India Equity market outlook - April 2010

8/9/2019 India Equity market outlook - April 2010

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BRICS Securities Ltd

19 April 2010

In these matters, the only certaintyis that nothing is certain.

~ Pliny the Elder

When one admits that nothing iscertain one must, I think, also admit

that some things are much morenearly certain than others.

~ Bertrand Russell

Not to be absolutely certain is,

I think, one of the essentialthings in rationality.

~ Bertrand Russell

[email protected]

\
http://www.finestquotes.com/author_quotes-author-Pliny%20the%20Elder-page-0.htm


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GLOBAL We argue that surge in global equity and debt markets in the last one year is not reflective of equally strong

economic recovery. The markets have run ahead of fundamentals

Key unsolved issues include high sovereign debt in large parts of Europe, Japan, and the USA a potential US problem of commercial real estate defaults leading to a policy of Extend and Pretend

Global excess liquidity is reducing markets demand more for debt

Nearterm debt requirements of several sovereign borrowers is so high that the probability of at least one

major sovereign default over next 6-12 months cannot be ruled out. This can lead to significant drying up ofrisk capital

INDIA Demand in the Indian economy appears exceptionally robust

However, going forward, consensus bets are dependent on increasing commodity profits and higher bankprofitability. Both are possibly subject to adverse shocks

Policy is perverse in several cases with food inflation being a function of government determined prices Agriculture credit growth figures hide more than they reveal With valuations nudging the top end of trading range, market has to become a bubble for it to go further

IN CONCLUSION India remains dependent on foreign capital to sustain growth and the equity markets Our base case assumes that there will be a gradual but definite tightening of fund availability leading to

market correction with a 10% downside Timing is uncertain, but cannot be too far in the future

The bull case in the absence of liquidity tightening can be 19%


3/43

Cheers!


4/43


0

20

40

60

80

100

120

140

1-Apr-08

22-Apr-08

13-May-08

3-Jun-08

24-Jun-08

15-Jul-08

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26-Aug-08

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7-Oct-08

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29-Sep-09

20-Oct-09

10-Nov-09

1-Dec-09

22-Dec-09

12-Jan-10

2-Feb-10

23-Feb-10

16-Mar-10

Equity Market Indices

MSCI INDIA MSCI EM ASIA MSCI EMU MSCI EM EUROPE MSCI NORTH AMERICA MSCI WORLD


5/43


VIX HIGH COMPLACENCYCURRENT 18, PREVIOUS YEAR 50

TED NO FEAR OF DEFAULTSCURRENT 13, PREVIOUS YEAR 110


6/43


YIELD ON 10-YR US TREASURYUP FROM 2.7% TO 3.9%

BAA TREASURY SPREAD 250BPS


7/43BRICS Securities Ltd

DOLLAR INDEX 82 AND RISING,PREVIOUS YEAR 86 AND FALLING

CRUDE OIL $80,PREVIOUS YEAR $50


8/43

Bounce from the bottom, not out of the woods



GLOBAL OUTPUT6% BELOW PREVIOUS PEAK

WORLD TRADE8% BELOW PREVIOUS PEAK

Source : ORourke & Eichengreen
http://www.voxeu.org/index.php?q=node/3421http://www.voxeu.org/index.php?q=node/3421


11/43


RETAIL SALES HAVE RECOVEREDCAR SALES ARE WEAK BUT HIGHERTHAN PREVIOUS YEAR


12/43


WORST DROP IN EMPLOYMENT INLAST 10 RECESSIONS

SLOWEST RECOVERY THUS FAR

-7

-6

-5

-4

-3

-2

-1

0

19

48

1953

1957

19

60

19

69

1973

19

80

1981

19

90

2001

2007

Largestdecline

froms

tartofrecession(%)

Year recession started

Change in US Employment Recessions

-2

0

2

4

6

8

10

12

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Changefrom

startofrecovery(%)

Months from start of recovery

Change in US Employment Recovery

1948 1969

1980 1981

1990 2001

2007*


13/43


HOUSING STARTS NO RECOVERYCONSUMER LOANS STILLDELEVERAGING


14/43


CHANGE IN US MONEY SUPPLY POSITIVE BUT LOW

MONEY SUPPLY SHRINKING INMOST PARTS OF THE DEVELOPEDWORLD


15/43



16/43


Sentiment The VIX [volatility index] was 50, not 18

Interest rates The yield on the 10-year Treasury note was 2.7%, not 3.9% Baa spreads were 580bps and tightening, not 250bps

