'Stability' was the theme in the Indian stock markets in August; accompanied by the attendant boredom. Though the Indian benchmark was thwarted in its attempt at surpassing the 15500 mark this month, it has managed to hold on to most of the gains made in the second half of July and has recorded a second positive monthly close.
This leaves room for the hope that with the advent of September, the rally from the July trough will progress further. FII selling abated last week though the tally for August stays negative. Turnover was dull in the first half and picked up in the last two trading sessions. The August series on the derivatives segment expired with healthy rollovers.
With the intra-week trough at 14002, the Sensex has retraced exactly half of the move recorded from 12514 to 15580. Despite the close below the 50-day moving average on Thursday, the weekly close is well above this line. The sagging momentum on the daily charts received a fillip from Friday's rally. The 10-week rate of change oscillator that is on the verge of crossing over into the positive territory should be closely watched next week. Successful crossover would signal that the medium-term up-trend from 12514 would resume.
The short-term trend in the index is down since the 15580 peak. The sideways move between 14000 and 14700 over the last two weeks could be a temporary halt before the down-trend resumes to take the index lower to 13690 or 13140. The risk of another bout of volatility will be averted only when the index is safely above 15000.
That said the fact that the Sensex is holding above 14000 is a positive from the medium- term perspective. As explained in our previous column, our medium-term view will stay positive as long as the index sustains above 13700. This will leave open the count that the third leg upward from the 12514 trough can take the Sensex higher to 15900 or even 17074 over the next couple of months.
The air of skepticism pervading the markets and the bouts of profit-taking that it causes, would pose numerous hurdles to the Sensex in its journey higher. The resistances next week would be at 14796 and then 14990. A close above the psychological 15000 mark would take the index to the previous peak at 15586. Supports would be available at 14002 and then 13700.
Nifty reversed from the intra-week trough at 4398 last week. The index has closed above the 50-day moving average and has also reversed after retracing 50 per cent of its previous up-move. If a medium-term trough has been formed at last week's low, then the index can rise to 4732 or 5061 over the medium-term. This view will be negated only on a weekly close below 4115.
In the short-term however, the index will face resistance at 4425 or 4478. Reversal below these levels can take the index lower towards 4200 or 4115. Target beyond 4478 is 4649.
The CBOE volatility index, also known as the investor's fear gauge, is trending lower and is fluctuating between 18 and 22 since early August. This signals that investors have learnt to live with the current gloomy market conditions.
The European markets had a strong week. The FTSE moved above the peak recorded in mid-August thus signalling the resumption of the up-trend from the July trough. CRB index, reflecting the commodity prices is attempting to stabilise at lower levels. The index is also hovering around its 200- day moving average that helps determine the long-term outlook. The upcoming weeks will help us determine the long-term outlook on commodities as a whole.
The Dow Jones Industrial Average is whipsawing in the zone between 11300 and 11700 showing the battle for supremacy that is raging between the bulls and the bears. As explained earlier, a decline below 11230 will make the outlook bleak whereas a reversal from here will open the path for a surge towards 12100.
Asian stock markets presented a mixed bag with no discernable trend among the indices.
This stock reversed from an intra-week trough at Rs 566 last week. But the short-term outlook remains negative and a close above the down-trend line at Rs 620 is needed to reverse this view. Subsequent targets are Rs 630 and then Rs 650. Tata Steel has been moving in a narrow range between Rs 560 and Rs 700 since July. The medium-term view will turn positive only after the stock closes above the upper ceiling of this range.
If we consider the last year's movement, Tata Steel has been moving in a broad range between Rs 550 and Rs 900. The presence of long-term support in the band between Rs 550 and Rs 600 makes it an apt juncture at which long-term investors can accumulate the stock.
Infosys moved in an extremely narrow band last week, closing below the key resistance at Rs 1,750. But the near-term outlook is now turning positive. An ascending triangle is obvious in the daily chart and the stock has also closed just above its long-term moving averages. A move higher to Rs 1,800 and then Rs 1,876 is possible in the near-term. Supports for the week would be at Rs 1,650 and then Rs 1,580. Short-term traders can buy in declines with a stop at Rs 1,635.
