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Deconstructing the rally

Deconstructing the rally
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First Published: Mon, Sep 20 2010. 10 00 PM IST

Updated: Mon, Sep 20 2010. 10 00 PM IST
An avalanche of foreign money has propelled the sudden spike in the market.
The Nifty’s trailing price-earnings (P-E) multiple is now at 25.3 and price-to-book at 3.9. In January 2008, when the market peaked, the Nifty’s trailing P-E was around 28.2 and price-to-book 6.5. From a P-E perspective and assuming one thinks the market in early 2008 was a rational one—a very big assumption—then market valuations are not too high.
Also See India Peg Ratio In Middle Of The Pack (Graphic)
But there could be a simpler explanation for the rally. Markets across the world had been discounting doom and gloom, what with fears of a double dip in the US and worries about European debt. When a bit of good data seemed to suggest that the double dip was not happening or had at least been postponed, traders returning from their summer vacations looked around and saw a world of very low yields. What other place did they have to put their money than in equities? And in equities, what option did they have but to look to emerging markets? And as usually happens with these moves, the leaders are usually followed, lemming-like, by a crowd. Moreover, as this column has pointed out earlier, hedge funds have increased their borrowing, no doubt encouraged by the very low interest rates in the US.
Not that we’re suggesting investors are going to jump off a cliff. Instead, as the chart shows, one could make a case for investing in India based on the macro numbers alone. India’s ratio of the Sensex’s price-earnings multiple to its GDP growth is around 2, below that of Indonesia and the Philippines and far below that of the US and the UK. The picture doesn’t change much if we take the GDP projections for 2011 instead of for the current year, except that Indonesia and Thailand’s price-earnings to growth (PEG) ratios look a bit better.
The fact remains that, in US dollar terms, which is what the overseas investor will be looking at, MSCI India has outperformed most other indices. As of 17 September, MSCI India was up 11.6% this month, compared with 7.9% for the MSCI Emerging Markets Asia index. But then the Philippines index has done even better and their market, together with those of Indonesia and Thailand, has overtaken their pre-crisis highs.
There’s also a lot of talk about money pouring into India exchange-traded funds. It’s true that the options for overseas investors to invest in India are much more limited than the options to invest in China. One indication of the appetite for the India story is the big rise in MakeMyTrip Ltd after its initial public offering in the US.
Nevertheless, the rally has occurred at a time when revisions to earnings numbers are getting fewer. There’s also another question: If we are so near the highs in terms of the P-E multiples, why are our price-to-book multiples still relatively low? Companies have raised a lot of cash, but they haven’t been able to put it to good use. That is why, while book value has gone up, earnings have not kept pace. That calls for caution, which is seen also in the rise of the NSE’s VIX.
Graphic by Ahmed Raza Khan/Mint
We welcome your comments at marktomarket@livemint.com
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First Published: Mon, Sep 20 2010. 10 00 PM IST