This year is interesting in many ways, least of which has been the Nobel Prize in economics to Eugune F Fama, Robert J Shiller and Lars Peter Hansen. The award recognises two contrasting ideas on asset prices. The theory by Fama says markets are efficient and price in all information, and, therefore, none can derive any extra return from market movements. On the other hand, Robert J Shiller says markets are not efficient and price changes occur for reasons not based on asset-specific information. To summarise the findings by this year's Laureates- there is no way to predict the prices of stocks and bonds over the next few days or weeks. But it is possible to foresee the broad course of these prices over longer periods, such as the next three to five years.
In this context, when it comes to Indian markets, I believe, they are inefficient as they lack the depth of domestic investors and are susceptible to the moods of foreign investors. While stock prices might oscillate between exuberance and dejection, value creation by Indian business is on a steady uptrend.
Year-to-date in 2013, the S&P BSE Sensex is down 0.2 per cent in terms of rupee and -12.7 per cent in terms of the dollar, despite foreign institutional investor inflows of $13.6 billion. The currency market saw dramatic movements with $7 billion exiting India in June and July. The Reserve Bank of India (RBI), to control the rupee decline, increased interest rates, resulting in higher volatility in the equity markets. A few more days of stock prices decline, like in August, would have made my commentary bullish as valuations would have looked very attractive. The US Federal Reserve's postponement of tapering and RBI's move to stabilise the currency helped and the market has rebounded since August.
The opportunity to invest at attractive valuations could come as the earnings growth for FY14 is likely to be lower than the 14 per cent expectations in general. This could disappoint investors resulting in a downward bias in stock prices.
Many firms had raised capital from 2005 to 2007 and implemented capital expenditure programmes assuming GDP growth to sustain at over nine per cent levels. They will now charge depreciation and interest paid, through their profit and loss statements. In addition, the revenues could be subdued as demand for products could be low, given the current macro trends. A slowing top line plus an increase in costs will impact earnings growth. Market euphoria based on availability of easy money might soon pass and give way to a depressing mood and share prices could test the August lows. Furthermore, markets might also face the headwinds of a quantitative easing withdrawal in January.
While cautious for the near term, I remain bullish on the long-term thesis. The Indian consumer is not dead; consumption is still a big growth engine. In a bullish economy he might buy premium products compared to less premium products in a bearish economy or consumption might shift from urban to rural India, but it's not heading to zero. A 15 per cent, long-term nominal growth expectation in earnings is rational. The price to earnings (P/E) ratio of the market is at 18 times historical earnings-a little expensive compared to historical average. However, sector valuations could be different. The capital goods sector, loved in 2007 at a price-to- book ratio of over six times, is now unloved and trades at 1.5 times price-to-book ratio. At the other extreme, some FMCG entities trade at 40 times PE ratio. These disparities also provide opportunities to invest. Fiscal or current account deficits will get adjusted in the long run, but the process to have sustainable returns from equities is to remain focused on the long-term and on valuations. Focusing on anything else, like elections, will only be a distraction.
The author is MD & CIO, Quantum Advisors
