Is India likely to continue its strong showing with an apparent slowdown in growth, richer valuations, and stubborn inflation? Here is our view: India?s low-beta response puts it at risk. India has outperformed emerging markets from February 2010, when the world started to worry about a growth slowdown and sovereign risks. This is attracting the attention of investors, making India vulnerable to a sharp correction.
India?s defensive behavior is backed by a strong policy environment, resilient domestic growth, healthy corporate balance sheets, and an improving government balance sheet.
But Indian equities still have some catching up to do. India is still underperforming EM (emerging markets) from the Jan-08 level. In other words, India has not yet fully recovered from its 2008 underperformance. The problem is that valuations are fair at best.
Investors cite India?s rich valuations as a key reason to sell the market. India trades at a 50% premium to EM above its five-year trailing average.
Growth is likely to slow down given the high base effect. To top that, it seems that growth is slowing down as the base gets higher. The latest IIP growth numbers highlight this issue. We are expecting broad market earnings growth to slow down to an average of around 25% in the coming 12 months.
India?s market correlations with the rest-of-the world remain high. India?s high external deficit, funded largely by portfolio flows, makes the economy and the market vulnerable to any big risk-aversion event.
However, growth is anaemic elsewhere. That said, it is difficult to find a growth story like India. India?s GDP growth could be twice as much as the global average in the coming years.
More important, this growth is likely to come with lower cyclicality. The year 2009 vindicates this point. India?s earnings growth was almost close to zero even as global earnings fell by over 40%. Significantly, for equity investors, India is delivering growth with a high a ROE (return on equity) as well.
It is interesting to note that the market seems to be pricing in the coming growth slowdown just the way it priced in the growth acceleration in 2009. To that extent, any growth slowdown may not affect market performance.
Also, RBI?s exit (from easy money stance) would be measured. Given its concerns about the world, we believe that the RBI may raise rates in a measured fashion, creating an extended period of low real rates. A combination of low real rates and strong growth is a recipe for robust equity markets. A benign world could add fuel to the fire. The flip side is the associated inflation risk? keep an eye on that.
Our proprietary indicators suggests dull or range-bound markets in the near term. We continue to believe that investors should buy the dips in India with an expected return of around 23% to the end of 2011.
We are overweight on Energy, Industrials, Materials, and Telecoms, and Underweight on Healthcare, Utilities, Consumer Discretionary, Financials and Technology. Our focus is on sectors with attractive valuations, reasonable earnings momentum and a negative consensus view.
Sensex target: 23% upside to December ?11
Our residual income model projects a fair value of 18,570 for December 2010. Our bull case (25% probability) implies 30% upside and our bear case (10% probability) implies 20% downside. Our residual income model projects a fair value of 21,115 for December 2011. Our bull case (25% probability) implies 48% upside and our bear case (10% probability) implies 7% downside.
The probability-weighted outcome for the BSE Sensex is 19,400 for December 2010, 8% above the current level, and 22,100 for December 2011, 23% above the current level.