The third part of the move that began from the March trough at Rs 1,301 can take the stock higher towards Rs 2,000 again. The positive medium-term view will be negated only on a close below Rs 1,500.SBI
This stock hovered above the support at Rs 1,320 in the first four trading sessions before recording a strong session on Friday. Immediate target for the stock would be the short-term down-trend line at Rs 1,450.
Subsequent targets are at Rs 1,519 and then Rs 1,577. As mentioned last week, key short-term support is at Rs 1,245. Traders can buy in declines as long as this level holds.
The reversal on Friday could be third leg of the up-move that began from the July trough. The medium-term targets as per this count are at Rs 1,690 and then Rs 1,930. This view will be negated on a close below Rs 1,245; paving the way for a re-test of the Rs 1,007 trough.
SBI
This stock hovered above the support at Rs 1,320 in the first four trading sessions before recording a strong session on Friday. Immediate target for the stock would be the short-term down-trend line at Rs 1,450.
Subsequent targets are at Rs 1,519 and then Rs 1,577. As mentioned last week, key short-term support is at Rs 1,245. Traders can buy in declines as long as this level holds.
The reversal on Friday could be third leg of the up-move that began from the July trough. The medium-term targets as per this count are at Rs 1,690 and then Rs 1,930. This view will be negated on a close below Rs 1,245; paving the way for a re-test of the Rs 1,007 trough.
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Reliance
Reliance Industries led the stock market lower last week. Though the stock has closed below its 50-day moving average, it has not violated the key short-term support at Rs 2,100 yet.
Short-term traders can hold the stock with a stop at Rs 2,050. A rally to Rs 2,180 or Rs 2,252 is possible in the near-term. However, failure to surpass the first target would imply that the stock is readying for a slide towards Rs 2,050 or even Rs 1,950.
Since RIL is poised more than half-way down its medium-term trading range between Rs 2,000 and Rs 2,400, our view for this period is neutral. Long-term support between Rs 1,950 and Rs 2,000 will act as a dependable buttress in a sharp decline.
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Unitech
This stock clung to the key support at Rs 156 in the early part of the week before ending the week slightly above this level. Our short-term stop-loss at Rs 150 has not been penetrated yet. The movement in the early part of next week will determine our medium-term view for this stock. As we have been reiterating, close below this level will mean a possible decline to Rs 130 over the medium-term.
Conversely, an upward reversal from this level will lead the stock higher to Rs 176 or Rs 200 over the medium-term. Positive divergence in the weekly rate of change oscillator implies medium-term strength. Short-term traders can hold the stock with a stop at Rs 150.
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Reliance Infra
The support at Rs 940 held last week and after a tentative sideways move in the beginning of the week, Reliance Infrastructure registered a strong close on Friday.
As we have been reiterating, a reversal from here will mean that the third leg of the up-trend from the July trough is in motion that can take the stock higher to Rs 1,200 or Rs 1,380.
Traders can hold their long positions with a stop at Rs 918.
The stock will however face resistance from Rs 1,052 or Rs 1,108 in the near-term. Reversal from either of these levels will result in the sideways trend between Rs 950 and Rs 1,100 prolonging for a few more weeks.
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Making the most of a range-bound market
Passive investing, beta-based switches across stocks and sectors, and paired trading are some of the ways to beat a volatile market, provided you can handle some risk.
Srividhya Sivakumar
In the long run, most of the uncertainties currently clouding the equity market may clear up. But in the short term, they are here to stay.
That stock prices aren't going to head steadily in one direction is not good news if you are a short-term investor or trader. This brings us to the question — is there any way to make money in such a volatile market? The answer is yes. A nd here is how you can do it.
