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Home > Knowledge Centre > India Markets - An Overview

Indian Markets - An Overview

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January 2010

After record gains made last year, the Indian markets limped in the first month of 2010 on combination of broad macro - economic concerns and a lacklustre earnings quarter. A global equity market retreat on back of potential regulatory changes in banking systems limiting their investment activities in hedge fund/ private equity / proprietary trading proposed by the US administration added to the pressures. Markets ended the month with a decline of 5.42% (Nifty) in USD terms while the midcap indices declined by 4.69%. IT, Telecom and Energy sectors were relative outperformers, while Materials, Utilities and Industrials underperformed. Mid caps continued to outperform the large caps over the month.

Prices rebased to 100 in 1st Sept 2008, Data in USD terms

Source: Bloomberg

As pointed out previously, while the growth factors in India are in motion, the economy faces near term challenges on inflation and fiscal deficit. On these issues, the recently announced credit policy and the forthcoming union budget is being keenly watched as this could give a direction to the markets for the next few months.

Inflation after lying low for better part of last year has surged in recent weeks and has touched 7.3%. Led primarily by food inflation, this number is likely to head higher in the next couple of months before retreating (Source: Kotak Institutional Equities). While a significant part of the inflationary pressures are supply driven (poor monsoons last year led to lower agricultural output), we have recently seen some demand side pulls also contributing to inflation. In this context a monetary policy action was expected and the markets largely reacted to that anticipating combination of money supply tightening and a rate hike. As we have been saying, the central bank has been walking a tight rope between managing inflation and ensuring credit growth, and while we expected some tightening measures, we also believed that the central bank would do that in a calibrated measure. The central bank, in its credit policy unveiled on the 29th of Jan did exactly that. In a move to anchor inflationary expectations via reduction in excess liquidity, the central bank increased the cash reserve ratio by 75 bps (25 bps more than market expectations), but left the policy rates untouched. Further, the central bank also revised FY10 GDP growth estimate to 7.5% from 6.0%, end-March 2010 inflation from 6.5% to 8.5% and lowered credit growth estimates from 18% to 16%.

Inflation may soften in FY2011E from 9% in FY2010E

Source: Government of India, Kotak Institutional Equities estimates

Monetary policy

Source: RBI, Kotak Institutional Equities estimates

The other macro concern for the markets has been fiscal deficit. The current deficit levels of around 7% at the federal level are unsustainable and there is a need to bring that down by 3% within the next two years. The reduction in fiscal deficit is expected through a combination of withdrawing some of the fiscal stimulus measures introduced in the 2008-09 (excise duty cuts and service tax reduction to be withdrawn), increasing revenue collection through better compliance and through disinvestment of government stakes in various state owned enterprises. Government has kick-started this with a largest ever offering of a public sector company, NTPC (the largest electrical utility in Asia by market cap, Source: Bloomberg) to raise around $2 bn in the first week of this month. However, the exact path of fiscal deficit reduction is expected to be unveiled in the next union budget which is scheduled for end of February 2010.

Results 3Q FY10 (Oct – Dec 09) were a bit disappointing. Benchmark companies (30 in Sensex) reported a PAT growth of 18% marginally below expectations. 10 companies reported PAT above estimates while 10 reported below estimates. Sectorally only IT and Automobile exceeded expectations while Industrials, Oil & Gas and Utilities had a setback (Source: Motilal Oswal Securities). While the overall breadth of earnings performance is positive, we see marginal earnings downgrades for the current year and next year.

Infrastructure

In line with the broader indices, Infrastructure as a segment also had a sharp fall particularly towards the end of the month. Disappointment over quarterly result led by lower execution during the previous quarter on account of non-availability of site for work, slower pace of financial closures, slower execution due to payment issues, overshadowed the increased activity of order tendering, order awards and financial closures in segments like roads and power.

Infra asset owners showed signs of improved economic activity through high traffic growth numbers in sectors like roads, airports and ports. In the next few weeks, we may see significant activity in road sector which will add to the order book and earnings visibility. We also expect some significant announcements for fuel linkages for upcoming thermal power plants shortly. The key take away from the results of infrastructure and related companies is that improved economic activity and increased government focused on spending may improve long term earnings visibility, though in the near term, there are some execution challenges which remain to be ironed out.

IIP Growth

Source: Bloomberg

While there are some macro headwinds, the economy is witnessing all round growth. Barring agricultural sector, all engines are firing up. November index of Industrial Production growth at 11.7% surprised on the upside (consensus at 10.2%) driven by surging consumer durables. After two consecutive declines in the manufacturing PMI, new orders and export orders have ensured a jump in PMI in December, suggesting a sequential improvement in December Industrial production. We have been highlighting the growth in automobile sales, cement sales, telecom subscriber growth which continue to be very robust. Newer data points in areas like hotel occupancy rates, passenger traffic in airlines, cargo at ports, etc, all point to strong growth. Significantly higher soft commodity prices can be strong incentive for farmers to work towards increasing farm yields which can lead to a positive surprise in agricultural output.  This can have meaningful impact on inflation which as it is, is likely to trend downwards from March end 2010. By then we will have clarity on the fiscal management and the government would have gone through with first of its many disinvestments.

After the sharp correction last month, the Indian markets are trading at less than 16X FY11 (year ending March 2011) estimated earnings, in line with the last 10 year average PE multiple. This has to be looked in the context of return of growth in the economy and corporate earnings in particular. On the back of 7.5% plus GDP growth in FY10 (RBI estimates) and 8.5% & 8.4% for F11 & F12 respectively (Source: Morgan Stanley India Research)), after a couple of flattish earnings, a new upcycle in corporate earnings has started. Corporate earnings are expected to grow by over 25% over FY10-12 (Source: Motilal Oswal Securities) in the next couple of years, implying a forward PEG of around 0.7X. In the current phase where the market is trying to outguess the policy makers, and headline inflation numbers continue to be worrisome, investors may consider this as a good opportunity to take/increase exposure to Indian markets at reasonable valuations. The first few months of CY10 is likely to be a consolidation phase and as the dust settles on macro concerns, economic growth and corporate earnings growth may be back in focus.

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