Banking shares could outperform India's main index in 2006, a year which could be volatile for equities as overall corporate earnings growth slows, a fund manager said late on December 27.
"One sector which has been a laggard has been banks... State-run banks may outperform in a volatile market," said Anup Maheshwari, chief investment officer at HSBC Mutual Fund who manages assets of about 70 billion rupees.
The main BSE index has risen about 40 percent to a succession of records in the past year while the BSE's Capital Goods index is up 90 percent, driven by increased infrastructure spending. Its Bankex index is up about 35 percent.
But 2006 is likely to be a testing time for investors and fund managers as they get to grips with slowing earnings growth and changes in the main drivers of expansion so far - low interest rates, moderate inflation and high consumption.
"If it is going to be tough for companies, it is going to be tough for the market as well," said Maheshwari.
"There will be volatility and one needs to look where earnings visibility is. It is with banks."
The main 30-share BSE index closed 2.2 percent up at 9,283.16 points on Tuesday, below its latest peak of 9,442.98, hit earlier this month.
In a recent report, Citigroup set a target of 8,500 for the index by the end of 2006, about 8.5 percent lower than current levels, and forecast earnings growth at 16 percent next year, down from an average of more than 25 percent in the past four financial years.
Maheshwari is confident about banks, which are experiencing strong growth in loans due to capacity expansion by corporates and consumption by India's swelling middle classes.
His equity funds hold shares in Punjab National Bank and Bank of India.
Banks' loan growth has been nearly 30 percent so far this year at 13.2 trillion rupees, up from 10.1 trillion rupees a year ago.
That has triggered a slew of capital raising to meet funding needs. Punjab National Bank and Oriental Bank of Commerce have raised funds through follow-on share offers and Union Bank of India and Bank of Baroda are set to follow suit.
Maheshwari also believes concern over high share valuations is exaggerated given a structural shift in the economy in the past 10 years and efforts by Indian companies to strengthen their balance sheets.
"There is no point in looking at issues independently," he said, noting that the 30-share index was more than 7 times higher than it was 14 years ago.
"You may say that price to earnings ratio is expensive at 15.5 times but the fact is that the average of the last 15 years is at 18.4 times and corporate profits have grown 25 times," he said.
Emerging rural consumption could be the next big theme for the economy, which is already growing at 7-8 percent a year.
"Profits for agriculture-focused companies need to be watched," he said. "With the emergence of commodity exchanges, middlemen are getting squeezed out, leaving a lot more money with farmers to spend."
Some top companies like ICICI Bank and diversified conglomorate ITC Ltd are focusing on rural markets as growth from urban centres flattens.
And smaller ones like fertiliser maker DCM Shriram Consolidated Ltd are setting up rural retail networks.
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