Turning passive
All too often, as markets rally, investors tend to buy stocks that performed extremely well in the recent past. This would have been a good strategy had the bulls remained in control. But, now, with a range-bound market at hand, this investing style needs to be changed considerably to survive a market that fails to hold its gains for any length of time.
A switch to passive investing, based on the overall valuation of the market, is one way to reduce downside.
Passive investing involves putting money into either index funds or index constituent stocks that are well-researched and followed. And, in the process, it not only promises average market returns but also reduces the risk of your picking the wrong stocks.
We suggest becoming passive when the CNX Nifty's price-to-earnings multiple (trailing) edges close to its long-term average of 18 times (PE multiples are available on the NSE Web site). Investors with a higher risk appetite can stretch the point of switch till such time the index nears this year's average PE of about 20 times.
A passive investing strategy can be adopted by switching your short-term investible money from stocks to index funds or ETFs (exchange traded funds) that mimic their benchmark indices doggedly. Doing this not only spares you the trouble of choosing the right stocks at interim peaks in the market, it also instantly buys you an exposure to a basket of index heavy-weights.
Index stocks may fare much better than the mid- and small-caps, if the market takes a sudden about-turn. If the broader market continues to soar, you get to participate, with lower levels of risk.
This strategy may deliver equally good results if you hold a portfolio of aggressive equity funds. Active funds in India have usually fallen more than the index during bear phases. The only flip side would be that ETFs tend to generate only beta returns (market returns) and will not give you the big out-performance that many equity funds may generate if the market continues to trend up.
If you opt to cut exposures at a Nifty PE of about 20 times, you can also consider taking fresh exposures when the Nifty nears a PEM of 16 times. This is a point at which the index has, over the last two years, found strong support.
Beating Beta
Beta, which captures the extent to which a particular stock will mirror the returns of an index, can also be used effectively to play a volatile market. Depending on which side of the PE range the market is in, switch decisions, either within the sector or between sectors can be made to lower your portfolio's sensitivity to market moves.
Capital goods, banks and power sector stocks that were in the limelight right through last year, in essence, enjoy a high beta coefficient. Other sectors, such as IT, pharma and FMCG, even after good returns in recent months, are 'low beta' sectors. This makes the case for switching to low beta stocks when the market is highly volatile or when you sense a peak.
You can also trim the risk on your overall portfolio through switches within a sector. For instance, buying a BHEL (Beta 1.1) at the lower band of the market PE may yield a decent upside, should the market rise. Diverting that money into a Thermax (beta 0.56) at a peak may curtail downside, if the market reverses from there. But do note that you will have to track market PE (available on the NSE's Web site) quite closely to implement this strategy.
Another strategy that can pay off in a sideways to bearish market is pair trading. This strategy, which usually involves buying a stock while selling another, thrives heavily on arbitraging opportunities across stocks and sectors.
Pairing-up to gain
Paired trades can be unearthed based on statistical, technical and fundamental factors. The unique advantage of using pair strategies is that they may deliver returns without having to take a directional call on the market.
The statistical technique in paired trading thrives on the belief that anomalies relative to the historic correlation or price ratio between two stocks, will not last for long. For instance, so far this year, the Infosys stock has averaged around 3.6-3.8 times the price of Wipro. Whenever there has been a digression from this, the stock prices have tended to slip back into range.
This suggests that whenever the mean price ratio is exceeded, traders can sell Infosys and buy Wipro; alternatively, if the ratio dips below its average, traders can buy Infosys and sell Wipro. Similar patterns can be discerned between Infosys-Satyam Computers, L&T-BHEL and HPCL-BPCL, to name a few pairs.
There are, however, quite a few caveats before you zero in on any such pairs for trading. For one, since this strategy requires shorting a stock while buying another, it can be best implemented only using stock futures. Therefore, it is suitable only for traders who are well versed with derivatives.
Second, as the strategy entails equal bets on both sides of the transaction (so that you take a market-neutral stand), you may need to balance the long and short transactions. This is because the lot sizes of the stock futures are not same.
