India’s stock market may be headed for a drop after running up more than 18% in the past 11 weeks, as shares get pricey and investors worry that higher costs could squeeze corporate earnings this fiscal.
But a correction—if it comes—might be only a temporary setback.
Although many fund managers expect the Bombay Stock Exchange’s benchmark index, the Sensex, to fall 10-15% from Friday’s close of 1,4570.75 (the Sensex closed at 14,495.77, down 74.98 points on Monday) over the next three to four months, they are upbeat about the market’s long-term prospects in the world’s second fastest growing major economy.
“We are circumspect about the near term. Valuations aren’t cheap and (corporate) earnings will be under pressure from rising interest, wage and input costs,” says Anoop Maheshwari, head of equities and corporate strategy at DSP Merrill Lynch, which manages Rs11,854 crore in assets.
The Sensex now trades at about 18 times of the projected earnings for this year. Other emerging markets, such as South Korea, Taiwan, Malaysia and Thailand, trade at an average 13-15 times the projected earnings, say analysts.
The Indian market has already taken investors on a roller-coaster ride this year. The Sensex touched an all-time high of 14,723.81 on 9 February, then skidded to the year’s low of 12,316.10 on 16 March. Its rise since then has been helped by increased interest from foreign investors.
One of the market’s main speed bumps in the near term will likely be a slowdown in corporate earnings, say fund managers. Maheshwari expects earnings to grow 15-17% in the year ending 31 March 2008, down from about 30% in the previous fiscal year.
“Interest costs have been rising, along with input costs such as wages and raw material,” says Mihir Vora, head of equities at HSBC Asset Management (India).
Since January 2006, the Reserve Bank of India has raised its key overnight lending rate by 1.5 percentage points to 7.75% to check inflation, which eased to an annual rate of 5.06% in the week ended 19 May after staying above 6% between January and March. Higher interest rates can cut into economic growth and corporate earnings. “Until inflation ticks down a bit and interest rates head back down, I think it is going to cap the upside,” says Jacqueline Aldhous, fund manager of the Forsyth Indian Opportunities Fund.
Indian exporters, including the IT sector that has been a main driver of the Sensex rally, are facing a threat to revenue and operating margins because of the rupee’s appreciation against the dollar.
The rupee hit its strongest level against the dollar in nine years 28 May, at 40.28 per dollar. It ended Friday at 40.61, putting it up about 9% this year. On Monday it was 40.53.
Still, some fund managers say shares in big IT companies—Infosys Technologies, Wipro and Tata Consultancy Services, which get more than 90% of their revenue from overseas—are worth buying because they can raise prices and cut the cost of operations to offset the impact of the stronger rupee and pressure for higher wages.
Forsyth’s Aldhous is “wary” of the oil-and-gas sector as global oil prices have climbed about 16% in the past three months.
The Union government will find it difficult to keep oil prices subsidized for long, she says, adding that any rise will push up inflation.
There is some risk, of course, that the Indian stock market could see a prolonged slide. If world oil prices shoot up and stay high for a long time, that would naturally push up inflation, lead to higher interest rates and further slow corporate earnings.
But many fund managers say that for investors with the patience to wait for returns, staying invested in Indian equities should pay off over a two- to three-year period.
The economy expanded 9.4% in the year to 31 March, its fastest pace in 18 years, driven by a boom in manufacturing and services. Though growth is expected to ease in coming quarters, the level should remain high.
According to official estimates, India is poised to grow about 8.5% in the current fiscal, second in Asia only to China.
And corporate-earnings growth of 15-17% is still “among the highest in the world,” says N. Sethuram, chief investment officer at SBI Mutual Fund.
Also, analysts expect many more individual Indians to buy stocks. With only about 3% of household savings in shares, “equity ownership is still very low in India,” Aldhous says. “There is immense potential with disposable income rising among the Indian middle class. I think (the Sensex) could go to 16,000” by the end of 2007.
DSP Merrill’s Maheshwari also is a longer-term bull, expecting the Sensex to rise 15-20% each year for the next three years, in line with his projections for corporate-earnings growth. He pegs sectors like capital goods, infrastructure and retail as offering strong potential.
He predicts construction companies such as Larsen & Toubro and IVRCL Infrastructures & Projects will benefit from government plans to increase spending to improve roads, airport and port facilities, and the severely crippled power sector in order to sustain economic growth.
Vora favours companies involved in power generation and transmission such as ABB Ltd (India), Siemens India and state-controlled Bharat Heavy Electricals Ltd.