Indian stocks could be worth a premium

Nov 3, 2009

In this issue:
» Indian indices have gained a lot this year
» RBI purchases gold from the IMF
» A reverse trend is unfolding in the Indian banking sector
» IT spending may never attain its pre-downturn peaks
» ...and more!

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There is perhaps an immutable law in investing. That is what is scarce will always get a good premium. So, if one jogs his brain a bit and really thinks hard as to what is scarce right now, one term that will more often than not pop out is 'growth'. Yes, real economic growth these days has become really scarce isn't it? No matter how much money the developed economies throw into their respective economies, the growth just doesn't seem to be coming.

In light of such a scenario, does it make sense to assume that money managers in the west would be willing to pay a premium to growth wherever it is happening the fastest? Indeed. And if that happens, don't be too surprised to see the Sensex trading at multiples of 20x-30x as compared to its old normal of 16x-17x. This bold prediction comes from none other than one of Asia's top strategists, Christopher Wood. Speaking to India's leading daily, Wood opined that India and China could end up trading at two or even three times the multiple of S&P 500 as investors look to pay a premium to get growth.

Wood also highlighted what he felt would be the key investment theme in India and it turned out to be none other than infrastructure. "I think, the two areas where you have got the biggest promise are actually finally getting action again - power and highways. I think, it is almost impossible to exaggerate the benign multiplier consequences on the Indian economy if you get follow-through on infrastructure," is how Wood chose to put it across. Coming from a man who knows where the money is flowing, he could probably be right. As for us, we find it difficult to make a case for Indian stocks trading at a premium considering that India still has many challenges that it needs to address.

 Chart of the day
We are almost towards the end of the year and as compared to last year when stockmarkets all over the world were battered and bruised, most of the stockmarkets this year have done pretty well. As today's chart of the day shows, stockmarkets particularly in the emerging markets have had a dream run in the year so far. While developed economies are still mired in recession and interest rates there are low, growth prospects of the emerging markets look a lot better in comparison. This explains why global markets have been making a beeline for emerging markets including India. India's BSE Sensex has in fact notched gains of around 69% in the year so far. Having said that, while one certainly cannot deny that the Indian economy is definitely well placed in comparison to its developed peers, valuations at the current levels do appear to be on the higher side.

Data Source: The Economist
The change is from 31 Dec 2008 to 28 Oct 2009 in local currency

There seems to be a reverse trend unfolding in the Indian banking sector. And you have to thank the global financial sector crisis for that. The private sector and foreign banks that were once associated with aggressive growth stance and lavish operating outlay, have suddenly become very conservative. Be it hiring, operating cost or balance sheet growth. Some have even gone to the extent of cutting down balance sheet and manpower sizes. But the public sector banks have had it all to their advantage.

Being considered a safe haven, thanks to their partial government ownership, these banks were able to attract plenty of low cost deposits during the last fiscal. This is turn helped improve their margins besides offering them a much larger balance sheet growth opportunity as compared to their private sector peers. Some even used this cost advantage to price their loan products very aggressively and thus eat into the private sector's market share. However, while acknowledging the fact that the PSU entities are now technologically very well equipped, their ability to sustain asset quality remains a grey area. Hence, an over-aggressive stance may leave them with too many baggages once the interest cycle turns.

A popular view among economists and stock market bulls is that the deeper this recession will be, the quicker will be the recovery. Well, they are right but only up to a point. Sure, economies do pick up fast after a normal recession. But unfortunately, "...the Great Recession of 2008-2009 is far from being a normal global recession," so believes the noted economist Kenneth Rogoff and a professor of economics at Harvard University.

Rogoff believes that the legacy of the huge contraction in credit is not likely to go away anytime soon. As he says, "Yes, if you are a bank, particularly a big one, you can raise money easily enough, thanks to sweeping explicit and implicit government guarantees. But, for everyone else, particularly small and medium-sized firms, the credit environment continues to be very challenging."

He however remains hopeful that the world economy will see a sustained sharp recovery after a deep cut, but is advising policymakers in the developed world to stay away from betting on when the recovery will actually begin.

