Nilesh Shah has tracked the Indian stock and bond markets for nearly two decades now. The deputy managing director of ICICI Prudential AMC points out that few markets have traded on a sustained basis at the kind of multiples that India trades at today and tells Shobhana Subramanian that there is now virtually no room for error.
Now that the Sensex has hit 20,000, where do you think the market is headed?
It’s a journey and yes, while 20,000 is an important psychological benchmark, it too will be forgotten like 10,000. It’s difficult to take a short-term call on where the market is headed but the positive that is supporting the market is flows, more from foreign institutional investors than locals. That’s probably because an Indian investor evaluates his investment opportunity by comparing it to the 8% risk-free return on the government benchmark whereas an American investor evaluates the Indian opportunity against the 3% government benchmark and a Japanese investor against a 1% return. So, the expected return for an Indian investor is very different from that for foreign investors. That possibly explains why they are bullish and are investing whereas we are becoming somewhat hesitant. But it’s the flows that are driving prices higher.
So, are valuations looking terribly expensive?
Yes, valuations do look expensive; they may not be outlandishly expensive like they were in 1991, 2000 or 2008 but they are not cheap like they were in 2009. And they are looking expensive both in absolute and relative terms. Historically, India has traded at an average multiple of 15 times one year forward earnings but today we are trading at 17.5 to 18 times one year forward earnings, so we are clearly at a premium. We are also more expensive compared to Russia, which is probably trading at 8-9 times or Brazil which is at 11-12 times or China which is at about 15 times. If I compare India to the developed world, which is probably not the right comparison, we are expensive. And even within BRICs, we are expensive.
But doesn’t India deserve the premium?
There’s no doubt that India deserves a premium, the question is how much of a premium. In the past we have seen that when the difference increases too much and too fast, then it starts cooling off. So, there’s no debate about whether India deserves a premium over Brazil or Russia because we have rule of law, better corporate governance standards, better entrepreneurs, we have democracy and all this reflects in the higher return on equity in India. But at the same time, how much higher can the premium be?
Where do you feel India should trade vis-à-vis peers like Korea or Taiwan?
It’s difficult to put an estimate on the premium today because it would depend on how Korea and India behave. Apart from fundamentals, there is also the issue of sentiment. All we can say is that today we are trading at reasonable premiums over our peer group and this is justified based on long-term fundamentals. But this means we have to deliver in line with expectations. And there is absolutely no scope for poor delivery or tardy delivery.
What is your reading of the June 2010 quarter numbers and do you feel that there are downside risks to earnings estimates?
The June quarter numbers were more or less in line with expectations in some segments like mid-cap tech, which turned in results below expectations. Is there a risk to downside earnings based on the June quarter numbers? The answer is no. But those were the earnings required when the market was at 16,500. But now that the market has crossed the 20,000 mark, obviously the earnings expectations have gone up and those enhanced earnings expectations will have to be met in the coming quarters. With the index having moved up, earnings expectations have gone up.
From what you’re seeing on the ground, do you feel companies will deliver?
That’s a million dollar question but I get the feeling that the market is expecting companies to deliver. My own feeling is that for the broad market to deliver the enhanced earnings expectations is going to be a tall order. We have to run faster and work much harder to meet those expectations. Certainly we have raised the bar for our companies and in a world where variables are changing virtually every day, it requires greater effort to get there. That doesn’t mean we won’t be able to do it. What you’re saying is that rather than the market trading at these high multiples, it’s earnings that need to grow faster now… How many markets have traded at 18 times one year forward on a sustained basis? Very few. So companies will have to grow and that won’t always be easy because our companies have also scaled up significantly so the base is no longer small. What I’m saying is that I don’t think valuations can remain at 18 times forward forever, they will change either way depending on how companies perform. So let’s not take this 18 times one year forward for granted.
What do you believe is a sustained multiple that India can command?
We are now priced for perfection. From 10 times forward in 2009, we have travelled to 18 times; in less than 24 months, we have shifted from all-disappointment to no-disappointment. There is a potential for a re-rating but it’s hard to say right now at how much of a higher multiple India can trade relative to the historical average. To take a call on earnings itself is difficult, to take on a call on earnings re-rating is adding to the complexity.
Given that there is going be abundant liquidity in economies overseas and that interest rates are going to remain low, do you see flows continuing?
In the longer term, chances of flows moving from developed markets to developing markets like India in search of growth are high. But it doesn’t mean that this can continue at every level of the market. At some point in time, the gap in the valuation of say India and China, Brazil or Russia could force the money towards those markets rather than ours, depending on which economy is doing well.
But it’s also a fact that India is underweight in many global funds…
That is true; we haven’t seen too much money from many of these big foreign funds. But at the end of the day, the money will come in depending on how we perform. There is possibly unlimited quantum money sloshing around in the system, globally. In the American money markets, funds have $3 trillion, virtually yielding less than 0.5%. Logically, they should shift all their money into Indian equities because these are expected to post better returns. But things don’t always work on logic. There is a balance of Rs 4 lakh crore in Indian banks yielding a 3.5% return; this should also have shifted.
But we’re talking only of equity funds...
Allocations are not made only on the basis of fundamentals, but also sentiment and valuations. It would be unfair to think that all global equity funds would have a 1% allocation at today’s valuations, which are priced for perfection; though I would love to get such a high allocation. They are expecting delivery in terms of growth, equilibrium of our macros in terms of interest rates, inflation, fiscal deficit and current account deficit. They’re expecting seamless growth in earnings. We are carrying the burden of too many expectations.
Once again, small investors have missed the rally…
We haven’t encouraged an institutional culture in equity investments. Our pension funds never invested in equities and our insurance companies came pretty late and while there was an LIC, the investments were tilted towards fixed income rather than equities. So, somewhere the institutional participation hasn’t been too high. Also, the relative performance of real estate and gold in recent times has attracted retail flows since investors are more comfortable with those assets.
Source: http://www.financialexpress.com/news/theres-no-scope-now-for-poor-performance/686238/0
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