Can the markets correct another 10% or more from current levels of 18,000? Going by the news flow it doesn?t seem unlikely because FIIs have sold just about $1.3 billion in January and the markets are already reeling. The two main reasons why the Indian market may not attract the kind of record inflows of $29 billion plus from foreign investors that it did in 2010 and therefore may underperform its peers are high inflation and moderating growth. With crude oil edging towards to the $100 mark, inflation promises to remain high. Moreover, there are few signs that food inflation will abate meaningfully since there are structural issues that need to be sorted out. Indeed, such a build-up of a rise in costs has not been seen since the food and energy scares of early 2008. In India, companies have started taking price hikes whether they are steel makers or whether they sell soap and sooner or later this will start telling on demand. If inflation continues to remain at elevated levels, it means that in addition to coking coal and palmolein, one more input, or money is going to become more expensive; already since the central bank upped key policy rates early last week, half a dozen banks have increased their loan rates and that too by a fairly steep 50 basis points.
Growth in emerging market economies gathered momentum in the December 2010 quarter; the HSBC PMI rose to 55.7 from a five quarter low of 54.2 in the September 2010 quarter driven by accelerated growth in economies like India and China. However, in India, growth is clearly moderating. Numbers crunched by Sujith Pillai of FE Research Bureau show that net profits for a fairly large sample of 1,314 companies (excluding banks and ONGC), net profits rose just under 14% year-on-year in the three months to December 2010. That?s despite a fair good increase in the top line of nearly 22% and a kicker from higher other income, which was up a steep 24%.
Not surprisingly operating profit margins have fallen by more than 125 basis points year on year to 17.3%. At a broader level, industrial growth has been moderating with the IIP growth for November coming in at an anaemic 2.7% way below the consensus number of 6%. Moreover, non-oil imports fell 5.4% sequentially in December, though exports have fared well. With the government not initiating action on projects, capital expenditure is not picking up. And, from here on, the rupee is expected to stay weak thanks to a high current account deficit and weaker balance of payments.
While the market has been pricing in the macroeconomic headwinds, what it has perhaps not factored in is a more-than expected rise in the price of crude and also further earnings downgrades. Already the Sensex is trading at its long-term average multiple of 15 times forward earnings compared to the 17 times that it was trading at late last year. If estimates for corporate earnings are revised downwards, and the rise in Sensex earnings is just 12-13%, the market multiple too may contract till growth picks up again. After all there?s recovery in the US and fund managers will want to move money there.