Opportunity in times of crisis
Dhiraj Sachdev August 7, 2008
The past seven months have been puzzling and challenging for Indian equity investors. The fall in stock markets has been compounded by a series of negative developments—high commodity prices leading to higher inflation and interest rates, increased risk aversion resulting from emerging market sell-offs and political uncertainty. The biggest impact has been due to inflation that went over 11%, a 13-year high, led especially by soaring crude oil prices.
We could argue that oil prices should moderate given the slowing economies like the US (accounting for close to onefourth of the global oil consumption), Europe and Japan. However, the extent and timing remain uncertain. Also, there are indications of demand destruction (cut in US airlines operations, miles travelled, etc) at higher crude oil prices.
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Given the rising cost pressures, we expect Indian corporate growth to be moderate, with 2008-9 earnings growth at 16-18%. While near-term earnings may be subject to margin contraction, the risk-reward ratio favours investment, though one needs to be selective.
What is hugely supportive is valuations. Despite near-term challenges on the macro front, equity valuations are quite favourable, with much of the excesses and froth out of the way. The market is trading at a PE of nearly 13, well below its long-term historical average of 15 despite better RoEs (return on equities). From trading at nearly twice the emerging market (EM) multiple, India now does so at 10-15% premium to EM, indicating a higher degree of correction than other EMs.
The fundamentals of the Indian economy remain intact as the three engines of growth—outsourcing, consumption and infrastructure—are expected to drive the GDP growth. With 7% plus growth rate, India is one of the fastest growing economies in the world. India’s growth, with rising consumption and high investment rate, cannot keep the global investors away for too long. Infrastructure spends of over $400 billion will benefit several businesses. So, we remain optimistic and believe the current weakness is a temporary cyclical downturn.
If one were to take a year’s perspective, most negative issues and uncertainties currently surrounding the equities might subside. The global slowdown in demand is likely to impact commodity prices, which in turn could bring down inflation. The political uncertainty will be over after the general elections.
Remember, the equity pendulum swings between euphoria and panic, creating bargain opportunities. In the current scenario, where fear and market sentiment are overshadowing the fundamentals, Indian equities offer an excellent risk-reward opportunity to invest for the long term.
Dhiraj Sachdev, Vice-President and Head of Fund Management, Equity, Portfolio Management Services, HSBC Asset Management (India) Pvt Ltd