New York-headquartered full-service investment company says the Indian equity market is among very few around the world that looks poised to advance on a long-term bull phase over the next 5-10 years
Oppenheimer & Co has in a report dated 7th December made out a very positive case for investments in India’s equity markets. Its key arguments are pretty standard—“demographics, a sound medium- and long-term earnings outlook, a vastly improved policy backdrop and India’s allure at a point in history where its growth premium is most likely bound to reset at higher levels.” Another important factor it says is “the vast under-owned status of Indian equities, both at the domestic and international levels (retail and institutional).”
The US-based investment company, which also has operations in India, believes that “the Indian equity market holds the potential for annualized returns in the vicinity of 12-18% in rupee terms, and 15-21% in US dollar terms over the next 5-10-year horizon.” Oppenheimer supports its forecast, saying it expects an improvement in the inflation scenario (but the report does not state how) leading to a fall in the risk premium, and a revaluation of the rupee versus the dollar. The firm also expects a stable government, with the Congress-led UPA at the helm until 2014, to implement policy reforms.
Among other positives, Oppenheimer mentions India’s lower vulnerability to global economic shocks due to high local demand and low exports. “India is considered primarily a domestic economy—its share in world trade is a measly 1.1%, with exports constituting only 21% of its GDP.” Of course, it is debatable if at 1/5th of the GDP, exports can be considered ‘low’.
Oppenheimer bets on the usual suspects, including favourable demographics, which means a high working age population and declining dependent population. It makes a good point when it says that since there are “limited investment options (globally) for overseas investors”, India, which is one of the few economies growing at sustainable 6%+ levels, makes a good investment bet.
Oppenheimer is counting on the wallet-share shift of the Indian consumer from basic necessities to discretionary items. It cites McKinsey’s estimates which predict that discretionary spending of the Indian consumer is expected to rise to 70% of the total spending by 2025, from 52% in 2005.
Contrary to the general belief that things are going to be tough for banks going forward, Oppenheimer is quite positive on the banking sector. “We expect further loan growth pickup due to the following factors: 1) working capital requirements are likely to rise on the back of increased industrial activity and rising inflation, and 2) capital expenditure related requirements are likely to increase on account of better confidence levels. Better loan growth is likely to be positive for bank margins and asset quality.”
Oppenheimer is also upbeat about the Indian IT industry. “Even though India has a 51% market share of the off-shoring market, there is tremendous headroom for growth as the current off-shoring market is still a small part of the overall outsourcing industry. Significant opportunities exist in core vertical and geographic segments of BFSI and US, and emerging geographies and vertical markets such as Asia Pacific, retail, healthcare and government respectively. Development of these new opportunities can triple the current addressable market, and can lead to Indian IT-BPO revenues of $225 billion by 2020.”
It is also positive on the education sector, citing the large young population as the reason for this. “India ranks second in the world in population. Of India’s population, 44% is below the age of 19, making it the youngest nation in the world. This bodes extremely well for the education sector. Demand for education will continue to increase over the next decade at surprising speed, we think.” It also points out that the education sector is recession-proof.
It must be said that while education remains a foreign investor favourite thematic investment, very few stocks have given any returns. A year ago, Educomp was at Rs730 and it now trades at Rs515. NIIT, which trades at Rs53 now, was at around Rs70+ levels a year ago. Only Everonn Systems seems to have given good returns—the stock was at Rs400 levels a year ago and now trades at Rs600.
On the retail business, Oppenheimer believes that “Indian retailers also need to go through two-three more business cycles, before they achieve meaningful stability.” It remains positive on media companies since low advertising spend as a percentage of GDP means good potential. However, with huge competition, only those players with deep pockets and quality content will survive. It is positive on the auto sector as well, but expects the cost of finance to rise sharply. It believes that domestic players (Maruti, Tata Motors, Mahindra and Hyundai) are better placed than new entrants.
Oppenheimer likes the Indian travel market, which it believes “is poised for growth, given a strong domestic economy, the growth in the LCC market and a highly-fragmented lodging industry.” However, Thomas Cook, Taj GVK Hotels, Indian Hotels, Hotel Leela Ventures have given poor annual returns. Only Cox & Kings has given decent returns.
(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author’s own and may not necessarily represent those of Moneylife.)
The Indian market is undergoing a secondary correction, after which it will be headed much higher
The markets have been correcting over the past few weeks and lot of traders and investors are asking themselves the question whether the bull market is over or if it is just a temporary pause and correction in the overall bull market. The Nifty made an "intermediate top" at 6,339 which was very close to its all-time high of 6,357 touched in January 2008. From there it corrected to 5,690, then bounced back from those levels to 6,080 levels and fell to below 5,800. Today it closed above 5900. What next?
