It's an old joke by now: How do you make a small fortune on the stock market in 10 days? Just start out with a big fortune. It's black humour at its best, since everyone's losing money these days. Or are they? Those who bought shares of JSW Steel at the beginning of March 2009 would have doubled their money in a little over a month. From Rs 163 on 9 March 2009, the stock had risen 102% to Rs 330 by 16 April. You'd have made a pretty profit from Tata Steel as well; the stock rose 76% from Rs 152 to Rs 269 per share. Unitech and DLF rose by 74% and 69%, respectively, over the same period. The bigger picture shows the BSE Metals Index gained 55% in less than six weeks, the Realty Index rose by 61%, while the BSE Sensex rose by 34%.
That's good news, right? Especially when you consider that these stocks were possibly the worst performers of 2008. So, does this dramatic rise mean you should stuff your portfolio with metals and real estate stocks? Not really. Experts give technical and fundamental reasons for investors to avoid these sectors. We take a look at the reasons for the recent rally in these sectors and why it might not be a good idea to buy now.
As we have seen, the metals sector seems to have rebounded from abysmal lows. But here's the reality: the big 70-100% gains are calculated on a low base. The fall in metal and realty in 2008 was so steep that these stocks entered the oversold territory and were due for a relief rally. Before the beginning of the current rally (9 March), the BSE Metals and Realty indices were deep in the red, with losses of 77% and 90%, respectively, from their January 2008 highs. So the present gains made by these indices are on the lower base, which makes percentages look bigger than the actual gains in stock prices.
Consider this. The 74% rise registered by Unitech helped it gain only Rs 18.55 per share to Rs 43.35. This is because the stock rose from its low of Rs 24.80 on 9 March 2009. The lower base effect is clearly visible if we compare the current numbers with the indices during the January 2008 highs. Even after adding the recent gains, both the BSE Metals and Realty indices were 65% and 83% lower than their respective January 2008 highs. In real terms, what the current rally has done is to help the indices hint at a recovery.
Individual stocks also performed well because of low valuations. "Markets adjusted to the overt negative reaction (in 2008) to these sectors. Some of the metals were beaten down to 10-year historical lows. Globally, commodities are at record lows. The view is that there is a greater possibility of an improvement in prices than a downside from now on. Therefore, metal stocks too performed well. It has more to do with cheap valuations," says Sonam Udasi, vice-president, consumer research head, BRICS Securities. The shares of metals companies rebounded amid hopes that commodity prices had bottomed out. With the price of base metals rising for the first time in 2009, investors hoped that the industry might have seen the worst of the price correction. "Base metal prices have rallied because of the continued buying by the Chinese government, production cuts and short covering. This has helped in improving the earnings outlook for non-ferrous companies like Sterlite, Hindalco and Nalco. Steel stocks too moved up due to an improved demand in the domestic market and the end of the price correction in international markets," says Sanjay Jain, senior vice-president, research, Motilal Oswal Financial Services.
The March rally seemed like light at the end of the tunnel for the real estate industry. It had faced a very bad year, beset as it was with problems, including price correction, lower consumer interest, tight liquidity and rising interest rates. However, it appears that things have indeed started looking up. With banks cutting housing loan rates and RBI pumping more liquidity into the banking system, most of these real-estate companies have been able to pull through the worst of tight liquidity conditions. This has helped the real estate companies to restructure their loans and raise fresh funds. "Realty companies were beaten down the most in the downfall. As the interest rates are likely to fall, these companies will outperform the Sensex," says Ajay Parmar, head of research, Emkay Global Financial Services.
These days, when we think of the real estate sector, we generally consider only the property development companies. But the recent rally saw cement companies in the limelight. The positive momentum in cement stocks is largely attributed to an unexpectedly strong growth in dispatches. According to Angel Research, cement dispatches have grown by 8-10% in the past five consecutive months as against the 4.5% growth in October 2008. "Our channel check with dealers and several industry experts suggests that the strong demand for cement in the past couple of months has been on account of the heavy infrastructure activities due to pre-poll spending by the government and the strong demand by rural housing," said Pawan Burde, analyst at Angel Broking, in a recent report on the cement industry. Many cement manufacturers were either going slow or were delaying setting up additional capacities due to the weak demand. This helped cement producers raise their prices. During January-March 2009, cement manufacturers raised cement prices by Rs 8-10 per bag. The price hike was witnessed more in the western and central regions of the country.
Experts have suggested that the recent rally was also helped by the rise in investors' risk appetite. "The increased risk appetite has compelled the investors to look at aggressive sectors rather than only at defensive ones. That's why we saw underperformance in FMCG stocks," says Parmar. With most of the defensives (FMCG and pharma) peaking at 15-20 times price-to-earning (PE) multiples, investors were forced to look beyond the conventional defensives.
Realty and metal stocks are available at cheap valuations—metal stocks are quoting at 0.6 times their book values and real estate stocks are trading at a steep discount to their net asset values. This, combined with improving liquidity conditions, saw more and more investors entering these sectors looking for good bargains.
The large-scale exit from defensives led to the relative underperformance of the BSE FMCG and Healthcare indices, which are historically known as reliable bets in bear market conditions. Between 9 March (the beginning of the recent rally) and 16 April, the BSE FMCG Index gained only 16% and the Healthcare Index rose by 20%, while the Sensex gained 34%.
"These sectors had been outperforming when the broad markets were down on account of higher risk perception. Now, with a positive change in risk perception among investors, the markets have rallied and the outperformance of these sectors is being reversed. Also, on a relative basis, these sectors had been quoting at premium valuation to the market and, hence, turned expensive," says Krishna Sanghvi, vice-presidentequity, Kotak Mutual Fund.
Should You Buy?
Though positive signs are emerging, experts are not too comfortable recommending a full-blown exposure to these stocks. "Yes, investors can look at these sectors with a two-three year perspective. But they also have to be ready to take the rough with the smooth. It can be volatile in the interim. It is time to look beyond defensive stocks simply because the risk-reward is favourable for investors with over a two-three-year time frame," says Udasi.
The major worry regarding these sectors is that none of them are completely out of the downturn or are showing any definitive signs of recovery. The recent rally is based on a couple of factors, which indicate tentative signs of recovery, like bottoming out of metal prices, rising dispatches of cement and falling home loan rates. The main factor to look for is the consistent rise in private/consumer demand for these sectors. The recent pick-up in metals and cement prices is largely attributed to the stimulus spending by governments across the world, not due to the consistent rise in demand from the consumer sector.
Analysts expect cement prices to peak soon and decline from the second quarter of 2009-10 because of supply catching up and demand slackening ahead of the monsoon season. "Though we do not expect metal prices to fall below the recent lows, there is an overhang of excess capacity. We expect a consistent pick-up in private demand only by 2011," says Burde.
However, there is one factor that's going in favour of these sectors—low valuation. From this perspective, analysts are comfortable buying steel and cement stocks with an investment horizon of two-three years. "I believe metals and cement would do well in the next two-three years. However, the market has moved up quite sharply. Wait for some correction as your timing and entry point will always provide you a margin of safety," says Parmar.
As we have said often enough, timing the market is best left to the professionals. If you must have some exposure to either metals or real estate, you might be better off with the former. Despite cement and related sectors pulling up the industry, recovery in the property market seems remote. The demand for metals, like other commodities, is cyclical, and so you might make profits when the industry revives.
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