A Commentary on Equity Markets
FY2008 (April 2007 – March 2008)… In retrospect
Despite the good index performance in FY 2008, it was a difficult year for active
managers. The markets were extremely polarized as the following table illustrates:
|
Company |
Returns (%) |
Contri-
bution to Sensex Return (%) |
Company |
Returns (%) |
Contri-
bution to Sensex Return (%) |
|
Reliance Industries Ltd. |
67 |
36.6 |
Ambuja Cement Ltd. |
15.8 |
1.8 |
|
Larson & Taubro Ltd. |
87.8 |
21.3 |
A C C Ltd. |
12.4 |
0.7 |
|
HDFC Ltd. |
54.8 |
11.4 |
Jaiprakash Associates Ltd. |
3.5 |
0.3 |
|
BHEL |
81 |
9.3 |
Hero Honda |
3.4 |
0.1 |
|
SBI |
72.1 |
8.9 |
Maruti Suziki India Ltd. |
1.8 |
0 |
|
I T C Ltd. |
40.4 |
8.9 |
Cipla Ltd. |
-6.9 |
-0.5 |
|
Tata Steel Ltd. |
78.6 |
8.2 |
Dr. Reddy's Laboratories Ltd. |
-12.3 |
-0.6 |
|
Reliance Infrastucture Ltd. |
157.5 |
7.4 |
Mahindra & Mahindra Ltd. |
-11.5 |
-1 |
|
H D F C Bank Ltd. |
42.6 |
6.3 |
Tata Motors Ltd. |
-13.1 |
-1.2 |
|
Reliance Communications Ltd. |
21.8 |
4.1 |
Bajaj Holding & Investment Ltd. |
-13.2 |
-1.3 |
|
N T P C Ltd. |
35.1 |
3.7 |
Wipro Ltd. |
-23.6 |
-2.2 |
|
ONGC Ltd. |
12.1 |
2.7 |
Satyam Computer Services Ltd. |
-14 |
-2.3 |
|
Bharti Airtel Ltd. |
8.2 |
2.6 |
D L F Ltd. |
-31.1 |
-4.1 |
|
Gr asim Industries Ltd. |
25.5 |
2.3 |
Tata Consultancy Services Ltd. |
-35.1 |
-5.3 |
|
Hindalco Industries Ltd. |
29.1 |
1.9 |
I C I C I Bank Ltd. |
-10 |
-5.9 |
|
Hindustan Unilever Ltd. |
11.6 |
1.4 |
Infosys Technologies Ltd. |
-27.7 |
-15 |
|
Ranbaxy Laboratories Ltd. |
27.1 |
1.4 |
BSE Sensex |
20.5 |
101.4 |
The table above includes index (BSE SENSEX) constituents which were removed / included
in the index during FY2008. Source: Bloomberg.
As can be seen from the table above, three stocks contributed to approximately 70%
of the index returns in FY2008.
The extreme polarization in the markets (in many cases not entirely justified by
fundamentals in my opinion), made it difficult for a long term oriented, fundamentals
led approach to work.
The current year seems to be telling a very different story altogether. Equities
are facing a challenging environment driven mainly by a large spike in oil and steel
prices (inflation, higher interest rates, moderation in growth rates are a consequence).
As a result, the excesses in the system are fast correcting and it appears that
at least for the foreseeable future, the markets will move on the basis of fundamentals,
which suits a disciplined investment approach.
Like opportunity is at times hidden in adversity, present market conditions seem
to offer an exciting opportunity for wealth creation / long term investors. Despite
the pessimism in the markets, things are quite reasonable with the Indian economy
and specific companies. It is true that the growth rates will moderate somewhat
for the short run, but it remains a fact that Indian economy is one of the fastest
growing economies in the world and is likely to remain like that for a number of
years. In fact, it is not unreasonable to expect acceleration in growth rates after
1-2 years as the underlying capex cycle gains momentum and large projects start
spending serious money. A moderation in real estate prices is also very positive
for the long-term savings / consumption of Indian households. High real estate prices
reduce resources available for savings / consumption and therefore any fall is very
good for the sustainability of long-term economic growth.
Whereas it is hard to be optimistic in these times, things could be very different
in a year’s time. What if a year from now, oil / steel prices moderate (this is
not a very unreasonable assumption given the sharp spike in last few months, which
is likely to impact demand, particularly in developed world); inflation / interest
rates should then head lower, growth rates should still be very attractive and general
elections should be over. Further, it appears, that after yesterday’s CRR / Repo
rate hike, the worst of rising interest rates are behind us. Clearly if the above
materializes, markets are unlikely to remain at present levels.
Looking at things in a slightly different way, the present markets are discounting
a very pessimistic long-term outlook of Indian economy, which in my opinion is not
accurate. With the nearly 30% fall in the markets, the P/E multiples of Indian economy
are now comparable to much slower growing economies (refer table below). With this
fall, in my opinion, the risk reward of equity investments in India has improved
remarkably compared to January 2008 (moderate prospects of index at levels of 21000,
was highlighted in a note titled ‘Fun with averages’ in January 2008).
|
Company |
Fwd P/E (May 2008) |
Fwd P/E (January 2008) |
|
USA |
13.9x
|
13.6x
|
|
Japan |
15.5x
|
13.8x
|
|
India
|
14.9x
|
20.4x
|
Source: CLSA Asia – Pac Markets
The short term in equities is always uncertain. That is the case this time too.
However, a point worth mentioning is that markets have never bottomed out without
deep pessimism and are unlikely to do so this time around as well. Perceived risk
and actual risk seldom go hand in hand.
The deep sense of pessimism that is prevailing and decent valuations generally and
quite a few bargains suggest that this is a good time to invest in equities and
that returns over the medium to long term should be above average from these levels.
The deep sense of pessimism that is prevailing and decent valuations generally and
quite a few bargains suggest that this is a good time to invest in equities and
that returns over the medium to long term should be above average from these levels.
Prashant Jain
June 25, 2008
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