Amid the daily noise of news and opinion about a recovery, rising liquidity and the return of optimism, one detail seems to have been completely lost—the fact that despite all the changes that have taken place both globally and in India in the last three months, the Sensex has gone nowhere.
Consider all that has changed in the last three months. In India, we’ve had an astonishingly rapid rebound in industrial production, we have a stable new government that has already started the disinvestment process and has promised several other reforms, such as a very liberal direct tax code and the introduction of a goods and services tax at an early date. We also have a very weak monsoon and high government spending.
The global economy, too, has bottomed out, liquidity in the markets has been plentiful and risk appetite has improved very substantially. The spread over US treasury for emerging markets bonds, represented by the Emerging Markets Bond Index (EMBI) + spread is lower by around 150 basis points than three months ago. The credit markets have returned to stability. France and Germany have come out of a recession.
China’s growth has been very strong. Commodity prices are rising. Yet, the Sensex is now just 3.2% higher than the highs it made shortly after the election results came in. Despite the improvement in the economy and notwithstanding the assertions of economists that the drought will at worst shave off around a percentage point off India’s gross domestic product growth, the Sensex has actually traded in a tight range since those heady post-election trades.
Graphics by Paras Jain / Mint
A look at the MSCI data confirms that the Indian market has underperformed compared with other indices. As of 13 August, the MSCI India index was up 7.2% (in local currency) compared with a rise of 11.4% for the Emerging Markets Asia Index. It has even underperformed the MSCI World Index, which is up 9.6% in the last 3 months. MSCI US is up 10.2%.
The numbers tell us two things: one, for whatever reason, be it the weak monsoon or the fiscal deficit or high valuations, investor appetite for Indian equities has waned; and two, the recovery in the developed markets is leading to more money going to them, whittling away the differential between developed and emerging market performance.
Is the lower growth in the Indian market because it went up too much earlier? Well, over the past one year, MSCI India is up just 1.79%, the same rise as for MSCI Asia. Several markets such as China, Indonesia, Malaysia and quite a few Latin American?markets?have?done?better.
A closer look at the Indian market shows wide divergence in performance among various sectors. If we measure sector performance from the peaks reached in May, the Bombay Stock Exchange Information Technology (BSE IT) Index has done the best, going up 24.6% from its May highs. The BSE Metals Index is up 15.4% since then, the Consumer Goods Index up 14% and the Auto Index 11.3%. The BSE Oil and Gas Index, the Capital Goods Index and the Power Index have underperformed, while the Realty Index has grown in line with the Sensex.
A simple explanation is that sectors such as capital goods and banks, and realty had gone up the most immediately after the election results, because investors thought they would benefit the most from a stable government, which would drive infrastructure spending and housing. Whereas, the government could do little in sectors such as home and personal care products, autos or IT, and sectors such as these accordingly had scope for positive surprises.
Looking ahead, Enam Securities’ Sachchidanand Shukla and Nandan Chakraborty argue the impact of the monsoon will be that the IT, power, pharma and gas sectors will take away the defensive premium from home and personal products.
Consumption-oriented sectors such as home and personal products, cement, autos and telecom could be hit by a fall in demand and inflation in inputs.
It’s very likely, though, that the recovery in the West is going to be tepid and long-drawn-out, primarily because consumer demand is weak. That should ensure that liquidity continues to flow to emerging markets. And liquidity is just another name for sentiment. Also, with valuations of most of the front-line stocks going up, the action is likely to shift to the mid-caps.
It’s no coincidence that the BSE Mid Cap Index is up 10% from its May highs, doing far better than the Sensex.
What kind of returns can we expect from the Sensex? Interestingly, the Reserve Bank of India’s latest survey of professional forecasters (for the first quarter of fiscal 2010) shows a median value of 15,000 points for the Sensex at the end of September and 15,500 by the end of March 2010. By end-June 2010, the median forecast is at 16,100, with the maximum forecast being 17,000. Since the survey was very likely done before the full impact of the deficient rains became known, these targets may well be scaled down now. But even if we go by these forecasts, the experts aren’t predicting a huge upside from current levels in the near future.
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