At a time when the reserve status of the dollar is being questioned, the RBI has bought 200 metric tonnes of gold from the International Monetary Fund (IMF) for about US$ 6.7 bn. This is also part of IMF's plan to sell about 403.3 metric tonnes of gold to shore up its finances so that it can lend money to the poorest countries at concessional rates. We think this is a good decision by the RBI as it is much better to hold gold which is a good option to protect wealth as opposed to the US Treasuries, whose safety is being questioned on the back of US' massive debt and the declining value of the dollar. Having said that, while the RBI has expressed its interest in gold, the same cannot be said of India's younger consumers who have been buying less of gold jewellery in recent times. According to the World Gold Council, India's gold demand dropped 38% in the second quarter, with jewellery purchases down 31% from a year earlier.

The adage 'Cash is king' is well known but US corporates seem to understand this only now. Hit badly by the global financial crisis, US companies are holding more cash than at any time in the past 40 years. For instance, as reported in the Wall Street Journal, in the second quarter, the 500 largest nonfinancial US firms by total assets held about US$ 994 bn in cash and short-term investments (around 9.8% of their assets). In the corresponding quarter last year, this figure stood at US$ 846 bn (7.9% of assets). What is more, this trend continued in the third quarter as well despite the US economy displaying signs of a recovery. However, having cash has its own set of advantages and problems.

While at present, companies having more cash means that spending is less thereby impacting economic growth, the advantage is that when the economy displays sustainable signs of a recovery, these companies can then deploy the cash amassed towards expansion and acquisitions. Given that the credit crisis badly impaired the balance sheets of many companies, it is not surprising that many of them are conserving as much cash as possible. Thus, while this move may not really bolster the still sagging US economy at present, which needs spending to revive, in the long run having sufficient cash will always augur well for any kind of business.

The optimistic lot of analysts and CEOs are talking about the green shoots of quick recovery in the global IT spending. However, Steve Ballmer, CEO of world's largest software firm, Microsoft, has no intentions to appease them. He reiterated that the global economic slowdown has reset the world to a new once in a lifetime low, from where there can only be a slow growth upwards and no quick recovery. Moreover, Ballmer doubts if global IT spending can ever attain its pre-downturn peaks. We believe that while things look a little grim for the global giant, prospects look a lot brighter for Indian IT firms as they expect to see a slow but steady revival in demand for IT outsourcing in the next couple of quarters.

The Indian stock market had a volatile trading session today as the indices oscillated on either side of yesterday's close. At the time of writing, the indices were deep into the red, trading lower by around 147 points. Software and metals stocks led the pack of losers on the bourses. Asian markets closed mixed today. Europe began the day on a weak note.

 Today's investing mantra
"Of one thing be certain: if a CEO is enthused about a particularly foolish acquisition, both his internal staff and his outside advisors will come up with whatever projections are needed to justify his stance. Only in fairy tales are emperors told that they are naked." - Warren Buffett

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4 Responses to "Indian stocks could be worth a premium"

h p aggarwal

Nov 3, 2009

very educating and thought provoking.


MN Sobti

Nov 3, 2009

There is insufficient logic to explain the continuous downturn in the global & especially the INdian market.



Nov 3, 2009

Regarding gold jewelry being bought by "India's younger consumers" as you call them - Good for them. Jewelry is the worst way of buying gold, and they seem to know it. Given the massive fraud committed by the large majority of jewelers on gold caratage, and the large wastage in "making charges", the younger generation is better off NOT buying gold jewelry. Your tone seems to suggest they are being foolish, whereas it could be argued that the opposite is true.

Regarding Ballmer's predictions - The recession is possibly forcing users to cheaper "open source" options like Linux (for operating system), Open Office (for spreadsheets, presentations and word-processing), Evolution/gmail (instead of MS Outlook) etc. It would indeed be great if MS never sees the pre-recession numbers - that means the world is moving to zero-cost options which offer much higher quality!!

This recession may well change certain things forever, some to the better.



Nov 3, 2009

Plse inicate asu have been mentioningabout th valuable stocks like infoys oca-oola etc worth purchsing but such report i have notbeen seeningin ur recent emails.Why?

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