Morgan Stanley expects bull market to pick up
Moneylife Digital Team 07 August 2012

The investment bank feels that India is on the verge of a massive bull market, the fuel to which will come from RBI cutting interest rates and a pick up in investments by corporate India

The Indian research arm of Morgan Stanley (MS) is expecting the bull market to pick up in the upcoming months and investors could expect as much as 14% returns over the next 12 to 18 months. However, this is subject to Reserve Bank of India (RBI) cutting rates by half a percentage point, or 50 basis points, in their next monetary review meet which is on 17 September 2012. The investment bank, in its latest report titled “When Will the Next Raging Bull Market Start? Here Is Our Framework”, has identified various factors and signals that point to a possible broad-based market recovery and a bull market ahead. It has said, “In summary, we believe that the market is preparing itself for the next big bull market, though we are not quite there yet. Meanwhile, investors can continue to make outsized returns because individual stocks, both large and small, are already in bull market.”

The first indicator is the Nifty range. While MS doesn’t quite admit that the Indian market is in a bull market phase, it feels that it is valued at levels that will leave ample space for an upside. The report said, “The Nifty seems to be a in a big trading range of circa 4,500 to 6,000. The market is in the lower half of this range, leaving us with decent upside—which we think can materialise in the coming months—but the market, is seemingly not breaking new levels.” So, it must first break new to make stage for the next bull cycle.

However, the investment bank feels that the yield curve will provide further clues to this. It has pointed out that the inversion of the yield curve has ceased which could mean that short rates (i.e. 91-day yield) could fall faster than long term yields (i.e. 10-year yields), which in turn could set the stage for expansion of the economy vis-a-vis access to long-term credit, as borrowing costs of long-term debt instruments will start to become attractive. This is, of course, subject to inflation expectations and how the RBI tackles it. If inflation does indeed fall, then there is a possibility of this happening. The investment bank said, in its report, “Core inflation is declining quite sharply, and this could form the basis for lower short rates in the coming months.”

Apart from interest rates, investors are concerned about lack of investment from corporate India, as profitability depends on investments, which in turn would lead to bull markets. In other words, according to the report, “profit margins are the interplay of the investment and consumption rates in the economy. The investment rate reflects revenue potential. The bottomline is that the investment rate is a critical driver of a major margin expansion cycle.” Despite slow down of government & consumer consumption and low asset turn, the investment bank believes that asset turnover and excess returns will pick up and trigger a new investment cycle which will pave the way for the next bull market. It said, “We see a recovery in asset turns and excess returns over the next 12 months to form the basis for a new investment cycle.”

One of the most discerning pieces of investment information is valuation. However, the bank has cited that there is value to be sought in companies having attractive price-to-book value levels, and there’s money to be made only with those companies having such depressed valuations. The report said, “Currently, valuations either are in the bottom deciles or close to them. This augurs well for forward equity returns.” However, it must be pointed out that each company should be looked at separately to assess book values. It is not known whether they have updated all of its numbers to reflect 2011-12 fiscal. Some companies would have come out with annual reports, while some are still pending.

Finally, it concludes by quantitatively evaluating what investors can expect, and hope to, make if their assessment turns out to be correct. MS came up with their own proprietary model using the gap between earnings yield and 91-day treasury yield to assess forward earnings. It said, “We find a very strong relationship between this gap and three-year forward equity returns. Rates need to fall further (i.e. liquidity has to improve) in order to make equity attractive.” Thus, for this to happen, RBI would need to cut rates by as much as 50 basis points, which would mean returns of as much as 14% could be a possibility. The report concluded, “We peg fair equity returns at 14% and the model currently implies a three-year compounded annual growth rate (CAGR) in returns of 12%. Rates need to fall by around 50bps to make projected equity returns to the ‘fair’ threshold.”

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