A scare in global markets is usually a catalyst for soul-searching on whether equity valuations are too high. The recent outbreak of nervousness was no exception, sending equity strategists back to their spreadsheets. In a recent report, Robert Buckland, global equity strategist at Citigroup, asks whether the doubling of the global equity market since 2003 has priced in the improvement in corporate profitability. He finds that the current MSCI World trailing price-earnings (P-E) multiple of 17 is well below the long-term average P-E of 23 and far lower than the unsustainable P-E of 35 reached during the height of the tech frenzy in 2000. Moreover, the world equity earnings yield (the inverse of the P-E multiple) is still much higher than the world bond yield, which means that equities continue to be more attractive than debt.
But while that data may be comforting to global investors, what about the Indian market? The current trailing P-E for the CNX Nifty is 19.82, below the 21.5 levels it was at the beginning of the year and also below the 20-21 levels it scaled in April 2006, before the meltdown in May. The Nifty’s P-E was around 21 at the beginning of 2004. And in February 2000, it went as high as 28. The CNX mid-cap P-E too is currently much lower than its level in early May last year. That doesn’t necessarily mean that equities are undervalued today, compared with where they were in May 2006, because the markets expect earnings growth to be lower going forward, which is why the forward P-E is a better indicator.
The MSCI India index is currently at around 17 times 12-month forward earnings and the earnings yield works out to 5.9, much lower than the yield on the 10-year government bond and below the interest rate for fixed deposits. In short, conditions in the Indian market are not as favourable as those in most markets across the world.
One of the prime forces that has driven wholesale-price inflation down is a deceleration in the rate of increase of food prices. Inflation in food articles, which averaged 10% between January and mid-April, has fallen to 6.5% year on year. Food articles have a 15.4% weight in the wholesale price index.
A look at the table alongside shows that each of the categories have seen a decline since mid-April. But what it doesn’t show is that inflation had picked up considerably in the year-ago period, leading to a high base. Inflation in food articles stood at 8.9% in the first week of June last year, nearly double the inflation rate of 4.5% in mid-April. ABN Amro Bank’s economist Gaurav Kapur points out that last year’s high base will shave off 88 basis points from headline inflation figures this June. This effect would reduce in July, but would pick up to 155 basis points in August and last all the way till September, he adds.
The moot question is how inflation figures will look like once the base effect wears off. In some cases, such as wheat, the 2006-07 crop has been bountiful and prices should be under control. As far as non-food products go, demand continues to be strong and so does the upward pressure on prices. Fuel prices could also be revised, with crude prices having risen globally. But much depends on the monsoons and the kharif crop which will hit the markets around October.
The big question is whether this means the Reserve Bank of India has reached the end of its tightening cycle. That is likely to depend on the strength of capital inflows and the strategy RBI adopts to combat them.
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