The Indian economic cycle is heading to the late expansion stage. Theoretically there are five stages viz. early expansion, middle expansion, late expansion, early contraction and late contraction. The very fact that we are heading to the late expansion stage suggests that we are still away from a top and 2007 might see a new high above 14000 before the real slowdown starts.
We at Or-phe-us still see the immediate preferred direction sideways to down with a potential upward breakout probably after first quarter. The Sentiment Theorist highlighted broad market non confirmations in Nov 06, which still stand firm. As barring Sensex, BSE BANK, CNXIT and BSE Capital Goods Index, rest all the Indices (Health Care, Small Cap, Mid Cap, BSE OIL, BSE FMCG, BSE PSU, BSE AUTO) are still below May 06 lows. Historically, such non confirmations do not guarantee that markets may turn down or remain sideways, but if you look at it from the Intermarket perspectives and add in a few technical aspects, we have enough reasons to validate our case.
Capital Goods sector has exhibited a clear leadership since 2004 with average returns over the last three years near 80%. This was the only sector to churn up more than 100% ever in a year. Capital Goods or Industrial sector growth mark the best run of the economic cycle. Materials and Energy sector should assume leadership from current levels. And the effects should be visible starting first quarter.
Materials and Energy: Though we are still negative on ZINC and other base metals on the intermediate term, materials sector is a mixed bag and steel and aluminium still seem to have upside left. Integrated Aluminium companies are still trended up. On the Energy front, we do not see OIL falling substantially below $50. After OIL hits base, the respective sectors should assume leadership. Till then we can see some negativity in both the Energy and materials sector. Energy is also a late expansion sector and seems in sync with our preferred wave count on market.
BSE BANK was the next best performer after capital goods sector. Credit expansion is the highest in late expansion stage. This boosts banking profitability on one side and makes banking sector very vulnerable to corrections. We are near our price targets on the sector and sector components and recommend pre budget reductions on the sector.
Technology: Despite the noise that Infosys and Indian Tech gets abroad, the sector has underperformed every other sector in 2006. The underperformance should continue. Technology is a Middle expansion sector and does not do well in late expansion sectors (current). We still believe the technology sector prices should correct sizeably from current levels. We will not be surprised if Technology gives a negative return for 2007.
The automobile sector should see negative surprises. The index and its constituent stocks should decline further from here. This push and pull of various sectors should result in the sideways to net negative movement we are expecting till the first quarter of 2007. In conclusion, banks and technology alone cannot sustain the markets at current levels. And with the capital goods story being more than three years old, we need smart sector allocations as we head into late expansion. Energy and materials should start ticking from this quarter. Let’s be conservative in 2007.