US' party over, but will India feel the hangover?

Mar 14, 2015

In this issue:
» LIC seems to be going easy on investments this year
» Concerns over food inflation are far from over
» India ends week lower by almost 3%
» and more...

American and Indian stocks have been on a tear over the past year - especially in relation to the non-US economies. With rest of the world showing signs of a slowdown, and indications of the worst being behind for these economies, they have become the preferred choices of investors worldwide.

US stocks have delivered 150% returns since March 2009 as compared to average gains of about 80% for non-US stocks.

It would however not be wrong in saying that a lot of this outperformance has been a factor of financial engineering which has led to strong earnings per share growth and stronger balance sheets in the process; all of which has been a result of the zero interest rate and money printing actions of the Fed.

So is the run up in American stocks likely to continue?

We came across an interesting article in the Business Standard which shares some data points that we would like to highlight here.

First coming to earnings expectations - analysts have downgraded the earnings growth (of the S&P 500) for the current year by as much as 14% from a year ago. So what has changed? High weightage of the energy sector - and its poor outlook - is a major reason for the same. In addition, the stronger dollar is likely to impact exports, which contribute to about a third of the revenues and 40% of the profits, of the top 500 companies.

Further, the author pointed out that margins are also at their peaks; but with a high chunk of technology and healthcare companies being part of this index, the same could be sustainable. But, expansion would be difficult. To add to that, with the seemingly improving job scenario, the expectations of interest rate hikes are getting stronger as the days pass by. And this would only impact profitability in the future. With no further expansion in margins likely from here on, it seems the long term sustainable growth should be in line with the GDP growth. The same would however be somewhere in the region of the low single digits.

Now, with US stocks trading at lofty valuations - amongst the highest levels seen in the past 100 years - the poor earnings growth is unlikely to justify current valuations, leading to a high likelihood of multiple compression.

In short, as the author puts it, the good days for US equities are over.

What makes it interesting is how this is likely to play out in the short term. Here you have a situation of other global markets trading at attractive valuations, and thus possibly attracting capital which could be pulled out of the 'There Is No Alternative' or TINA markets. And this includes India too, which has been a beneficiary of being the jewel in the emerging market crown, so to say. Foreign institutional investor ownership in Indian stocks has been at the highest levels ever. Adverse market movement in the world's largest economy is likely to bring about some panic in Indian stocks!

With factors such as surprise interest rate cuts (which has been something that all have been waiting for) failing to enthuse markets, it only goes to indicate that all of this optimism seems to be priced in.

As per us, this would only provide long term investors with good buying opportunities, which is why it makes sense to accumulate some cash; rather than participate in markets now. The Indian economy is well placed in terms of broader economic indicators - such as deficits being under control, inflation and interest rates likely to come down, amongst others.

With key events such as the budget behind us, all eyes will be on the capex and earnings trends. If these aspects do not show signs of improvement anytime soon, the possibility of an outlook similar to the US stock market mentioned above does remain as well.

On the other hand, one comforting factor is the high likelihood of improvement in financial performance of India Inc. Margins over the past two years have been the weakest in the decade gone by. We will discuss more on this in one of the editions of The 5-Minute Wrap Up next week.

Do you agree with our view that the poor outlook of the US stock market is likely to shake up things in India? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
Think insurance float and the stock markets and the first name that invariably comes to mind is of course Warren Buffett. If there's one firm that's made the most productive use of the float available at its disposal, it is indeed Buffett's investment vehicle Berkshire Hathaway. However, if there's one Indian company that Buffett will be proud of, it is our very own home grown insurance behemoth, the Life Corporation of India or better known as LIC. And the reason for the same is given in today's chart of the day.

LIC: Taking it easy on equity investments in FY15?
* Data from April to February

As the chart highlights, while the rest of the investment community seem to be buying stocks with gay abandon, LIC has actually gone on and booked profits to the extent of Rs 220 bn. Of course the firm has also committed Rs 400 bn as equity investments but it pales in comparison to the Rs 533 bn the insurance behemoth put into the markets in FY14 when the markets were relatively cheaper and provided a better entry point. Having said that, not all of the company's investments are made with a view to maximize wealth. It has also been made to act as the saviour of last resort whenever shares of PSU entities like ONGC and Coal India are put up on sale and find few takers.

The RBI has been under constant pressure to take cognizance of the recent fall in consumer inflation numbers. The fact that the central bank has not executed a free fall in interest rates in response to fall in oil and food prices has surprised many. However, the central bank stood its ground. And without the government taking reform measures to keep inflation under control, interest rates in India are unlikely to come down too much too soon. Now, a recent IMF paper points out that El Nino conditions may soon hit the prices of agri products in India. Of course, over the years, Indian agriculture has become less susceptible to El Nino. Increase in the contribution of rabi and decline in kharif crops, more developed agricultural markets and policies, rising agricultural yield, early warning systems on climate etc have aided drought-resistant and short-duration crops. However, the concern over food inflation is far from over. Therefore as inflation raises its ugly head once again, one can expect the RBI to get cautious in its Monetary Policy stance.

It seems that low crude prices are here to stay for some time. The Organization of Petroleum Exporting Countries (OPEC) and the US shale producers have locked horns over one-upmanship. Neither of them is in a mood to reduce output to arrest the fall in crude prices for fear of losing market share. This has led to an oversupply situation with supplies in the US jumping to 80-year high levels. The steep fall in crude prices has adversely impacted oil producing economies of Venezuela, Russia, Eucador and Nigeria. However, low crude prices are music to India's ears considering that it imports more than half of its crude needs. Low crude prices will not only reduce the country's import bill but will save costs for a number of end-user industries. But there are some downsides as well. The resulting meltdown in commodity prices in global markets will hit farm income back home. Moreover, even exports to oil producing nations in West Asia and Russia are likely to suffer as these nations are forced to conserve foreign exchange in the light of low crude prices.

In the week gone by, stock markets around the world witnessed a lot of volatility. Investors were nervous about the possibility of the US Fed raising interest rates in June. Volatility in crude oil prices also kept markets on tenterhooks. The US Dollar surged this week as weak inflation data did nothing to allay fears of the US Fed starting the rate hike cycle. US markets were down 3% this week.

European markets delivered a good performance in the week gone by. The Euro fell against the Dollar and European markets looked beyond worries that Greece may not remain in the Eurozone for long. The European Central Bank's bond buying program has helped European stocks rise for a sixth straight week.

Back home, the Indian markets ended lower due to worries of a rate hike by the US Fed. Investors are also keenly watching for moves on the reforms front. With the Insurance bill being cleared more reforms are the need of the hour.

Performance during the week ended March 13, 2015
Source: Yahoo Finance

 Weekend investing mantra
"I've found that when the market's going down and you buy funds wisely, at some point in the future you will be happy. You won't get there by reading 'Now is the time to buy." - Peter Lynch

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