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News Analysis


11/02/2011
The Indian markets are now seemingly on the verge of panic and capitulation. The markets are falling everyday, mostly on limited volume, with the mid- and small-caps getting hit particularly hard. Markets are now down over 15 per cent in dollars, being the worst performer among the larger EM universe. We are now approaching the levels of January 2010, effectively implying that the majority of the gains the markets delivered in 2010 have evaporated. So, in little over a month, we have opened up a performance gap of 20 per cent vis-a-vis the US and given back most of the gains of the last 12 months. In certain sectors like real estate, infrastructure and construction, we are back to the lows of early 2009, and below those levels if one were to adjust for the incremental equity raised since then. India has gone from being fashionable, where investors were convinced of a great long-term growth outlook, to being panned for its governance and economic weaknesses, all in a matter of a month. In 2010, investors could not get enough of India, in 2011, they can’t seem to leave fast enough!! The reasons for this change of view are all well known, from inflation to interest rates, commodity prices and governance. So, what does one do now? It is probably too late to sell, unless one expects a total collapse (something I do not subscribe to). On a stock-specific basis, good values have already begun to emerge (many stocks are down 35-40 per cent). Even for the broad market, valuations are approaching reasonable levels. My sense remains that we will see Sensex earnings of about 1,200-1,225 per share for the year ending March 2012. Taking a multiple of about 13.5 times (slight premium to the EM average) on that leads to a Sensex target of about 16,500, giving a further downside of about 5-7 per cent. At that type of market level and multiples, one can build a strong long-term investment case for India. I remain convinced that irrespective of all the inflation issues and governance deficit, the country will grow at between 7.5 and 8 per cent for the coming three-five years. Combine this with inflation coming down to about 5 per cent, and we have a nominal GDP trajectory of about 13 per cent. The listed corporate sector will grow earnings slightly faster, as it doesn’t have the drag of agriculture (most of the listed sector represents the faster-growing industrial and service sectors), and is gaining share from the government in many sectors. Thus, we have the listed corporate sector delivering an earnings trajectory of near 15 per cent, with an ROE of 20 per cent and limited leverage. This earnings profile can be accessed through some great companies and management teams. This earnings trajectory has also only limited correlation to US and EU consumption demand. Will investors be willing to pay 13-14 times earnings for this type of growth profile? Given the likely subdued longer-term growth trajectory of the West, I see no reason why these multiples are not sustainable (the main factor constraining our multiples is our vulnerability to external capital flows and the exaggerated volatility they cause). All you need is one quarter of poor economic data coming out of the US, and see how the search for uncorrelated growth picks up again. The fact also remains that India is under-represented in all market indices (because of the free-float adjustment), and its weightage will only increase over time. Most smart investors I talk to already have country allocation for China and Brazil, but are still sitting on the fence for India. Not yet fully convinced on the country, they will eventually bite the bullet and allocate over the coming years. In this sense, you don’t get the feeling that India is over-owned, at least not by the smart, long-term money. The markets have already given up on this government and expect no reforms; no further disappointment is likely when expectations are already so low. If this government can get even a few basic things done on financial sector reform, skills-building and education, tax reform, infrastructure, etc, markets will react positively. Earnings expectations are also getting whittled down, and are now more realistic. Budget expectations are also now very muted, just maintaining basic fiscal discipline and meeting their own fiscal deficit road map will be seen as a victory by the markets. The buying power of local institutions is also compromised in the short term because of regulatory issues. As we cycle through these distribution changes, money flows will resume to both mutual funds and insurance, we are probably at a cyclical low point in flows today. India as a country has got de-rated, nobody expects anything positive to come out of this government, nor any policy action. While maybe true in the short term, this cannot remain so, something has to give, the government will be forced to be more decisive. Policy inertia forever cannot be the base case assumption. India is also getting hurt by rising commodity prices, again more a cyclical issue and not something which will be permanent. Can the market come down a lot more? Yes, obviously it can if we have further political uncertainty, and mid-term polls. Alternatively, if there is any shock to global risk appetite, triggering a massive outflow of equity capital, equity indices can fall sharply. Markets can also easily overshoot, and become much cheaper than you would expect (for a short period of time). RBI could also overshoot in its desire to be seen as being tough on inflation. It is fashionable to bash India right now, and sentiment has seemingly turned on a dime, but investors would be better placed to do the work and spend the time to figure out what they can buy over the coming months, rather than trying to scramble to sell. You are probably too late, with the risk/reward against you, unless one is looking for a quick trade. The contrarian bet from here is, if Parliament actually functions, some Bills get passed, Budget is reasonable, some governance-related clean-up happens and markets stabilise. The markets are oversold, expectations are very low, valuations are nearing attractive levels, and perception is worse than the ground reality. An intriguing combination for someone looking to put money to work.

	Analysis by Mihir Sandesara, CEO of Padmam Capital Pvt. Ltd. : CAPITULATION – indication of this word in Business Standard article (11-Feb-2011) caught our eyes. Just sheer mention of it is VERY MUCH concerning because Indian equity market has indicated significant weakness beginning from 4th January 2011 till as of this writing. We informed our software users more than twice in month of January (captioned image) about market repeatedly making intermediate lows. If you are a technical analyst, you are aware that both Nifty and Sensex have broken all short term, mid term and long term support levels by now. Simply speaking, all market movement indicators have started pointing downwards. What this means for shrewd investors? Even though India growth story is intact, Indian equities market appears to be in a mid-term bear market. This is the time to exhibit some great discipline. If your investment horizon is for long term and you hold stocks for nearly two years and more, you may not be concerned. Currently a great uncertainty comes from possible mega scams, government action (or inaction) against fighting inflation, looming impact of new budget and tax provisions for ending fiscal year. While all these add further weakness to the market, it also creates a new buying opportunity. Keep your cash on the sidelines – CASH IS KING.
Source : Business Standard