SUDDENLY, WHEN everything appeared to be going smooth, the stock market hit a speed breaker. As the problems in the US economy, led by the collapse of its housing industry and the subprime crisis, spiralled out of control, the investor community, globally panicked. The weakness in the stock markets worsened with large financial institutions selling off their stock market portfolios across the globe to meet the liquidity crisis. Once the fall began, it snowballed to gargantuan proportions, with most listed companies in the domestic stock market losing between 30% and 50% of their market capitalisation in the space of two months.
The downward journey of the stock market was accompanied by daily doses of bad news. The bears used every piece of negative information to hammer down stock prices. Before they could realise and react, retail investors were left with heavily depreciated portfolios.
However, we at ETIG, believe that the time has come to stop despairing and do a reality check. To assess and take stock of the situation, we carefully examined five factors that are most important for stock markets, namely, the economic outlook, global currency movements, India Inc’s quarterly performance, current market valuations and the Sensex’s technical overview. We believe that the five parameters determine the market’s movement in the long term. Our analysis reveals that the market seems to have reached its bottom, but some short-term volatility cannot be ruled out. Thus, longterm investors may find excellent opportunities to enter the market over the next few days. The others may consider entering once definite signs of recovery are visible.
MACRO SIGNALS
It’s true that in the case of a slowdown in the US, India’s exports to that country can go down. However, just around 14% of India’s exports are sent to the US, which means that the direct impact may not be that severe. On the contrary, it is believed that if US companies start facing the heat, they may be forced to outsource more to low-cost destinations such as India. This will increase India’s service and manufacturing exports to the US and improve the growth prospects of Indian companies in sectors such as IT&ITeS services, textiles and auto components.
Apart from problems emanating from the US, India still has its own worries. During ’07, the domestic manufacturing industry witnessed a slight, but persistent slowdown in growth to just 8.4% for the quarter ended December ’07, which further slowed down to 5.2% in January ’08. The performance of six core infrastructure industries decelerated sharply in January ’08, recording 4.2% growth, against 8.3% during January ’07. Fortunately, however, the services industry that contributes to more than half of India’s GDP continues to grow at over 10% yearon-year. The growth in the services industry is expected to push India’s GDP growth to 8.7% during FY08.
Going forward, the Indian economy and India Inc are also likely to get a boost from huge capital expenditure currently under implementation across manufacturing and infrastructure sector. Recent data from the Centre for Monitoring Indian Economy (CMIE) reveals that the total investment under implementation has grown to over $630 billion in the quarter ended December ’07, nearly 50% higher compared to $425 billion during the quarter ended June ’06. Even if just half of these projects get completed over the next three years, it will nearly double India Inc’s current asset base of $300 billion.
Considering India Inc’s current revenueto-assets ratio of 1.8, this additional investment can generate recurring annual revenues of over $500 billion for Indian companies. And if we assume that even around half of these revenues come to the listed players with their PAT-to-sales ratio remaining intact, their revenues and net profit will expand by around 60% and 50%, respectively.
Hence, this trend of rising investments, which hint at expansion of the economy, can be heartening. But a slowdown in the growth of imports of capital goods contradicts this view. The imports of capital goods registered an 18% growth in the April-October ’07 period, against a 48% jump recorded in the corresponding period of the last year. The domestic production of capital goods, however, continues to grow strongly.
But with high crude oil and food prices, inflation can be another major problem for the Indian economy. After staying at around 4% level for 25 consecutive weeks, inflation has risen steadily above 5.92% for the week ended March 8, ’08. The government is trying hard to control inflation with a variety of subsidies and proposed a 2% cut in excise duty across the board in the recent Budget. However, such measures will put pressure on the government’s exchequer and worsen fiscal deficit, thus resulting in higher inflation later.
CRUMPLING DOLLAR
Currency movements hold the key to fund flows across nations and can influence the stock markets strongly. As a direct result of the weakening US economic growth, the dollar has weakened substantially against global currencies over the past few months. Over the past 12 months, the US dollar has lost over 18% against major international currencies such as the Japanese yen and euro, while it has depreciated around 4% against the pound sterling and 8% against the Indian rupee. With the US Federal Reserve cutting interest rates relentlessly, the dollar’s position against its peers can deteriorate further in future. As the interest rate gap widens, logically, dollar investments should start flowing into emerging markets, which has not happened so far. However, as and when the uncertainty ends and the market comes out of the crisis engulfing the global financial institutions, foreign investors are likely to return to the equity markets.