Macro The US federal deficit was $450 billion, not $1.4 trillion Oil was at $50/bbl, not $80/bbl The DXY [US dollar index] was at 86 and depreciating, not 82 and

appreciating

Valuations The market was 20% cheap as per Shiller P/E ratio, not 25%

overvalued


17/43

Correction is difficult to time, but certain


18/43


DELEVERAGING IS NEEDEDDEPENDENCE ON EXTERNAL

SOURCES CAN INCREASE COSTS


19/43



20/43


WITH INTEREST RATES OF 1.3%,JAPAN STILL PAYS OUT ALMOST 14%OF ITS REVENUE AS INTEREST

SAVINGS RATES HAVE BEENFALLING. AN AGEING POPULATIONWILL EVENTUALLY LEAD TO HIGHERINTEREST RATES

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

Dec-91

Dec-92

Dec-93

Dec-94

Dec-95

Dec-96

Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Japan Net Govt Interest Payment as % of Total Revenue

0

2

4

6

8

10

12

14

16

Jan-00

Dec-91

Dec-92

Dec-93

Dec-94

Dec-95

Dec-96

Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Japan Household Savings Ratio


21/43


CDS MARKET DOES NOT THINK SO NOR DOES THE BOND MARKET


22/43


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50

60

70

Mar-10

Apr-10

May-10

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Oct-10

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Dec-10

PIIGS Bonds Due (bn euro)


23/43


Bank Exposure to Commercial Real Estate, CMBS, and CDS (as of 9/30/09) (US$ mn)

Commercial Banks(classified by assetsize)

Total AssetsTotal CREWhole LoanExposure

TotalCMBSExposure

NotionalAmount ofCreditDerivatives

Notional Amountof CreditDerivatives(Guarantor)

Tier 1 Risk-basedCapital

CRE WholeLoans/Tier1 Capital

CMBS/Tier 1Capital

CDS/ Tier1 Capital

$10 billion

(85 banks)9,460,306 842,794 47,304 12,985,697 6,273,213 749,303 112.50% 6.30% 1,733.00%

$1 billion to $10billion (440 banks)

1,158,908 364,533 1,943 60 31 104,897 347.50% 1.90% 0.10%

$100 million to $1billion (3,798 banks)

1,104,244 353,651 708 132 24 102,542 344.90% 0.70% 0.10%


24/43


Equity markets are assuming that central banks willsort things out. This is unlikely

High government debt and high fiscal deficits leave littlespace for policy action without sacrificing growth

Commodity prices are reflecting return of the globalconsumer when global growth forecast remain muted

In this scenario, India appears to be a relative high-growth island


25/43

Is all well?


26/43


BRICSMulti-factor

MarketModel

MacroFactors

FundFlows

Valuations&

Earnings

InterestRates

We model the market as acomposite of several factors,some of which may beoverlapping, but are largely

orthogonal Our model assumes that changes

in indicator levels are moreimportant than the levelsthemselves

Different factors may havevarying importance at differentpoints of time. However, when allindicators are up or down, thechance of a definite marketdirectional move increases


27/43

Positive aggregate demand environment; fiscal deficit will likely rise

beyond budget estimates


28/43


Cement prices are stable despite significant capacityadditions

Steel companies are operating at full capacity

Auto companies are finding it difficult to cater todemand

Roads order flow has exceeded plan for previous year

IT hiring is back


29/43


HIGHEST EVER COMMISSIONING OFNEW PROJECTS IN FY11E

BASIC INDUSTRIES ARE ADDINGCAPACITIES

0

1000

2000

3000

4000

5000

6000

7000

2008 2009 2010E 2011E

Investment commissioning (Rs bn)