Third, sometimes the price ratio may take several days to revert to its mean. This would call for high margin requirements from traders. Most importantly, pair strategies require constant monitoring and strict adherence to stop losses, on both sides, as any change in the outlook for a particular stock can lead to significant losses in no time.
On a fundamental basis, you can use a paired strategy by taking a relative call on the performance of two stocks, based on a macro event. For instance, a long position on Cairn India (an oil producer) and a short on Deccan Aviation (a consumer) can be paired to play a rising oil price outlook. The two stocks share a negative correlation (they tend to move in opposite directions on any given day).
Jet Airways, which is another consumer of oil and has a negative correlation with Cairn, can also be considered.
The price outlook on steel and other commodities can also be used similarly to build pairs of a commodity producer and its user (for instance, Tata Steel and Tata Motors). While integrated steel players such as Tata Steel will benefit from a rise in steel price, companies that use steel as a crucial input in the auto or capital goods sector may face margin pressures from the same event.
But before you begin with your trades, a few words of caution — on the surface, while most of these ideas may appear easy and logical, do not be in a hurry to deploy funds. As these are trading strategies, if your basic assumptions do not pan out, there is a risk of your positions turning in losses. Do spell out strict stop-losses at the outset and stick to them as if your life depended on it.
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Larsen & Toubro: Buy
Investors with a 2-3-year perspective can consider adding the stock of Larsen & Toubro to their portfolio. The company's proven execution skills, quality clientele, well-entrenched presence in a wide range of businesses and ability to borrow/raise funds at very competitive rates are factors that are likely to ensure a less tumultuous journey for the business during a slowdown, such as the present one.
It is for the above reasons that the stock deserves a premium to other engineering sector peers as well as to the broad markets. At the current market price, L&T trades at 18 times its expected per share earnings (consolidated) for FY10 on a consolidated basis.
L&T's 70 per cent growth in profits for the quarter ended June 2008 and a massive order book of about Rs 58,000 crore (twice its consolidated sales for FY08) belied fears of earnings taking a hit due to the slowdown in domestic infrastructure and capex spending.
L&T has immensely benefited both from its own superior execution skills and the quality of its clients at a time when the macro scenario carries a fairly high degree of uncertainty. Its superior track record has helped L&T retain its pricing power, with the company managing to protect over 70 per cent of its orders with price escalation clauses.
On the other hand, a roster of frontline clients has ensured that there is no significant slowdown in the company's capex spending due to funding constraints.
For instance, the active expansion plans of large clients in the metals, minerals, oil and gas and material handling sectors have resulted in huge orders flows for the company. Added to this, presence in regions such as West Asia has also provided the necessary hedge against a domestic slowdown.
While L&T's current order book is driven by infrastructure and hydrocarbon sectors, the company has made significant progress in adding breadth to its portfolio. Its entry into power equipments, railways and shipbuilding followed by healthy order flows in these new spaces are indicators of this. Any slowdown in the key infrastructure and hydrocarbon sectors is likely to be made up by revenue flows from these new segments especially after 2010.
The company has also managed to raise money at economical rates for all these ventures in a tough interest rate scenario.
A combination of equity expansion and low-cost borrowing has left the company still low on gearing, with no threat of earnings dilution. While lower staff and administrative expenses ensured improved operating profit margins, commodity costs remain a cause for concern. In this regard, L&T's strategic stake in vendor companies may provide a solution over the long term.
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Infosys: Buy
Apart from enhancing its consulting and package implementation offerings, the Axon buyout could also strengthen Infosys' geographic footprint.
K. Venkatasubramanian
With bulging cash coffers and inorganic growth aspirations, Infosys Technologies has for long been scouting for suitable acquisitions. It seems to have finally found an ideal candidate in the Axon Group.
Axon has been a consulting and solutions implementation partner of SAP for the past 14 years. Implementation of SAP, Microsoft or Oracle software packages, is usually an enterprise-wide exercise for most clients. These services also command higher billing rates compared to application development and maintenance services. Axon's strength in consulting and solutions implementation is evident from the fact that the company derives 19 and 69 per cent revenues respectively from these two services.
