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Stockmarkets: The breaking news...

Sep 5, 2006

The stock markets have found their way back to the front pages of pink dailies of late! If the index 'breaks' the 12,600 levels once again, we will most likely see 'breaking news' on business channels. Once again, we will have many experts suggesting that the worst is over (wonder where they were when the going was tough), the "India Story" is on a much stronger foundation and we will have index targets.In a recent finance event organized by a premier business school in India, one full day was dedicated towards the topic - 'Emerging markets strike back'. Once again, we had experts highlighting the fact that India will be lot younger five to ten years down the line, corporate India is on a global spree and more importantly, the investment boom will propel India's economic growth into a new trajectory. We agree with these broader themes. But what if 'the US strikes back?' could have been an even more interesting topic of discussion. Compared to six months back, there are fewer topics on US interest rates and its implications on the Indian stock market in the pink dailies. Why? Just because the US Fed did not increase the benchmark interest rates the last time, it is assumed that the rate hike cycle is over.

In this backdrop, we have the Indian stock markets (including some other emerging markets) bouncing back sharply. Just to put things in perspective, from its peak, the BSE Sensex fell by more than 29% to test sub-9,000 levels in mid-June 2006. Since then, the Sensex has gained almost 34%. Among the sectoral gainers, we have had the banking stocks outperforming the broader market. Midcap stocks, which were out of flavor post the May-June 2006 fall, have also gained sharply. The NSE Nifty is trading around 19 times trailing twelve-month earnings, a tad lower than the multiples at peak (around 22 times trailing).

So, what has changed in the last three to six months?

  1. Perhaps the most important is the change in outlook towards interest rates. After the US Fed's 'pause' in the last meeting, the benchmark 10-year yields in the US and India has cooled down (the US 10-year yield has come down from over 5.2% to 4.7% currently). Despite the significant rise in house hold debt and very minimal savings, the US Fed seem to have taken a softer stand on this core issue. It remains to be seen how the household debt and current account deficits unwinds in the next two to three years. In India, given that liquidity has been very strong, despite strong demand for money from corporate and retail sectors alike, there are no major 'India-related' factors that are alarming per se.

  2. Perhaps the most important is the change in outlook towards interest rates. After the US Fed's 'pause' in the last meeting, the benchmark 10-year yields in the US and India has cooled down (the US 10-year yield has come down from over 5.2% to 4.7% currently). Despite the significant rise in house hold debt and very minimal savings, the US Fed seem to have taken a softer stand on this core issue. It remains to be seen how the household debt and current account deficits unwinds in the next two to three years. In India, given that liquidity has been very strong, despite strong demand for money from corporate and retail sectors alike, there are no major 'India-related' factors that are alarming per se.

  3. Another key factor is that the performance of India Inc. has come as a surprise to many, including us. Earnings growth, which was expected to slow down (because of higher capital expenditure, significant increase in borrowings, input-related pressures), has been stronger on the contrary. Looking at the manufacturing sector growth and IIP, there is lot of steam left.

  4. Commodity prices, including crude oil, have softened significantly. While estimates of crude prices range from US$ 50 to US$ 60 per barrel (what a sea-change in view), if it materialises, we believe that it is a big plus for the economy and the stock markets. Again, we do not have a view on crude prices. But even if it remains at the current levels, it is manageable (as per the Oil Ministry).

While these are significant developments, in our view, current valuations are reasonable. We see relatively more value in select mid-cap stocks from a long-term perspective. Again, we suggest investors to have a balanced mix of both large-caps and mid-caps in their portfolio. Perhaps the key learning from the recent stock market crash is that the next time the stock market is 'breaking news', it is the time to sell!


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