India Strategy
On the cusp of a new bull run; target 25,900 by Dec 2014
India is expected to enter a new bull market with a potential upside of 29% from the current levels. We believe that the Sensex will touch a new high of 25,900 by December 2014 where it will trade at 15.3x one year forward EPS as against 13.8x CY13e EPS.
On the fundamental side, this rally will be driven on the back of the recent correction in commodity prices (Oil & Gold), fall in interest rates and continuous efforts by the government to revive growth. The correction in commodities will lead to a cool-off in inflation and lead to deeper correction in deposit and lending rates. The April WPI index is already at 4.89%, the lowest since Nov’2009.
We believe that the Indian economy has bottomed out which is evident from the revival in the IIP data and improvement in Gross Fixed Capital Formation (GFCF) as seen in recent quarterly GDP data. Average IIP for the last 6 months is at 1.6% against 0.5% recorded in the preceding 6 months. Recent quarterly GDP data shows that the GFCF has grown 6% YoY, up from -4.6% in the June quarter of 2012 and the strongest since April – June 2011. Also, the trend in goods traffic movement (for both rail and ports) is showing tell-tale signs of revival in economic activity. This makes us believe that the worst is over for the Indian economy.
Other factors supporting markets include strong liquidity from FIIs which will continue to flow in the Indian markets. They have already invested more than US$15bn YTD and we believe that more inflows are likely to come on the back of economic improvement and increased allocation to equities. Also, the Indian government will continue to create conducive environment and adopt favorable policies to attract capital flows from FIIs. FIIs have already seen positive returns from government divestments like Oil India and ONGC.
Retail investors who have wisely chosen to stay away from equities over the past few years are likely to join the party once they see a sustainable rally and will increasingly allocate funds to equities. Negative returns from gold, real estate and a fall in interest rates coupled with rising returns from equities could lead them to shed their reluctance to enter the equity market. This we believe could add liquidity to the market and even make a case for a higher target propelling this rally to levels of 28,000.
Key downside risks to our analysis are poor monsoons, backtracking by the government on key reform initiatives and offering populist sops before the general elections. Also, in the last few days the rupee has weakened which could offset commodity price corrections to some extent.
Summary: We believe that the Indian markets are set to break out of the consolidation phase of the past 4 years and enter a new bull market on attractive valuations, falling commodity prices and interest rates, high liquidity from FIIs and increasing optimism on the street.
m Correction in gold price, boon for equity markets: Gold has corrected by 22.5% to U$1,387 (13.3% fall post April 1, 2013) from its peak of US$ 1,790 on Oct 4, 2012. Technical indicators show extreme weakness and we expect gold to slide to its support level of US$1,301 very soon and further to US$1,155 in the coming months. Historical evidence shows that correction in gold leads to a stellar run for equities. We believe that the gradual shift of money from safe havens like gold will result in the emergence of risk on trade leading to a sharp rally in equity markets.
m Indian economy to benefit from correction in the gold & crude: We believe the recent correction in gold and crude prices will provide a respite to the burgeoning Current Account Deficit (CAD) which in turn will restore investors’ confidence in the economy and Indian equity markets. Our calculation shows that CAD (as % of GDP) can come off by 20bps if gold prices stabilize at current levels (even if we factor in 5% growth in volumes).Similarly, if crude prices were to stay near current levels CAD will come down by another 41bps.We believe that exports will pick up significantly with the revival of the global economy and India will be able to bring down its CAD to acceptable levels.
m Government set to control fiscal deficit and CCI in action to revive economy: The government’s manifestly pragmatic approach in the Union Budget for FY2014 and its determination to contain fiscal deficit is encouraging. We have seen a gradual hike in diesel prices (bulk diesel comprising ~14% of total consumption is being sold at market price now) and tightening of LPG cylinder consumption aimed at bringing subsidies to acceptable levels. In addition, CCI (Cabinet Committee on Investment) has also sprung into action to revive the investment cycle.
m Easing Inflation to spur policy rate cuts: Inflation has eased materially to 4.89% in Apr ’13 and is expected to ease further with the correction in crude price. This, along with already low core inflation data, CAD benefits from correction in crude and gold prices and improvement in fiscal position should induce RBI to reduce policy rates more than that anticipated by the street currently. We expect a repo rate cut of ~50-75 bps over the next 12 months.
m Lead indicators suggest revival in global economy, improvement in liquidity & risk perception: The developed world has seen smart improvement in lead indicators’ index over the past 6-9 months pointing to better economic prospects ahead. Importantly, PIIGS nations too have seen continued improvement in CLI (Composite Lead Indicator) in the past 12 months. Improving economic prospects further supports our thesis of money moving out of safe heavens (such as gold) to riskier assets.
Improving economic activity in the developed world along with PIIGS and the encouraging trend in leading indicators have paved the way for easing in CDS spreads. As reflected in Exhibit 17, sovereign CDS spreads across nations have eased and are hovering near the lower end of the range (for 1 year).
m Undemanding valuations - strong case for re-rating: Besides improving global and domestic fundamentals, the current valuation of India is still well below its historical averages. Sensex is trading at 14x 1-year forward EPS (on consensus earnings) against its 10-year historical average of 15.3x. Moreover, India’s premium over other emerging markets has eroded recently - MSCI India’s premium over MSCI EM (ex-Japan) stands at just 11.5% against 10-year historical average of 28%. We expect India to regain its lost premium in line with our expectation of economic recovery. We expect Sensex to touch 25,900 by December 2014 – an upside of 29%.
m Technically too Sensex poised for a strong rally: From a technical stand-point, Sensex has seen long term bottom formation for the last three years with RSI breaching 30 levels multiple times. In March ’13 RSI slipped below 30 levels for the first time in last 8 months and 39 Period Stochastics, which is also a trend change indicator, reached its highly oversold zone of 2-3 levels. Both the indicators have rebounded well from that level now which makes us believe that Sensex formed a near-term bottom at 18,300 level in March ’13. Sensex has taken the support of the upward trend line for the last 3-4 years and this trend is likely to continue, which will lead to another 15-20% upside from the current levels.
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