Well, we are working with the assumption that while Nifty has resistance around 6,357 which is its all-time high and the index can fall all the way to 5,350, a new journey for the market has begun a few months ago which will take it to much higher levels over the next few years-a target of 30,000 to 50,000 on the Sensex over the next three to seven years is imaginable and achievable. The market has chosen to correct first before the upmove after hitting 6,330 in early November. This is a "secondary correction of the primary bull market" which generally takes off anywhere between 33% and 66% of the previous primary upmove.
The Nifty has formed certain bearish formations like "three black crows", of which first is a "bearish engulfing pattern" and "dark cloud cover" on the weekly charts, "evening star" on the long term monthly charts, in the process of forming a "high wave candle" on the long-term quarterly charts, "black turnaround line" on the weekly three-line break charts, conversion from yang (thick bullish) to yin (thin bearish) line on the weekly 4% kagi charts, breakdown of price oscillators (RSI, ROC, MACD, KST, DI, Stochastics), fall of the 50-day MA, and so on.
The secondary correction will have a first target of 5,650 on the Nifty (18,800 on Sensex) which is a reasonable support (falling window). That is the level when the Sensex had hit the lower circuit in January 2008 and which was the beginning of the previous bear market. Without going into detail, looking at the chart patterns, candle sticks, neo-classical wave, time series analysis, retracements, trendlines, MAs, oscillators, etc, if the 5,650 level does not hold then the next support is at 5,350 and the final support-as it could go down further-is 5,050 (17,200). If for whatever reason the level of 5,050 is not held on the Nifty, which I personally don't believe will happen, then we have to question the validity of our assumption of it being a "secondary correction" of the primary bear market. At every major support level, that is 5,650, 5,350 and finally 5,050 we have to look at "bottom formation" patterns on the charts. However, once this secondary correction is over, the primary bull market will resume, which will have a first target of 7,000 (23,500) over the next medium-term.
The breadth has been very negative last week and lots of mid- and small-cap stocks have been butchered. The BSE Mid-cap index was trading at around 7,260, a level when the Sensex was at 15,600. It has major support around 6,300. Similarly, the BSE Small-cap was trading at 8,745 last week, which corresponds to the Sensex trading at 15,400. The BSE Small-cap index has major support around 8,000. The only positive thing in all the recent carnage is that the mid- and small-caps have corrected too sharp and fast, which is what happens during "secondary corrections" of primary bull markets. Now, the large-caps might correct somewhat over the next few days/weeks and then an "intermediate bottom" might be formed in the Nifty at close to the levels stated above.
To understand the current price movements more clearly, let us look at the 20-year chart of the Sensex. The Sensex was at around 690 in February 1990, from where a bull market began and it topped out at 4,650 in March 1992 (when the Harshad Mehta securities scam broke). Then it touched a bottom at 2,000 in March 1993 which was a bear market bottom. However, this was not the commencement of a new bull market. It then made another top at 4,615 in August 1994 and a cyclical bottom at 2,700 in December 1996. The real bear market bottom was made in October 1998 at 2,785. The new bull market which began there, took the Sensex to 6,175 in February 2000 where it topped out with the 'technology bubble'.
The Sensex crashed to 2,600 by September 2001 which was a cyclical bottom. The real bear market bottom was then made in August 2003 at nearly 2,900 from where the new bull market took it to 21,206 in January 2008. Kindly note, the four corrections in the interim, that is April 2004 (the Congress party victory in the Lok Sabha polls and formation of government with the support of the Left), October 2005 (small-caps bubble), April 2006 (mid-caps correction), and August 2007 (first news of sub-prime) were all secondary corrections within the primary bull market.
After making the bull market top in January 2008, it entered a corrective phase and made a cyclical bottom at 7,697 in October 2008 and the real bear market bottom at 8,050 in March 2009. From there on the new bull market commenced which made an intermediate top at 21,108 in November 2010. Currently, we are going through a secondary bull market correction which is likely to make a bottom somewhere between 18,800 and 17,200. And once the secondary correction bottom is in place, we will have a first target of 23,500 and then the longer-term target of anywhere between 30,000 and 50,000 over the next three to seven years.
Fundamentally, most of the factors remain long-term positive with the P/E at 15.2x FY2012 estimated earnings, which is at 9% premium to the long-term 10-year average, but below the peak bubble P/E of around 25x in January 2000 or January 2008. P/BV is 2.8x FY2012E which is at 15% premium to the long-term 10-year average, but ROE at 17.8% is lower than LTA of 18.7%. Market cap/GDP at 1.1x is not cheap, but below the peak of 1.8x in January 2008 and the earnings yield of the Sensex is 6.6% compared to an 8.1% bond yield (10-year GSec) and the earnings yield/bond yield is 0.81x as compared to the long-term 15-year average of 0.88x.
However, the major negative remains the high short-term interest rates. The yield curve from being steep a few months back has now in fact become inverted. Having said this, the positive factor is that the long-term (10-year GSec) yields have been in the range of 7.5% to 8.1% when short-term rates increased by almost 600 bps from 3% to 9% over the past few months. Hence, the short-term interest rates have risen too much, too fast. These kinds of rates are certainly not sustainable and they would come down. The peaking of interest rates might correspond with the end of the "secondary correction" in equities. Each asset class performs differently during different phases of the economic cycle. The general rule for different stages of an economic cycle and the preferred asset class during each stage is described below.
