On slippery surface

Market valuations aren't stretched, but only in the case of large caps

CSFB's Global Risk Appetite index has lately been in the "euphoria" territory. The last time this had happened was in March 2000, which is causing some concern.

What's more, the euphoria in the markets is being confirmed by the VIX (the volatility index based on the S&P 500), which has been hovering near multi-year lows. Low volatility is taken as a contrarian indicator since it points to complacency among investors.

CSFB's research further shows that in the past six occasions when the Global Risk Appetite index was in the "euphoria" zone, there has not always been an immediate correction.

Nevertheless, there have been significant corrections within six to 12 months on most occasions. Going by history, it looks like returns from equities may not be great in the next six to 12 months.

The Indian markets, for now, seem to be in agreement. The Nifty has posted negative returns in six of the last seven trading sessions. The index has lost about 2.6 per cent this week.

Investors in the Indian markets could, however, take heart from the fact that current valuations are far from stretched, which means the downside could be limited. The Nifty trades at a forward PE of 11.8 times, and based on the cumulative estimated profit of its constituents in FY05, it gets a valuation of about 13.2 times.

What's more, of the 50 constituents, only seven get a valuation of over 20 times estimated FY06 earnings. Three of these are high-growth IT companies, Infy, TCS and Wipro. Another three are from the healthcare sector, which makes these stocks look a tad expensive given that earnings growth is expected to slow down in the near term.

Overall the valuations may not look stretched for top-tier companies, but Indian markets could still take a further beating if world markets go on a tailspin. This could lead some FIIs into the retreat mode.

Further, the fact that valuations aren't stretched applies mainly to large-cap stocks. There are a host of midcap and small-cap stocks that have run up way beyond their fundamentals. If the correction continues, these stocks would fall at a faster pace.

February exports

Exports in February may be higher by 8 per cent on a year-on-year basis, but essentially they remain at the same $6.7 billion notched up in January, and slightly below December's festive season level of $6.8 billion.

Imports during the month however actually declined to $9.3 billion, compared with $9.5 billion in January. However, oil imports rose sharply during the month to $3.19 billion, thanks to higher oil prices.

But non-oil imports appear to have taken a breather, going down to $6.9 billion, from $7.8 billion in both January and December. Higher non-oil imports imply stronger economic growth, and, if the slowdown is sustained, it will send negative signals.

On the other hand, one month's data doesn't make a trend, and it's worth remembering that February's non-oil imports are still well above the November or October levels.

The net result was a trade deficit of $2.6 billion in February, slightly lower than January's $2.8 billion. The level of the deficit is no reason for concern, given the comfortable forex reserves and burgeoning services exports as well as robust remittances.

Financing higher levels of imports is one way of putting the reserves to good use. But in February, the main reason for the high deficit was higher oil prices, a trend that should continue this month.

UTI Bank's GDR

With investor appetite for bank stocks so high, this is the right time for banks to tap the capital market. No wonder banks like Dena Bank, PNB and Oriental bank have either raised money locally or are planning to do so.

However, a secondary offering by a listed bank, is priced at a considerable discount to the ruling share price. This disadvantage can be addressed by a preferential issue, but that entails a one-year lock-in for investors.

Far better, accordingly, to go in for a GDR issue, where select investors can be targeted without any lock-in, while at the same time avoiding the regulatory costs of an ADR issue. UTI Bank has done precisely that.

The stock has doubled in the last six months, comfortably beating the Bankex, and its GDR has been priced at $5.91, with one GDR representing one underlying share. That's more or less at par with the price ruling in the local market.

The 40.49 million GDRs will dilute equity by 17.3 per cent, and that took some of the sheen off the stock which has fallen a bit in the last few days.

But with net interest income growing by 26 per cent in Q3, and with its quarterly diluted earnings per share up 34 per cent on a year-on-year basis, any dilution should be taken care of quite soon, particularly since the additional funds are being raised pretty cheaply.

The appetite for the stock can be gauged by the fact that bids over $1 billion were received for the $239 million finally raised. That's in spite of the high pricing and in spite of the RBI's roadmap putting a spoke in foreign acquisition plans.

With contribution from Mobis Philipose