BOAML-Correction, But Not A Crash! We have got a few investor queries whether the market is getting into a 2007-like situation from where we saw a crash like in 2008. Our base case on the market is that while we expect a correction, we do not see a crash like 2008. While there are similarities in the market moves between the two periods, we think there are 2 key differences: (a) while markets are definitely not cheap, they are still 12% cheaper than they were in 2007 (c) earnings are rising after 2 years of zero growth compared to 2007 when we had a strong spell of 5 years of 25% growth. Hence, earnings downgrades should be much lower. Markets not cheap – watch commodity prices While markets are not in a bubble territory, we think they are not cheap either. India has benefitted, along-with all other asset classes, since Bernanke's Jackson Hole implicit promise (in August end) to re-introduce quantitative easing. Given the current valuations, we think any slow-down in flows could lead to a correction in markets. While structurally we think India will continue to receive large FII flows, near term we think there are 3 risk factors that could affect flows to secondary markets: (a) relative valuations in India are expensive – this could lead flows into other countries, (b) issuance of paper (more IPOs/QIPs) could divert flows to primary markets (c) any sharp increase in commodity prices, especially oil could lead to flows moving away from India as worries on inflation and rising current account deficit surface. September 2010 seems flashback to September 2007 Asset prices have gapped higher since the implicit promise of another round of Quantitative Easing (QE2) by Bernanke towards end-August. The rally this time is occurring in anticipation of QE rather than in Sept, 2007 when the rally was led by a cut in Fed rates in August. However, the reaction in the Indian markets has been similar – markets in Sept, 2010 are up 11.7% very similar to the 12.9% rally in Sept, 2007. Similarly, FII flows in Sept, 2010 at $5.4bn are very similar to the FII flows of $4.1bn in Sept, 2007. One difference, however, was that India has been the best performer YTD amongst the larger EMs while it under-performed the EMs in the similar period in 2007. Valuations are not a bubble There are 2 crucial differences in market between 2007 and today. First, valuations have not yet reached the bubble levels they were then. Markets are currently trading at 17.2x 1-year forward earnings compared to 19.6x in Oct, 2007 (based on then earnings estimates). Of course, given earnings downgrades markets were on 22.2x actual earnings. Secondly, we do not expect earnings to see the major downgrades we saw in 2008. eg FY09 earnings ended with a g rowth of only 0.4% vs the growth expectations of 18.5% in Oct, 2007. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints. Nothing in this article is, or should be construed as, investment advice. |
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