Editorial: Not yet cheap enough

After China, India's has been the worst performing stock market in Asia this year, having dropped 36 per cent since January. The capitulation in the last few trading sessions has brought the BSE Sensex down to below 13,000, the lowest level since April 2007. It was surplus liquidity and the final excesses of a bull run that drove the market to near the 21,000 level in January. Since then, the oil price surge has raised questions about the strength of the rupee (on account of the growing current account deficit), and put pressure on corporate profits, and therefore encouraged overseas investors to sell and get out""to the extent of $6 billion so far. The selling may have started because fund managers needed to take home profits to compensate for losses in other markets. But if they have continued to sell Rs 500-Rs 1000 crore worth of stocks every day, it is because the risks to market valuations in India (which is hugely dependent hugely on imported oil) are higher than in other emerging markets. Risk aversion to equities remains high around the world, and much of the money that is currently being invested is looking for absolute rather than benchmark returns. Thus fund managers will be looking first to protect capital and are, therefore, likely to head for relatively safe markets. India with its weak currency and growing macro-economic imbalances is not one of them; soaring crude prices are expected to hit India the hardest and slow down growth. So foreign fund managers, grappling with redemptions in global emerging market funds, Asia funds and, as of last week, even global equity funds, are likely to be overweight on Brazil, Russia and South Korea, rather than take a punt on India at this stage.

At 13,000, the Sensex trades at just over 13 times estimated FY09 earnings, which is lower than the 8-year average price-earning (P/E) multiple of 15.6, and not much higher than the trough level that market players have talked about in recent weeks. The broad market is probably even cheaper. But that assumes a certain rate of growth for profits, which may not materialise as demand slows in many sectors, and others get hit by cost increases. If earnings grow at 12 per cent, the price to earnings growth, at a trailing P/E multiple of 15.5, works out to 1.3. That is not cheap for an economy where 10-year bond yields are expected to hit 9.5 per cent by the end of the year. In June 2003, at the start of the bull rally, bond yields were closer to 6 per cent, earnings were growing at 20 per cent plus and the market was trading at an earnings multiple of around 10.

It's unlikely that India will find itself in such a sweet spot again very soon. To those who argue that you cannot time the bottoming out of the market, and that the opportunity is now there for bottom-trawling, the counter will be that risk levels will mitigate only when oil prices show signs of stabilising and falling. The quality of results that companies turn in for the June and September quarters will be important; any nasty surprises will mean further pain for those invested in the market. If, however, the numbers turn out to be better than expected, there could be a change of sentiment. But the key issue remains the one thing that has caused much of the instability: oil prices. The markets will stabilise and start a sustained move upwards only when there are clear indications that oil prices have peaked and that bond yields are heading south.