If markets can reward the good performance of companies by taking their share prices to sky-high levels, they can also bury them if the situation turns sour, whether at the micro or macro level. This seems to be exactly the case with the banking stocks.
A few months back, while the market was exuberant about the performance of banking companies despite the challenge of rising interest rates, it has now turned cautious.
The proof: the BSE Bankex has underperformed the Sensex by a wide margin after touching its all-time high in the middle of January. Share prices of banking stocks have been severely battered in the range of 30- 50 per cent.
Even private banks like ICICI Bank, HDFC Bank and Axis Bank-once the hot favourites-have not been spared.
Public sector banks, which were quoting in the range of 1.5-2.5 times one-year forward price-to-book value before the market mayhem, are now quoting between 1-1.5 times. Similarly, for private banks, the valuation has fallen from 4.5-6 times to 2.5-3.5 times.
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However, there is a reason for the recent pounding of banking stocks, as things have not been going well for the industry. The inflation rate is way above the Reserve Bank of India's (RBI) targeted levels of 5 per cent. Credit growth has not picked up as expected despite many banks reducing their rates in the last few months.
Treasury profits have been affected as yields started moving up (bond prices have fallen) due to rising inflation leading to mark-to-market (MTM) losses. And, the potential losses on account of forex derivative contracts of companies are looming large on the face of private sector banks.
Experts believe that the market has overreacted to all these concerns and feel that investors with a long-term horizon should take the plunge and start buying stocks in smaller quantities.
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But, before taking a call, it is better to ensure the outlook on one of the major issues haunting bank stocks, which is inflation, and also evaluate the sector's performance in the last quarter of FY08. The Smart Investor provides a perspective.
Inflation and interest rates
Rising inflation (at present, a little above 7 per cent) has played spoilsport and dampened expectations of benign interest rate scenario in India, which was widely believed by most in the industry.
On Thursday, April 17, 2008, RBI hiked the cash reserve ratio (CRR) by 50 basis points-to be implemented in two tranches