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Relative valuations fall in line

Relative valuations fall in line
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First Published: Mon, Mar 10 2008. 12 33 AM IST

Updated: Mon, Mar 10 2008. 12 33 AM IST
Mid-cap and small-cap stocks have fallen the most in the recent plunge—while the Sensex, the benchmark index of the Bombay Stock Exchange (BSE), has fallen 25% from the all-time peak it reached in January, the BSE mid-cap index is down 34% and the BSE small-cap index has dropped 41%.
While the correction in the overall market was overdue, the underperformance of mid- and small-cap stocks was on expected lines.
After all, at its peak in January, the BSE mid-cap index’s price-earnings multiple of 28.5 was almost the same as that of the Sensex (28.97). After the recent correction, mid-cap shares trade at a 17% valuation discount to their large-cap counterparts and that better reflects the higher risk involved with smaller-sized companies. Similarly, the valuation discount of the small-cap index had narrowed to 18.5% at the peak. This has now corrected to 34%. The continued uncertainty in global markets has taken its toll on risky asset classes, and within Indian equities, small- and mid-cap stocks have borne the brunt.
Three-fourths of all stocks with a market cap of less than Rs250 crore and which hit their all-time highs this year have fallen by more than 40% from their respective peaks. Within the lot between Rs250 crore and Rs1,000 crore, two-thirds lost more than 40%. But, among stocks with a market cap of over Rs5,000 crore, only about one-third have lost more than 40%.
This relative underperformance of mid- and small-cap stocks occurs almost every time the market corrects, simply because these stocks also outperform by a wide margin when the going is good. The moot question is whether the underperformance will continue. Investors in these set of stocks can perhaps take heart from what happened in May-June 2006.
At that time too, these stocks had underperformed the larger ones, but at the nadir in mid-June, the mid-cap index was at a discount of only around 4% and the small-cap index had a discount of 24.5%, lower than the current discount. But if the current bout of risk aversion continues, as it shows every sign of doing, the discount may only widen.
The rupee bucks the global trend
The falling dollar is making headlines around the world.
The dollar index, which measures the performance of the dollar against a basket of currencies, fell last Friday to its lowest point since 1973. This year, the dollar has already depreciated 4.2% against the euro and 6.5% against the yen. (All rates taken are interbank rates). But it’s not only against the major international currencies that the dollar has fallen—it has seen lower levels against emerging market currencies also. For instance, this year, till 8 March, the dollar has depreciated against the Chinese yuan by 2.7%, the Indonesian rupiah by 4.2% and the Taiwan dollar by 5.4%.
The Indian rupee, however, has been one of the few currencies to buck the trend this year, with the dollar appreciating by 2.9% so far this year. But the dollar’s biggest appreciation this year has been against the South African rand—the dollar is up 18%.
Why has the rupee bucked the trend?
Selling by foreign investors in stock markets is undoubtedly a factor—with the exception of Turkey, MSCI India has been the worst performing emerging market this year (in local currency terms). But, it’s also striking that, in spite of the dwindling foreign portfolio investments and lower external borrowings, India’s foreign exchange reserves have gone up by $25.9 billion (about Rs1 trillion) this year to end-February (although part of it is due to the appreciation of the euro and gold), which means RBI continues to buy dollars.
A weaker rupee already seems to be helping export growth, which accelerated in January to 20.5% year-on-year. But, coupled with sky-high commodity prices, it’s also going to stoke inflation.
Risk aversion on the rise
The signals continue to show that risk aversion is rising.
Investors in the US have become so risk-averse that they have been piling on to treasury securities and the yield on the two-year Treasury security plummeted to a low of 1.52%. In contrast, rates on 30-year US mortgages are currently higher than where they were six months ago, in spite of all the rate cuts. Yields on corporate bonds rated AAA are higher than they were at the beginning of the year. And the less said about the credit markets the better—as evident from a seven-week high in the euro inter-bank offer rate.
Data from funds tracking outfit EPFR Global show that US money market funds continuing to rake in money hand over fist. Investors also flocked to commodity sector funds and commodity producing country funds, such as Brazil, Russia and West Asia funds.
The pull of commodities has also been felt in the currency markets, with the dollar depreciating sharply against the currencies of some of the commodity-producing countries, such as the Brazilian real (6.8%) and the Australian dollar (5.5%) this year.
This combination of risk aversion and high commodity prices hurts markets such as India.
“Not surprisingly, funds geared to regions or countries that are big importers of commodities did not fare well. Asia ex-Japan Equity Funds were hit with net redemptions for the 12th time in the past 13 weeks,” says EPFR.
Write to us at ­marktomarket@livemint.com
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First Published: Mon, Mar 10 2008. 12 33 AM IST
More Topics: Market | Sensex | Nifty | Mid-Cap | Small-Cap |