Counting green shoots before they sprout

India’s economy is still in negative mode, regardless of the Index of Industrial Production (IIP) growth coming in at 8.2 per cent in October, something which lifted up Finance Minister P Chidambaram's sagging spirits.

The sentiments were not mutual. Chief Economic Advisor (CEA) Raghuram Rajan saw the 16-month high IIP figure as just “green shoots of recovery", nothing more.

So much so, that Rajan went to the extent of telling the media, “We should not be overly influenced by one number; issues of base effects are there. We should take it as part of a pattern.”

The low base effect kicked in for two reasons -- a five per cent contraction in the same month a year earlier, and pick-up in demand during the festival season. IIP had contracted 0.7 per cent in September this year. Data reveals that consumer price inflation (CPI) remains high having edged up to 9.9 per cent in November this year from 9.75 per cent in October.

Yet, domestic equities are surging, making the Indian stock market the second most expensive after Japan with FIIs pumping in over $22 billion into domestic shares -- the second highest inflow since 1993 (see chart).

What's more, the bellwether index of BSE, popularly known as the Sensex, is trading at a price to earnings (P/E) ratio of 15.77 times estimated 2012 earnings per share, making it among the most valued equity benchmarks in the emerging markets today.

Even among the BRICS (Brazil, Russia, India, China and South Africa) nations, India is the costliest market, trading at a substantial premium to China. On the basis of 2013-14 estimated earnings – factoring in the growth estimates of companies comprising the respective indices –, the Sensex remains the second most costly market after Japan.

For one, unabated FII inflows have aided the upswing in India’s stock valuations. Foreign investment banks such as HSBC, Morgan Stanley and Goldman Sachs are betting on further upsides in the country’s benchmark indices, as FII inflows are expected to continue amidst the government's attempts to revive investor sentiment through a slew of reforms, including foreign direct investment in multi-brand retail and more flexible monetary policies adopted by global central banks.

Morgan Stanley expects the Sensex to rise nearly 26 per cent to 23,079 by December 2013, while Goldman sees Nifty scaling to 6,600 by December 2013. HSBC feels that the Sensex could touch 25,000 by next year.

Who sees it first?

The moot question is what foreign institutional investors (FIIs) see first in Indian equities, which domestic financial institutions (DFIs), including insurance behemoth and domestic investment titan LIC, are missing. P Phani Sekhar, Fund Manager - PMS, Angel Broking, offers an explanation.

He says that India’s problems can be resolved with some deft political handling. “So, FIIs know that it is just a question of when, and not whether India comes out of the fiscal mess. On the other hand, the challenges before the US and Europe are almost insurmountable as they will take at least 8 to 10 years to sort out their problems,” says he.

Policy makers in the developing world, Sekhar points out, have limited options to tackle the problems of reviving growth. As such, Sekhar says, “FIIs are betting on India sorting itself out, and in any case, India offers them a better relative growth of 6 per cent compared to their home countries.”

Jagannadham Thunuguntla of SMC Global Securities says FIIs are pumping in money into India shares without waiting for a complete economic recovery. Even now, FIIs are better placed in India from an investment perspective as they get relatively better returns on investment in the India market than at home.

Domestic financial institutions have been keen to invest in the markets, though largescale redemptions in mutual funds have severely curtailed flows into the insurance sector, leading to insufficient funds for investment. “LIC is mandated not to control more than 10 per cent of a company. As it has already hit that ceiling with many blue chip companies, it is forced to sit on idle funds,” says Angel Broking’s Sekhar.

Indian stocks have always traded at a premium to most emerging markets since the last bull run; a testimony to superior economic and earnings growth. Another reason for only FIIs with deep pockets to appear comfortable investing in India. “...current valuations reflect an average earnings growth of 8-10 per cent over the next couple of years. But then there is very little space for stocks to re-rate here,” observes Religare Capital Markets’ director & strategist Tirthankar Patnaik.

However, with earnings outlook turning hazy, many analysts do not see much room for further expansion in valuations. Where does that leave investors? Angel Broking’s Sekhar notes that earnings expectations have in fact bottomed out already with no material downgrades expected further.

While the outlook may not be clear, Sekhar points out that the action has shifted to the broader market where investors are warming up to the idea of investing in good companies hitherto beaten down by the market. “So, you are witnessing a robust deal pipeline and the primary market (for IPOs) is also reviving.”

Earlier this month, the Rs 540-crore IPO of credit rating agency Credit Analysis and Research Limited (CARE) was oversubscribed 41 times. Bharati Infratel’s Rs 4,500-crore offer was more than fully subscribed (1.3 times) and PC Jewellers’ Rs 609-crore IPO was subscribed 6.7 times.
Experts maintain that oversubscription of IPOs does not necessarily indicate a turnaround in the primary market.

Yet, Prabhudas Lilladher’s CEO of portfolio management services, Sandip Sabharwal says, “This is an indication that investors are keen on quality issues and companies with clean management... may not mean a revival of the IPO market. It is still a wait-and-watch situation.”

Do’s & don’ts for investors

D-Steet sentiment spells that the government’s recent moves may not be enough to revive a sagging economy. On most economic parameters, India is still on a weak wicket. So, investors have to be discerning about the stocks they invest in. “Positive sentiment is not equivalent to a bull market,” says Sekhar, explaining that it only means the market is springing back to normalcy and stocks with good fundamentals will be rewarded more favourably as compared to the last two years.

Nonetheless, 2012 has been a good year for Indian markets, logging in 25 per cent so far with many mid-cap and small cap stocks delivering returns in excess of 50 per cent. Sekhar expects quality mid-caps to turn in a similar performance as last year's while the broader market may deliver 15 per cent returns.

This may look expensive when measured against Sensex valuations, but is not so where stocks beyond the top 200 are concerned. A bulk of the FII money coming into the country’s stock market is finding its way mostly into large-caps and some (well-known) mid-caps. “There is still a lot of value in many India shares outside the top 200 stocks that is yet to be tapped. But this will not happen unless retail investors return to the market,” Patnaik added. Wait and watch.

FII investments in 2012

Month    GrossPurchase    Gross sale    Net Investment    Cummulative
    (Rs.Crore)    (Rs.Crore)    (Rs.Crore)      Investment($Mn)

January     50,467.40    40,109.90    10,357.70    2,037.22
February      79,898.60    54,686.60    25,212.10    5,127.67
March          3,795.10    55,413.80    8,381.10    1,684.82
April        41,091.90    42,200.50    -1,109.10    -205.53   
May            42,443.30    42,790.70    -347.10             -57.99
June           44,751.20    45,252.40    -501.30             -86.16
July           49,557.40    39,284.80    10,272.70    1,852.81
August       48,136.50    37,332.50    10,803.90    1,945.35
September     66,752.50    47,491.20    19,261.50    3,560.57   
October         56,832.40    45,468.20    11,364.20    2,175.48
November      51,143.80    41,567.00    9,577.20    1,746.26
December*      39,435.60    26,157.30    13,278.20    2,440.61
Total              634,305.70          517,754.90          116,551.20          22,221.11

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