Is the equity market overheated?

DEBATE

Nikhil Johri,
Executive Director ABN Amro AMC

The personal credit to GDP ratio remains low "" the growth in credit-fuelled consumption can continue for a while before hitting a wall

The economy continues to be on a sound footing as far as growth is concerned, and a 7-8 per cent sustainable growth rate looks achievable. The key drivers to this growth are consumption, investment and exports. These three, in turn, are supported by low interest rates and sanguine global growth conditions.

India has the largest and fastest growing population in the age group of 25-44 years. This makes India amongst the youngest countries in the world, with increasing purchasing power. The urban as well as the rural consumers have an increasing propensity to spend, backed with rising disposable incomes. The personal credit to GDP ratio for India remains low compared to most other countries "" the growth in credit-fuelled consumption can continue for a while before it hits a wall.

While the Indian public (including government) sector and private sector lagged significantly in investments in infrastructure and manufacturing capacity in the past six to eight years, with most sectors running at near optimal capacity utilisation, we are now seeing the beginning of an investment cycle in all these areas. Exports, at $90 billion, are around 17 per cent of GDP, a significant number compared to virtually nothing in 1991. This component of GDP, with 10-20 per cent growth can contribute significantly to incremental GDP growth.

After spectacular growth of around 30 per cent for the past three years, overall corporate earnings growth should now be more "normal" "" we expect 12-15 per cent earnings growth over the next few years. From a historical perspective, valuations are not in a zone that can be called "euphoric" or "irrational". However, valuations are also no longer in the undervaluation zone. At a P/E ratio of 15 times FY07 earnings, valuations are close to average. Other parameters like EV/EBITDA and so on, too, are similarly around average. Hence, going forward, we expect earnings growth to drive market returns and we would not rely on a significant re-rating of the market for returns.

In the global perspective, India has been a star performer, both in terms of returns and in attracting fund flows "" with the result that Indian valuations are now at a premium to emerging market valuations. This is partly explained by the strong domestic demand growth that India has compared to other emerging markets and the fact that our market capitalisation is not skewed in favour of any one sector. However, on a relative basis, the quantum of out-performance seen over the past two years should not be expected going forward. Local and global sentiments towards Indian stock markets remain positive "" as can be seen in FII flow and collections by domestic mutual funds. Tighter global liquidity conditions globally can reduce the rate of inflow. However, the current sentiment conditions are conducive for India. Overall, we have a positive view on the markets in 2006.

Kavita Hari,
MD and CEO, ING Vysya Mutual Fund

The sensex is trading at a one-year forward PE multiple of 16x "" not only high by historical standards, but India is among the top in the region

In 2005, barring the US markets that were flat, most other markets saw positive returns. Amongst the leading markets, the best performing market was Korea, with returns of 54 per cent during the year. This was followed by India, with returns of 42 per cent during the year. The big surprise was Japan, which rose 40 per cent during the year, and continued its bull run for the third year in a row. Indian equity markets ended the year on a strong note, with the sensex rising 7 per cent in December 2005, and 42 per cent for the year. The sensex is presently trading at a one-year forward PE multiple of 16x, which is not only high by historical standards, but India is also among the top in the region. But, are they overheated? I would not think so. But there is need for caution.

The macro economic themes have not changed and three mega themes for 2006 will continue to be: (1) strengthening of capex upturn: the government has increased focus in the infrastructure sector and taken initiatives in various sectors such as telecom, roads and so on; (2) strong growth in urban consumption due to non-farm GDP growth and consumer credit expansion: a rapidly growing middle class, increase in disposable incomes and day by day reducing costs of credit are going to lead to an increased consumption in the country; 3) continued widening of outsourcing opportunities in non-technology areas: with cost competitiveness and high level of service, India has moved from being a preferred business process outsourcing country to a knowledge outsourcing destination; 4) dream team at the centre: with P Chidambaram and Manmohan Singh adding to the comfort factor of various FIIs, the increased interest by FIIs are testimony to India's changing place in the global scenario and its eminent growth potential.

Favourable demographics, the reform process and global competitiveness have changed India's global position. We believe that India will continue to gain from the changes in the world economy and its own reform process.

The above factors, we believe, will lead to a sustained GDP growth rate of 7-8 per cent a year for the Indian economy over the next three to five years. This should translate into 15-17 per cent annual growth rate for Indian companies. We continue to believe the long-term outlook for the market remains healthy, as the earnings momentum itself will drive the markets upwards.

I believe that Indians are under-invested. Everybody should emerge a winner in 2006, unless the economy is undergoing a 10-15 year depression or deflation, which India is certainly not. It's good times for investors and we should be flirting with the markets although with ..... CAUTION.