Currently, we are in the stage where over the next few weeks/months interest rates are likely to peak out, bond prices should bottom out, demand for credit might decline at higher interest rates, The central bank will increase money supply and liquidity, which it is already doing daily through repos, and equities will bottom out. (That is, the secondary correction in equities which we are seeing currently will end.)
To conclude, a good strategy might be to shift funds from short-term money market instruments to long-term gilts/bonds or lock into long-term rates and keep funds ready to buy in the "secondary equity market correction" so as to benefit when the interest rates peak out and start coming down and equities resume their primary uptrend.
(Mehrab Irani is general manager, investments, with Tata Investment Corporation Limited. He has over a decade of experience in investment research, portfolio management and investment banking. The views expressed in the article are his own.)
The troubles in Greece, Spain, Portugal, Ireland, have forced these countries to refocus their priorities. On the other hand, so-called successful economies like Brazil, India and China may have to pay, perhaps very soon, for lop-sided growth
Investors don't like trouble. Instinctively, like vast herds of wildebeest running across the Serengeti Plain, investors will also often stampede away from assets, markets, and countries that are having problems. Although it often sounds both prudent and cautious to follow the herd, over time it may be a bad idea.
Recently, investors have been savaging the so-called peripheral countries of the euro zone. For one reason or another, countries' sovereign debts have been considered very risky, at least by the default swap markets. Certainly if you look at some of the numbers this appears to be true. However, it might also be prudent to think of something else.
As the American White House Chief of Staff, Rahm Emanuel, said, "You never let a serious crisis go to waste." What he meant was that crises, especially the ones forced on countries or companies by the market, create a climate where reform goes from should to must. The greatest contribution that the market can make to efficiency, and ultimately economic growth, is discipline. And market discipline is never as effective as during periods of economic stress.
One of the most economically stressed countries has been Greece. Prior to the recent economic crisis, the Greek economy benefited broadly from its membership in the European Union and the euro. It allowed the Greeks to borrow at lower rates without the requirement of fiscal prudence. But it was not simple profligacy that brought the Greeks down. Their monetary problems stemmed from an economically inefficient legal infrastructure.
The Greek regulatory environment is a major detriment to growth. The economy is filled with inefficient state-owned industries that were a heavy burden on both the economy and Greek taxpayers. Its tax system is complex and compliance was a bad joke. There are substantial barriers to entrepreneurship and the labour system fails to align wages with productivity.
Before the crisis, reform of all these barriers to economic growth seemed politically impossible. But the cost of international help required that the reforms proceed. The resulting strikes and riots were evidence that the political fears were justified. Nevertheless, the reforms have gone forward and they will increase Greece's productive potential and economic growth whether it remains within the euro zone or not.
Spain is another country that has recently been a victim of the markets. Like Greece, Spain suffers from inefficiencies within its legal infrastructure. One of the most severe problems is a two-tiered labour system. Centralised, compulsively collective bargaining agreements, indexing of wages and protection for permanent employment worked exceptionally well for those people with jobs, especially those within the civil service. But the system discouraged new hires and so discriminated against the young. The result is an unemployment rate stuck at over 20%.
Earlier this year, Spain's prime minister initially refused to attempt any reform and steadfastly maintained that Spain was not Greece. The recent troubles with the Irish banks and Portuguese sovereign debt have happily refocused his priorities. If market pressure continues, the result will be real reform followed by real growth.
In contrast to the problems of developing countries, economic growth in emerging markets seems positively stellar. The economies of Brazil, India and China were almost untouched by the global recession. They are all now growing at an impressive rate. This is a problem. Over the past two decades all three countries have undergone extensive and often painful reforms of their regulatory systems. The fruits of these reforms are evident in their more recent economic growth and resiliency. Sadly, their success has led them to rest on their laurels.
In Brazil, economic growth has created a new middle class intent on using credit to purchase imported consumer products whose price has been lowered by the strong real. The result has been a deficit and inflation. Since there has been little need, the Brazilian government has not dealt with its tangled bureaucracy, inefficient tax system and poor infrastructure.
The booming Indian economy and the stronger rupee have also pulled in more imports than exports. This trade deficit is being filled by short-term capital. Like Brazil this could easily lead to a disastrous balance of payment crisis.
China's growth has led to a new assertiveness which is based on the false conclusion that their market-controlled economy functions far better than a market system. The optimism and exuberance masks massive problems with their financial system, real estate market and mercantilist export strategies.
In time, perhaps very soon, the markets of China, India and Brazil may have to pay for their success. In contrast, the productivity forced upon Greece by the markets will no doubt reap rich dividends. What investors need to understand is that investment in regulatory reform during a crisis is a signal to change direction and run away from seeming success toward apparent failure.