By Ven Ram, Barron's | 9 January 2009
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For those tempted to wade into the indian stock market with a view to making a quick killing after its massive slide, consider the advice that Punch magazine once gave a person who was about to marry: Don't. Although India's benchmark Sensex has fallen about 55% from its peak a year ago, the market is still not attractive as a short-term investment. November's terror attacks in Mumbai aren't even the half of it: The Indian economy, valuation issues and broad political uncertainty all argue for real caution.
Mumbai's Taj Hotel smolders after November's attacks. Reuters/Arko Datta"Even as absolute valuations have corrected, India's relative valuations remain rich," says Ridham Desai, India Strategist at Morgan Stanley. The market's price-to-earnings multiple, based on expected earnings for the next 12 months, is 60% higher than that of emerging markets as a group. And its price-to-book ratio is a whopping 72% higher.
India fares no better on the dividend-yield front. The roughly 2% dividend yield on the Sensex pales in comparison to what is [now] available in some of the more advanced economies. The dividend yield for the Australian market, for example, is an eye-popping 6.5%, while most other regional markets offer yields well north of 5%.
Seshadri Sen, Associate Director, Research and India strategist at Macquarie Capital Securities, says that even though the Indian markets are trading at just nine times forward earnings, investors need to exercise caution in interpreting that multiple. "With all the earnings cuts that we have seen from companies, what appears cheap may not be so," he says. "We are seeing a fairly sharp slowdown in the economy, but it remains to be seen whether the markets have discounted all the bad news that is in store."
Just how far the indian market got ahead of itself in recent years is borne out by comparing the total market capitalization with gross domestic product. In May of 2007, India's market capitalization overtook its GDP; by January 2008, it had climbed to a frenzied 180% of GDP. In comparison, the ratio for the U.S. market at the height of the dot-com boom was 131%. The ratio for Japan at the peak of its market was 150%.
Those heady days for the Indian market seem distant now. In July the market-cap ratio dropped below 100%, indicating saner valuations. But the market's considerable fall since July doesn't make a persuasive case for a quick return of faith. Any investor betting that the market will go right back up in the short term is essentially saying that there will be an India equities bubble all over again.
While the Indian economy, whose output is now around $1 trillion, looks likely to do well over the next two decades or so, GDP would have to more than double for market capitalization to return to its past glory without valuations being caught in bubble territory. And a doubling of output would likely require at least 10 years of growth, assuming the economy keeps growing at a 7.2% clip.
Passage to Losses: The market fell some 55% in 2008.
It also pays to bear in mind that the Japanese equity markets have yet to recapture the orgiastic exuberance that once caused that country's market capitalization to outstrip GDP. Indeed, Japan's Nikkei index is now roughly at a fourth of the peak set nearly 20 years ago. One of the biggest reasons for the surge in the Indian equity markets was the inflow of funds from foreign institutional investors. But that luck hasn't held in the current bear market: Foreigners have pulled $20 billion from the market since the start of 2008, according to provisional data issued by the Bombay Stock Exchange.
In its 24 years, the Sensex, now at 9,647, has held above 7,000 only for the three-and-a-half years starting in June 2005. The index's mammoth 200% gains between 2005 and early 2008 are perhaps never to be repeated again. Even Warren Buffett would have trouble coming up with returns like that.
A new bull market, Morgan Stanley's Desai argues, is at least 15 months away. "Even if we assume that the market has hit its bottom, previous bear markets show that the market almost always tests the previous low before a new bull market gets underway," he says. "This process of retesting took between 15 and 24 months in the previous three bear markets."
He says the Sensex will probably end 2009 at 8,559, down 11% from now— and it could fall as much as 34%. In a bullish scenario, Morgan Stanley says, the market could climb about 30%. From an economic perspective, Citigroup contends that India is more vulnerable than many of its regional peers when it comes to external financing.
The country's current-account deficit and its debt repayments amount to a significant 18% of its foreign-exchange reserves, hurting the outlook for the currency, Citigroup says. An emaciated rupee— which has lost around 20% so far this year— leaves those Indian firms that have borrowed overseas more vulnerable to a downturn. Says Rajeev Malik, head of India and Association of Southeast Asian Nations, or Asean, economics at Macquarie:
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He expects India's GDP growth to slow to a seven-year low of 6% in 2009-10. Consequently, the rupee is likely to remain under pressure and weaken from around INR49 against the U.S. dollar now to INR52 by March, but recover thereafter, he says. There are also geopolitical reasons that don't favor an entry into the Indian market at the moment.
For one thing, the country goes to the polls before May to choose a federal government. Most political commentators agree that voters are disenchanted with the current Congress-led coalition, but the other major contender— the Bharatiya Janata Party— seems direly in need of a credible leader at the national level. What's more, Pakistan's current economic crisis, though largely unconnected to India, is likely to make fund managers jittery about the entire South Asian region.
So what do you do if you still want to get some exposure to the India growth story? Picking cheap individual American depositary receipts of Indian companies may be the way to go. Infosys (ticker: INFY), which has a reputation for being one of India's best-managed and most transparent companies, has an undemanding P/E of 11 and a dividend yield of almost 2%. The infotech consulting and software services firm has a cash balance of $1.9 billion, zero debt and a return on equity of 36%. And its cash is held in bank deposits, with absolutely no exposure to mutual funds.
Another stock that appears to offer a decent risk-reward proposition is ICICI Bank (IBN). The stock, which traded around $75 at the height of the India bubble, is now around $18. That is basically where it was trading in 2004, before the India fever caught on. At its current price, the stock is trading at a modest trailing P/E of 14 and an attractive dividend yield of 2.8%. Shares of the country's largest private-sector bank have taken a beating because of concerns about its international business. With 26% of its loan book coming from overseas, investors are rightly worried about problems that might creep up amid the current credit crisis.
The bank has slowed credit growth and is seeking to preserve capital, but worsening global credit-market sentiment might lead to larger-than-expected losses on its international investment book. If the bank can successfully cope with the crisis, its current share price should provide a good entry point for those with a long-term investment horizon, perhaps five years or longer. Right now, that's about the only way to look at any investment in India.
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| The Bottom Line: A new bull market in India may be at least 15 months away, thanks to a host of economic and political challenges. |
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