Strengthening its package implementation (enterprise solutions) and consulting services practice, penetration into a client segment where Infosys does not have a big presence (for instance, government clients) and expanding its EMEA (Europe and Middle-East Area) footprint may be key payoffs for Infosys from this proposed acquisition. The acquisition may also add to Infosys' strengths in providing enterprise solutions to the BFSI and manufacturing segments. It may, however, be a few years before Axon may add significantly to Infosys' EPS.
Reasonable valuation?
Making a deal… Mr N. R. Narayana Murthy (left), Chairman and Chief Mentor, and Mr S. Gopalakrishnan, CEO & MD. At £407 million (Rs 3,258 crore), the buyout consideration is approximately twice Axon's 2007 revenues. Its current market capitalisation is £391.6 million (Rs 3,135 crore). The company has grown its revenues at a compounded annual rate of 53 per cent over the past three years. The valuation may, therefore, not be too expensive. With nearly $2 billion (over Rs 8000 crore)cash in its kitty, funding this acquisition may not be a problem for Infosys.
Lower margin profile
This could have set the tone for the creation of a high-margin business for Infosys. But the (net profit) margin profiles for the two companies are quite different; Axon's 10 per cent being much lower than Infosys' 27 per cent levels due to the former's different cost structure and higher tax rates. A wage cost structure that is 48 per cent of revenues and a tax incidence of 31.5 per cent means that Axon has much lower margins compared to Indian players. Only 350 of its 2,000-odd employees are working offshore (low-cost destinations), that too on application management services. Infosys derived $993 or 24 per cent of its 2007-08 revenues from consulting and package implementation services. Within this, 33 per cent was from SAP package implementation and related services.
Newer verticals
Over the next few years, Infosys could look at creating a larger offshore component and leverage its global delivery model in the enterprise solutions services line to include Axon's clients, thus optimising costs. Axon's clients comprise those in segments such as government and oil and gas, areas where Infosys is yet to make significant headway. These offerings may turn out to be complementary. The other benefits that Axon bring are strong business process consulting expertise — an area that is not yet a key strength of Indian players — and a substantial presence in the Europe and the fast growing West Asian region (61 per cent of revenues for Axon).
With enterprises in the Americas and Europe looking to expand in the Asia-Pacific region and West Asia, replication of business processes becomes critical. That could well provide considerable business opportunities for Infosys, with added enterprise solutions expertise to tap. Other opportunities for Infosys include the possibility of up-selling and cross-selling services to Axon's clients.
In its own business, Infosys has embarked on a series of initiatives for achieving non-linear growth.
Growth initiatives
Its latest version of Finacle tries to offer the entire gamut of banking services and includes features such as Islamic Banking and Wealth Management.
With the investment phase nearly over for this product, this may pave the way for multiple revenue streams in the form of licensing, implementation (with minimum customisation) and maintenance revenues.
Finacle also has substantial domestic presence. Delivering services through a different platform such as Software as a Service (SaaS) is also an initiative.
Together, these initiatives might see a growth in revenues without a proportional growth in manpower recruited, thus enabling margin expansion over a two-three year period.
The acquisition is not a done deal yet. Axon may have counter offers from other suitors that may better Infosys' offer, hurting the acquisition or escalating the price.
A prolonged slowdown in the US and Europe would mean lowering or postponing spends on enterprise solutions implementation.
The sunset clause on STPI in 2010, may increase tax incidence for Infosys.
However, apart from changing its service mix in favour of high-margin services and initiatives on achieving non-headcount-linked growth, Infosys has headroom to steer key operating metrics and manage margins.
This makes Infosys one of the best placed Tier-1 IT services player in countering the current challenging macro environment and achieving growth. In this light, investors with a two-year horizon can consider buying the stock.
At Rs 1,740, the stock trades at 17 times its likely 2008-09 earnings.
