Indian Markets : Is it bottoming Out?

The Indian market went through an impressive five-year bull market, beginning in 2003 and running until January 2008, fuelled by over $50 billion in FII inflows. During this period, corporate earnings surged at an unprecedented annualised rate of 32%, while multiples expanded from 9x to 19x at their recent peak.

Unfortunately, since then, India’s market sell-off has been equally intense, accompanied by higher credit costs, inflation, lower industrial production, and several high-profile earnings disappointments. Although recent quarterly earnings growth has remained high, the trend has been one of QoQ deceleration, with contracting EBITDA margins (23% vs 26% last year) and net profit growth of 22% compared to 32% last year.

And rising commodity pricing, particularly oil, of which India is a net importer, are likely to strain margins and earnings growth for the foreseeable future. It is instructive to look at India’s high inflation environment in the mid-1990s.

In 1994, inflation was high at 10.8% compared to today’s 11.42%, and the market was trading at similarly high P/E multiples of 23x. A very sharp correction of over 40% and a de-rating of the market P/E to around 13x soon followed.
Today, by contrast, market multiples have already contracted to 14x. Moreover, in addition to lower inflation, today’s GDP growth is forecast at 7%+, versus only 6.3% in 1994. In short, a strong argument can be made that the economy, as well as the market, are in better shape today.

Nevertheless, the situation could quickly worsen if oil prices continue to rise. India’s net imports of oil as a percentage of GDP is likely to rise to 6% this year, and research shows that every 10% increase in oil prices can shave off at least 0.1% in GDP growth and add 0.4% more inflation. Much, then, depends on where oil prices are heading, not something anyone can confidently predict.

So has the Indian market survived this correction, or can it de-rate further to, say, a 10x multiple, like in 2003? Past bear markets in India have fallen 40- 55%, while MSCI India has already fallen 40% since December 2007. On the plus side, an argument can be made that India’s corporate sector today is stronger, deeper, and better positioned to weather this slowdown than in the past.

In addition, though the economy is not without challenges, with the exception of the oil price, many of these appear less daunting than they have in the past. Combined with a growth to valuation profile that remains attractive relative to global peers, we would argue, the Indian market can avoid a further significant de-rating, unless commodity prices continue to rise.

Nevertheless, we would hasten to add that any immediate upside is also unlikely. Absent improvement on the global market front, the Indian market is likely, more than anything else, to be range-bound.

Ever since markets slid precipitously in January and continued on the downward turn, one has been wondering if the market has fallen enough to see a sustainable trend reversal. Amidst around 7,000 point fall in sensex from January peak till date, there have been as many as four 1,000-point rallies, including a 20% rise from mid-March low to end-April high.

Debate as appeared in ET.