cent in the last one month, these stocks are under pressure now.

Metal Stocks: As shown in Table 1, metal stocks have given a return of almost 100 per cent in
several cases. This is driven by 15 to 30 per cent rise in base metal prices, like, copper,
aluminium and nickel on LME in the last one or two months. In India, it is reported that steel
sector is showing some signs of revival. The steel sector’s fortunes are dependent on world
markets. Globally, there is an overcapacity as far as steel sector is concerned. China is the
dominant consumer of steel in the world. If China’s economy shows any signs of early recovery,
then steel sector may rebound. But, there are, at present, no clear-cut signs from China to this
effect despite a massive economic stimulus package announced by the country.

Banking Stocks: Going forward, banking stocks in India may underperform in the next one year
as the sector is facing challenges on the NPA front, depreciation in their G-Sec investment
portfolio exacerbated by higher government borrowing, rich valuations, tepid growth in advances
going forward, pressure on other income, overcaution on the part of banks to lend to certain
sectors of the economy and less conducive atmosphere for further banking reforms.

Sectoral rotation: In the last six months or so, massive sectoral rotation has been taking place
very frequently by several marketmen. The only beneficiaries of such a churning of portfolios will
be stock brokers and professional traders.

Balance Sheet risks: Indian corporate performance may be weak due to certain balance sheet
problems, like, huge forex losses, dilution of accounting standards, goodwill impairment for
companies that have acquired global companies during stock market peaks, conversion of
FCCBs into debt due to weak stock prices, higher debt levels, etc. The results of FY 2008-09 are
still being announced and the process may continue till the end of June 2009.

OUTLOOK: In the next one or two weeks, Indian markets will be driven by the news flow related
to national elections, IIP data that is being released next week, corporate results that are being
announced and the perceptions of FIIs towards emerging markets. Domestically, there are more
downside risks compared to upside. As such, it would be prudent to stay away from markets for
the time being and wait till some clarity comes after the formation of national government and the
presentation of the Union Budget 2009-10. As predicted by Deepak Parekh, HDFC Chairman,
GOI may increase tax incidence for corporates during the current financial year.

Professor Nouriel Roubini and Nobel Laureate Paul Krugman are still skeptical of the current
optimism that is exhibited by several economists. They still feel the world economy is not yet out
of the woods. If one goes by the opinion of these two experts, the current optimism in the stock
market may prove to be short-lived.

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