Industry FY10 FY11 E

Cement 16.10% 18.80%

Steel 5.80% 15.90%

Primary Aluminium 28.60% 67.80%

Electricity Generation 7.80% 14.60%

Change in outstanding capacity


30/43


Government fiscal deficit is dependent on Ability to raise money from disinvestment which depends, in turn, on state

of the market Oil price remaining at or around $80 per barrel its already higher No additional social sector spending current indications are that this may

have to increase draft food security bill is a case in point Fund flows

Emerging markets have received more-than-proportionate share ofinvestment flows as evidenced by the relative stock market performance

India remains a preferred destination and is one of the best performingemerging markets

Domestic fund managers are holding approximately 6% cash one of thelowest levels in recent times

Supply of paper from both government and private sources is significant.Government alone has announced a $9bn divestment program. This should beseen in the context of average portfolio inflow of foreign investment of $20bn


31/43

Headed upwards


32/43


We argue that almost 43% of inflation is driven by policy factors food andenergy

Consequently, the ability of the RBI to keep inflation in check through interestrate signaling has limited utility. RBI will, however, still be expected to go throughthe motions, and raise policy rates

Base Case

As inflation becomes more wide-spread we expect RBI policy rates to rise RBIs ability to raise policy rates will be somewhat constrained by slow/low rise in

international interest rates since, without resorting to quantitative restrictions, RBI will notbe able to constrain Rupee appreciation if the interest rate arbitrage between dollar/euro/yenand the rupee becomes even higher than it is

Higher interest rates, along with rising prices, will eventually hurt demand though the Indianconsumer is currently underleveraged and therefore has the ability to sustain demand even inthe face of higher interest rates

Infrastructure expenditure will be hit worse than consumer demand in the face of risinginterest rates

Bull Case The most benign scenario is that interest rates remain at or around 100bps of current levels,

while inflation eases off because of a combination of base effect, and fresh capacity addition,and global interest rates rise to reduce arbitrage between domestic and international rates


33/43


INFLATION CAGR OF 6.5% OVER 10YEARS

MINIMUM RISE IN GOVERNMENTSET MINIMUM SUPPORT PRICE 6%

100.0

110.0

120.0

130.0

140.0

150.0

160.0

170.0

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10P

Components of Inflation

Wholesale Manufactured Agricultural

100.0

110.0

120.0

130.0

140.0

150.0

160.0

170.0

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10P

Components of Inflation

Wholesale Manufactured Agricultural

Agri Commodity 1999-2000 2009-2010 Growth % CAGR %

Moong 1,105 2,760 250 15

Sugarcane 56.1 129.84 231 13

Urad 1,105 2,520 228 13

Arhar 1,105 2,300 208 11

Maize 415 840 202 10

Paddy Common 490 950 194 9

Sunflower 1,155 2,215 192 9

Wheat 580 1,100 190 9

Paddy Grade 'A' 520 980 188 9

Jute (TD-5) 750 1,375 183 8

Groundnut 1,155 2,100 182 8

Soyabean Black 755 1,350 179 8

Barley 430 750 174 7

Gram 1,015 1,760 173 7

Cotton H-4 1,775 3,000 169 7

Rapeseed/mustard 1,100 1,830 166 7

Soyabean Yellow 845 1,390 164 6

Cotton F-414/H-777 1,575 2,500 159 6

Safflower 1,100 1,680 153 5

Source: CMIE Source: CMIE

Rise in MSP over last 10 years (Rs/unit)


34/43


INFLATION IN AGRI PRICESOUTSHINES THAT OFMANUFACTURED GOODS

AGRI CREDIT IS WAY AHEAD OFPRODUCTION (REAL) HIDINGNPAs?

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

Agricultural Credit and Output

Agri Credit Agri Prod

90.0

92.0

94.0

96.0

98.0

100.0

102.0

104.0

106.0

108.0

110.0

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10P

Index of Agri prices/Mfg Prod


35/43

Pushing the upper end of historical range


36/43


0

5,000

10,000

15,000

20,000

25,000

30,000

Mar-93

Sep-93

Mar-94

Sep-94

Mar-95

Sep-95

Mar-96

Sep-96

Mar-97

Sep-97

Mar-98

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

12m fwd PE (x)