THE MAGIC OF NUMBERS
But India Inc’s quarterly results will be the single most important specific indicator of the stock market’s performance over the next few months. Over the past few quarters, Corporate India has reported deceleration in earnings growth, which is worrying market participants. Worse still, bottomline growth is being increasingly fuelled by growth in the other income, rather than operating income. While the operating profit margin on an aggregate level appears intact, sales growth has visibly slowed down. For example, the set of companies, which reported a year-on-year (y-o-y) earnings growth of 31.6% in December, has recorded a y-o-y growth of just 16.4% in the December ’07 quarter.
How the future plays out will depend on India Inc’s results for the March quarter (Q4 FY08) over the next couple of months. And if the corporate advance tax figures are any indication, the tone appears robust. The advance tax payments for Q4 FY08 have jumped 110% compared to last year, indicating better corporate results than what the current sentiment indicates.
The market has so far been wary of unpleasant surprises in Q4 results, fearing that companies may report heavy losses from treasury operations. The fears were fuelled by two major instances — firstly, when ICICI Bank reported its $263-million markto-market losses to its portfolio, and secondly, when L&T acknowledged a potential Rs 200-crore loss on hedging transactions, or nearly 10% its estimated FY08 net profit. The advance tax payments of both these companies have doubled during the current quarter, which should put investors’ worries to rest.
WORTHY OF YOUR ATTENTION
The current meltdown has eroded nearly 29% of market capitalisation since January 11, ’08, resulting in more sober levels in the valuation. The Sensex is currently trading at a price-toearnings multiple (P/E) of 19.5, substantially down from 28.4 in January. Compared to this, the benchmark index of China, Shanghai Composite, is trading at a P/E of above 33.
The latest estimates from the International Monetary Fund (IMF) put China’s growth in ’08 at 10%. Against this, the most conservative estimates of India’s growth this year expect the economy to expand by 7%. If we work out the forward P/Eto-growth (PEG) ratio after factoring in these expected growth rates, the Sensex with a PEG of 2.7 appears more attractive against 3.3 for the Shanghai Composite.
We can also look at the valuation issue from another angle. Analysts expect the Sensex to close FY08 with an EPS of Rs 820-830, which is projected to grow over 15% in FY09 and cross Rs 950. At the current level, the Sensex is discounting this forward expected EPS for the next year at 15.8, which is substantially below its average P/E of 18.2 since ’00. This indicates that fundamentally, the stock market has neared its bottom and further downside is limited.
GETTING TECHNO
While we have considered fundamental factors, it will certainly help to take a look at the technicals of the Sensex. The technical analysis depends heavily on past trends in the market movement to predict its future trajectory.
The current bull run in Indian equities started in the summer of ’03 from a Sensex level of just under 3000. In the past five years, we have seen four meaningful corrections.
The first one took place in May ’04, post the debacle of the NDA government at the Centre; the second one occurred in May-June ’06; the third one in early ’07 and finally, the current one.
However, during all the previous three corrections, the lows that the Sensex made were deeper than the lows it had made during the previous corrections. At the same time, after making deeper lows, it went on to make a higher top.
In the last significant correction that we saw in early ’07, the Sensex had made a bottom at around 12300. So, as long as that is not violated during the current crisis, we can still consider the current fall as just a correction in the bull market and expect to see a bounce-back.
At the same time, a point to be noted is the similarity between the current correction and that of May-June ’06. In ’06, the Sensex lost 30% of its value from a high of 12671 in May to a low of 8799 in June.
Similarly, from the intra-day high of 20206 in January to a low of 14677 last week, the Sensex has lost a similar 30% of its value. So, if last week’s lows are not violated, the bottom may just be in place.
While we try to take a stock of the situation, it remains dynamic and ever changing. Most of the current indicators are pointing towards stability. The short-term risk appears to be minimal and the long-term outlook appears clouded, but with a positive undertone.
The quarterly results from April onwards will give a clearer picture about where India Inc stands. At the same time, changes in the economic data in India and more particularly, the US, should also be tracked to get a better view of things. For those investors who have faith in India’s long-term growth story, the next few days may be a good time to enter the market.
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