Business Today

This, too, shall pass

Rajiv Bhuva        Print Edition: September 4, 2011

Stock markets are showing signs of collapsing again. The European sovereign debt crisis, the logjam over the US debt ceiling and the cruellest blow of all on August 5 when Standard & Poor's, or S&P, lowered the long-term sovereign credit rating of the United States from AAA to AA+, have sent global markets into the red zone. In a knee-jerk reaction, the S&P 500 index plummeted by more than six per cent. In India, the Bombay Stock Exchange, or BSE, Sensex shed 1.82 per cent, or over 315 points, on August 8.

Is it yesterday once more for investors in the short to medium term? In 2008, the Sensex had crashed close to 58 per cent from its peak of 20,827 on January 11, to 8,701 points on October 24.

PERSPECTIVE: Bears maul bulls, Sensex falls 297 pts

India's gross domestic product, or GDP, growth rate has fallen since 2008. Inflation is lower than in 2008, but real rates are higher. Unlike in 2008, the government's fiscal health is not in great shape. Capital inflows in 2011 are lower than in 2008. "India's current account balance is not that different, and hence dependence on capital flows remains intact," says Ridham Desai, Strategist and Head of India Equity Research at Morgan Stanley, in a research note. The global concerns increase risk aversion, which is a negative for equities, and will impact Indian stocks, too.

Despite that, experience suggests there is no reason to panic. When terrorists attacked the Twin Towers in the US in September 2001, the Sensex crashed. But in the next three years it went on to generate a smashing 84 per cent return. The results of the June 2004 general elections, in which the ruling BJP was unexpectedly defeated, again saw the Sensex tumble. But it climbed back, providing 200 per cent returns in the next three years.

PERSPECTIVE: What US rating cut means for India

The 2008 sub-prime crisis and Lehman Brothers's collapse in the US sparked a global recession. But in less than three years, the Sensex has rebounded over 100 per cent. "The message is simple," says Prashant Jain, Executive Director and Chief Investment Officer of HDFC Asset Management Company, in his latest newsletter. "If growth persists and if price to earnings is low, equity returns cannot be far, at least not too far." Parul Saini, Singapore-based India Strategist at The Royal Bank of Scotland (RBS) Asia Securities says from a medium- to long-term perspective, the higher growth trajectory of India versus the low or no growth in the developed economies should lead to more capital inflows to India. Moreover, India's exports to the US and Europe are less than six per cent of its GDP, which means the economy will not be overly affected even if exports nosedive.

"While globally there is 'flight to quality', barring the US downgrade and the challenges in Europe, nothing has significantly changed for India," says Ashu Suyash, Managing Director and Country Head - India for Fidelity International.

Saini adds that from a short-term risk aversion perspective, India should fare better this time because of moderate valuations, muted foreign institutional investor, or FII, inflows, and significant under-performance versus the region. Indian equities have fallen sharply this year compared to other emerging economies, notes Boston-based Punita Kumar Sinha, Senior Managing Director at Blackstone Asia Advisors.

However, along with Indonesia, India is the only market which has got positive FII inflows this year. "But of course, the inflows are low compared to last year," she says. Besides rising interest rates and higher commodity prices, the other concern is corporate earnings. Corporate earnings in the last two quarters have not been that impressive, and there has been pressure on margins and a drop in volumes. This, along with other macro concerns, has brought valuations down closer to the long term average. The BSE 500's price-to-earnings multiple is 14.11, while that of the BSE Sensex is 15.69.

"India is not cheap at current valuations," says Sinha. "The big problem in India is the divergence between quality stocks which are not cheap, and others. Stocks in sectors such as real estate and infrastructure, where growth is uncertain, are cheap, but consumer-oriented sectors are still expensive."

Finally, since the dampening factors are better understood this time than they were in 2008, there is no major reason to expect a double-dip. "A growth recession with no seizing up of capital markets is India's best case in the context," says Morgan Stanley's Desai. "Significant global stimulus or a breakdown in financial markets will hurt India on a relative basis as in 2008." Every bout of correction is a value buying opportunity.

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