Price 7x 10x 18x 26x 15x


37/43


10

12

14

16

18

20

22

24

26

28

30

Apr-95

Apr-96

Apr-97

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Apr-99

Apr-00

Apr-01

Apr-02

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Sensex Rolling Avg PE

5yr Rolling Avg PE 10yr Rolling Avg PE


38/43


FROTHINESS IS EVIDENTONLY FEW SECTORS HAVE NOTMOVED

8.8

7.2

6.8

6.5

5.5

4.94.9

4.8

4.3

4.1

3.5

3.3

3.1

3.1

2.3

1.6

0.9

0.3

0 2 4 6 8 10

Telecom

Hotel

Pharma

Banking

Oil & Gas

Sensex IndexConstruction

Retail

Metals

Engineering

Cement

Real Estate

Media

Power

FMCG

Auto

IT-Services

Misc

1M Sector Perf (%)

11.6

10.1

8.7

7.9

7.5

5.34.0

3.3

3.1

2.3

0.9

0.9

(0.0)

(0.2)

(1.3)(3.2)

(3.5)

(9.6)

(15) (10) (5) 0 5 10 15

Retail

Media

Pharma

Engineering

Banking

CementAuto

IT-Services

Misc

Hotel

Construction

FMCG

Metals

Sensex Index

TelecomOil & Gas

Power

Real Estate

3M Sector Perf (%)


39/43


886

1,046

6

1.1 3

2.6

26.0

11.6 1

0.1

6.5

0.2

4.8 1

.8 1.1 0

.53.4

800

850

900

950

1000

1050

1100

Mar-10

Metal

Banks

Oil&Gas IT

Engg

Auto

Power

FMCG

Realty

Pharma

Telecom

Cement

Mar-11

Sensex (FF adj.) EPS Contribution by Sector


40/43


Rs 1,046 for Sensex (FY11) is Bloomberg consensus estimate

Estimates sensitive to commodity prices China will play the determining role. Aslowdown in China can adversely affect commodity prices

Global metal demand remains subdued Alcoa reports revenue slowdown, whileArcelor Mittal has significant unused capacity

Higher interest rates with low credit growth will constrain banks ability to re-price loans while deposit rates may move up to compensate for higher rates

Oil & Gas company profits are dependent on being able to pass on crude priceincreases to consumers. Already, crude prices are higher than when the last priceincrease was allowed

For earning forecasts to increase all these factors need to turn positive not onthe horizon at this time


41/43


Earnings and Valuations Earnings estimates => bullish consensus adverse movement in commodity

prices can reduce estimates Valuations already pushing upper end of the band higher levels require

bubble formation

Interest rates flat or higher (greater probability) => lower valuation

Money flow Emerging markets have done well. Incremental flows may be positive Governments disinvestment plan will provide large stock supply Domestic institutional investors fully invested

Macro Fiscal deficit budget estimates likely to be significantly overshot Incremental capital requirements will rise as investment in infrastructure rises

increasing dependence on world economic environment


42/43


Bull case (20,900 Sensex, 20x FY11E) International macro situation improves or stabilises without significant outflow from

emerging markets including India Trade down providers of liquidity will derive higher returns

Base case (15,700 18,750 Sensex, 15x FY11E, FY12E)

International situation worsens, but in stages, allowing money managers time to adjust Benchmark large part of portfolio, while betting on continued consumer demand thedomestic consumer is again unleveraged. Lighten up on high investment sectors

Bear Case (12,500 Sensex, 12x FY11E) International situation worsens sharply especially with a sell-off in commodities Raise cash levels to maximum permissible. Stay largely benchmarked

YearConsensus

Sensex EPSBase Case Bear Case Bull Case

FY11E 1,046 15,690 12,552 20,920

FY12E 1,250 18,750 15,000 25,000

Source: Bloomberg

Base case: 10% downside in Sensex


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Disclaimer: All reasonable care has been taken to ensure that the information contained herein is not misleading or untrue at the time ofpublication, but we make no representation as to its accuracy or completeness. All information is for private use of the person to whom it isprovided without any liability whatsoever on the part of BRICS Securities, any associated company, or employee thereof. Nothing containedherein should be construed as an offer to buy or sell or a solicitation of an offer to buy or sell. The value of any investment may fall as well asrise. Past performance is no guide to the future. The rate of exchange between currencies may cause the value of investment to increase or

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Documents

India Equity market outlook - April 2010