When it comes to the market – think global, act local


Director, Banyan Tree Advisors

December 20, 2011

Globalisation is all very well, but there are some fundamental differences between the Indian market and the developed world.

THE PAST couple of years have seen a very strange change in the behaviour of equity investors in the country. Many professional stock market analysts spend their nights avidly watching TV, following each move in the US markets. In the morning, hour before the stock markets opens, it is not uncommon to hear conversations on how the Nasdaq or Dow has performed the previous day. Trades in India are accordingly put through. This is strange.

Agreed, the technology boom and the increasing exposure of the Indian markets to globalisation could lead to a degree of correlation with the international markets. Short-term money flows are often influenced by markets elsewhere, so it’s certainly important to follow global events.

Having said that, it’s important to understand that there are some fundamental differences between the Indian market and the US. I believe there are three reasons why you should refrain from basing your investment decisions solely on what happens in the US market.

India posed for a boom
The US market is now coming out of one of its longest periods of economic boom (along with a corresponding stock market boom). The boom technically lasted almost 20 years. In the 10 years between 1985 and 1995, the S&P 500′s average PER (price:earnings ratio) stayed between 16 and 17–and shot up to 28 in 2000 (it’s currently around 23-24).

Conventional wisdom has it that such a long bull phase would be followed by a reasonable period of correction. The average S&P 500 earnings are expected to fall from about $50 to about $40 this year. Chances are that we could see the market correct another 30 per cent before the US market stabilises-leave alone a bear phase.

In contrast, the Indian economy has seen relatively slow growth over the past decade, and the market has stayed almost flat. The market’s PER is currently around 12, down from a high of over 25. Chances are that we should see a correction upwards. Especially, with a fall in interest rates, the market’s average multiples should rise-so, the market should do better over the next decade.

Falling interest rates
Over the past two decades, US interest rates have fallen from over 12 per cent to the current 4.5 per cent. The US economic boom in the 1940s was led by widespread road construction. The recent economic expansion was led by housing (the US currently has 120 million houses for a population of 260 million).

This correlation between low interest rates and growing economic activity is a well-proven fact. Take the Mumbai-Pune expressway project, for instance. At an interest rate of 13 per cent, the project would require a daily traffic of 60,000 vehicles. If interest rates fall to 5 per cent, the project’s financing becomes so cheap that it needs just 25,000 vehicles a
day to be viable. India is on the right path for an economic boom, as interest rates are falling from abnormally high levels. That will make a huge number of pending projects viable.

Falling interest rates will also spur a growth in housing. The EMI (equated monthly instalment) per Rs 1 lakh (for a 15-year loan) has fallen to the current Rs 1,200, from Rs 1,500 a couple of years back. Very soon, housing loans will become so cheap that funding your own house through a loan would seem a smarter option that living in a rented house.

Let me illustrate. The rent on a Rs 10-lakh house would be around Rs 5,500 or thereabouts. If you were to buy that same house with your savings (say, Rs 2 lakh) and a Rs 8 lakh loan, your EMI would work out to Rs 9,000. You would also get a tax benefit to the extent of Rs 2,000, in effect dropping your monthly cost to Rs 7,000. Many would rather buy their own house at Rs 7,000 per month rather than pay someone a rent of Rs 5,500. Imagine the housing boom that could happen in such a situation.

The US market has already been there, done that. That market is not about to see such a boom anytime soon.

Market width
Many analysts can’t stop touting the market’s depth. With 6,000 listed stocks, they say, the Indian market’s depth is far better than that of many other developing markets. On the other hand, the market lacks representation by industries that account for a vast chunk of the GDP. End-user food sales, for instance, add up to over Rs 300,000 crore every year, but the food sector’s representation in the stock market is marginal.

Retail, apparel and insurance are some other sectors that are well-represented in the stock markets of developed economies, but lack such a presence on Indian bourses. (I especially like retail because that sector accounts for five out of the top 10 performing US stocks over the past 20 years.) Then there’s telecom (there is a cellular phone boom going on and there is no way of getting a stock market exposure!). These areas have a huge market capitalisation across the world, but they are sadly missing in Indian bourses. This will change, sooner or later.

Rough estimates of the enormity of many sectors are staggering. It does look like India is poised to perform a lot better than many international markets. Blindly following the West is one sure way to miss the new boom.