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Using options to time investments
After a bull run that lasted a good four years, the temptation is often strong to grab stocks when the market plummets. But your recent experience would have taught you that in a sideways market, gains may only be temporary, which makes it difficult to decide on an entry point so that you can maximise your long-term returns.
Determining entry point
If the huge swings in the market worry you, you can use stock options to time your investments. Say, you want to buy shares of Reliance Communication for your long-term portfolio, but fear that the stock's price may fall after you buy it. Instead of buying the stock in the cash market, you can use options to postpone the purchase to a price and entry point that you would be more comfortable with. This can be done by buying call options (at a strike price that you want to buy the shares at) on Reliance Communication.
Now, if the stock price does fall, as you had feared it would, while you may stand to lose the option premium paid, you can still take advantage of the lower entry point.
Alternatively, if the share price moves up, the call would give you the right to buy the stock at the strike price, which will then be lower than the market price of the stock.
Removing market influence
If a rising tide lifts all the boats, a falling one may well take them all down. So, if you have made large investments in a particular stock whose prospects you are convinced about; but are worried about overall bearishness in the market taking a toll on it, here's a strategy.
You can buy Nifty puts and weed out the broad market influence on that stock. The number of puts you might need would depend on the stock's Beta value and the percentage of hedge you require. So, even if your stock loses value because of a fall in the Nifty, the puts you hold would gain in value and offset (to an extent) the notional loss suffered by your investment. But, if the market does not fall as you feared it would, you would have incurred a cost in the form of the premium paid for buying the Nifty puts. Consider this a one-time payment for securing your investment!
The fine print
In both these strategies, we have suggested only buying options, though the same results can be achieved by selling options too. This is because selling options entail not just the stomach for risk, but also the pocket for it, and hence is best left to seasoned traders.
Further, while buying options make sure that the premium you pay does not exceed the amount you are comfortable losing. Since the liquidity in most option contracts is good only for the next one month's time-frame, it is advisable to use these strategies for that period only.
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Rate sensitives back in focus
The BSE Sensex gained by 1.1 per cent during the week August 22-29. The interest-rate sensitive sectors such as banking, auto and realty led the increase, with the WPI inflation lower at 12.4 per cent for the week ended August 16, compared to 12.63 per cent the previous week. Lower GDP growth of 7.9 per cent for Q1FY09 did not appear to surprise investors as the market had already factored in lower growth. Further, encouraging cues from the global markets provided hope. The GDP growth rate of the US economy was at 3.3 per cent, surpassing expectations.
Prominent sectors
The BSE Capital Goods and Metal indices were the only sector indices that declined. Many banking stocks registered a rise, on account of lower inflation and expectation that the RBI may not resort to further monetary tightening. The dip in inflation, which the Ministry of Finance viewed as 'early signs of moderation' in prices resulted in heavy buying among banking and realty segments, in anticipation of steady interest rates. HDFC Bank (6.9 per cent), State Bank of India (4.3 per cent) and ICICI Bank (4.2 per cent) were among the top gainers in the BSE Sensex. Among the stocks in the Realty Index, Akruti City topped the list with a weekly return of 12.6 per cent.
Among the IT majors, Infosys gained 3.2 per cent after its acquisition of British consultancy major Axon Group Plc. Satyam gained the most, with an 8.7 per cent increase. The increased activity in IT stocks can be attributed to the appreciation of the US Dollar vis-À-vis the Indian Rupee.
Stock-specific action
The shares of Jindal Photo surged 8.3 per cent during the week after its board approved a plan to delist the company's shares from the BSE, this may be precded by an exit option for investors. The shares of Kilburn Engineering rose after it had won orders and letters of intent worth Rs. 14.9 crore for the supply of driers.
Reliance Industries with a decline of 4.8 per cent was the top loser of the week among the Sensex stocks. The decline should probably be seen in light of its plans to seek the approval of the Government to transfer 80 per cent of its holding in the D6 block of the Krishna Godavari basin, to four of its unlisted units.
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