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Strategy: Pause, then Buy India
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Strategy: Pause, then Buy India
High domestic inflation and the political impasse warrants a further de-rating of Indian equities in the near term and a ‘Sell India, Buy US’ trade will continue to yield a positive pay-off over the next few months. However reversing that trade in 1QFY12 is the best long term structural bet given the underlying positions of the two economies.
Too early for bottom-fishing
Whilst the Sensex has corrected by 11% since November 2010, near-term macro-political fundamentals in India will continue to be weak until 1HFY12 thus translating into a slower reform process, sluggish sign-offs on public sector orders as well as margin pressures on account of high inflation. Historical precedents as well as the shape of the current correction suggest that Indian equities are yet to bottom out. Moreover, an analysis of derivatives’ positions in fact suggests that bearish sentiment in the market is likely to persist.
Macroeconomic fundamentals to remain weak in the near-term
Over the next 6 months high inflation will deliver a triple blow to margins through higher raw material costs, employee costs and interest costs. In our past research we have shown that this dynamic is responsible for the historical phenomenon whereby a high repo rate environment is characterized by higher interest costs and then lower PAT margins with the relationship being most evident after a lag (see exhibit 1 in the right margin).
Indian equities still overvalued
Historical precedents suggest that the ongoing de-rating process for India is not yet complete. India trades at just a shade below its long term trailing PE despite near-term macroeconomic headwinds. Also in comparison to the broader EM pack, India continues to trade at a premium on forward PE despite the ongoing policy-paralysis and the higher domestic inflation (see exhibit 2 in the right margin).
Comparing the shape of the current correction with the correction in Jan-Aug 2008 (for its arguable similarities in terms of high inflation, tightening monetary policy and falling equities) also suggests that Indian equities are yet to bottom out (see exhibit 7 & 8 on pg 4 for details).
Investment Implications
The direction of Indian and US equities over the past few months has been a function of their respective macroeconomic dynamics, and each of these is temporary in nature. Whilst the political gridlock which is retarding economic growth in India is temporary in nature, the US economic recovery is also temporary driven mainly by an unsustainable fiscal stimulus.
Given that the political headwinds in India should neutralize by 1QFY12 (once the 5 State elections are behind us) and given that inflation is expected to ease by then as well (assuming oil prices do not spike and Indian monsoons are normal), we reckon that 1QFY12 is the best time to start bottom-fishing.
We have provided in the Appendix 2 (on pg 9) a list of 85 stocks which look good both on our accounting quality screens and in terms of their immunity from the prevailing inflationary forces. This portfolio of stocks easily outperformed the BSE 500 during Jan-Aug 2008 and performed in-line with the BSE 500 between March-June 2009.
Too early for bottom-fishing
Whilst the Sensex has corrected by 11% since November 2010, near-term macro-political fundamentals in India will continue to be weak until 1HFY12 thus translating into a slower reform process, sluggish sign-offs on public sector orders as well as margin pressures on account of high inflation. Historical precedents as well as the shape of the current correction suggest that Indian equities are yet to bottom out. Moreover, an analysis of derivatives’ positions in fact suggests that bearish sentiment in the market is likely to persist.
Macroeconomic fundamentals to remain weak in the near-term
Over the next 6 months high inflation will deliver a triple blow to margins through higher raw material costs, employee costs and interest costs. In our past research we have shown that this dynamic is responsible for the historical phenomenon whereby a high repo rate environment is characterized by higher interest costs and then lower PAT margins with the relationship being most evident after a lag (see exhibit 1 in the right margin).
Indian equities still overvalued
Historical precedents suggest that the ongoing de-rating process for India is not yet complete. India trades at just a shade below its long term trailing PE despite near-term macroeconomic headwinds. Also in comparison to the broader EM pack, India continues to trade at a premium on forward PE despite the ongoing policy-paralysis and the higher domestic inflation (see exhibit 2 in the right margin).
Comparing the shape of the current correction with the correction in Jan-Aug 2008 (for its arguable similarities in terms of high inflation, tightening monetary policy and falling equities) also suggests that Indian equities are yet to bottom out (see exhibit 7 & 8 on pg 4 for details).
Investment Implications
The direction of Indian and US equities over the past few months has been a function of their respective macroeconomic dynamics, and each of these is temporary in nature. Whilst the political gridlock which is retarding economic growth in India is temporary in nature, the US economic recovery is also temporary driven mainly by an unsustainable fiscal stimulus.
Given that the political headwinds in India should neutralize by 1QFY12 (once the 5 State elections are behind us) and given that inflation is expected to ease by then as well (assuming oil prices do not spike and Indian monsoons are normal), we reckon that 1QFY12 is the best time to start bottom-fishing.
We have provided in the Appendix 2 (on pg 9) a list of 85 stocks which look good both on our accounting quality screens and in terms of their immunity from the prevailing inflationary forces. This portfolio of stocks easily outperformed the BSE 500 during Jan-Aug 2008 and performed in-line with the BSE 500 between March-June 2009.
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