No strong co-relation between Indian & US mkts: Experts

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It was a big bad scare.We started off this morning with weak cues from the US markets, whole Asian region sold off and most markets were down between 2-4%.We closed more than 500 points down on Sensex and about 175 on Nifty .

Samir Arora, Fund Manager at Helios Capital has a view that weak cues from US triggered selloff though he is not sure how US subprime issue can affect India. He feels that no strong co-relation between Indian & US markets and money from weak currency markets is likely to come to India

Manishi Raychaudhuri of UBS however feels that the problem in US consumption is not the reason for fall and feels that India is not linked to US consumer slowdown. He feels that India looks stretched and is trading around 17.7x. Manishi Raychaudhuri adds that the correction is unlikely to be of the magnitude as seen in 2006 and feels that more money waiting to come into India.

Excerpts from the exclusive interview with Samir Arora and Manishi Raychaudhuri:

Q: You are not very surprised at this sell-off, are you?

 

Samir Arora: The reasons are different from what I thought. A few weeks-months ago I thought that this will happen because of the unbridled speculation in India and the low quality of speculation that we were doing in our own market but it has emanated first from the US. 

 

 

Q: What is your take on this? Do you think it is going to end up being a big global problem, which will take a while to deal with or do you think the markets had to correct in any case and this has come as an easy trigger in terms of an excuse for setting this correction off?

 

Samir Arora: I think it is more of an excuse, if we believe that this correction is happening because of US sub prime and that problem expanding to US prime, it means that the US consumers becomes nervous because either his house is repossessed or payments and EMIs go up and he has a sort of a weak outlook about his own future. Therefore the US institutional investor by looking at what is happening to the US or any institutional investor, looking at the fact that the US consumer is weak, first decides to take out money from India, because he is risk averse. My thinking would be that an institutional investor would look at the places, which feed the demand of the US consumer, and India is definitely not one of them and in fact if that were to be the scenario, China, which more directly feeds into the US consumer, would be more directly hit and China was up today.

 

Secondly, if you look at the fact that one part of the problem in recent months or weeks has been the weakness in the US dollar therefore it is viewed as riskier to invest in India, which has had the strongest currency this year among many currencies. So I think this logic of saying that because there is a US sub prime problem, investors will redeem from all over the world and they will go back to their own market, which used to be the case when the problem was triggered by a stock market rather than by currency but I think will not apply to this situation.

 

 

Q: What is your take on the genesis of this problem, the whole CDO, sub prime mortgage issue and do you think it will become a persistent problem or just blow over as another scare?

 

Manishi Raychaudhuri: It is difficult to answer, as I am not an expert on the US economy. But I tend to agree with what Samir said just now because it turns out to be a slightly long run out problem in the US consumption cycle. It is difficult to imagine why that should lead a major slowdown in inflows into the Indian market because the Indian market apart from the IT services is not really strongly linked to the US economy and one would have expected the other Asian markets, for example like China to have grown down more significantly. If you look at 2007 YTD India has actually underperformed rest of Asia. I think leaving out today's correction; Asia is up about 26% this year while India is hardly up about 11-12%. So it is a bit perplexing.

 

If I were to borrow the opinion of our global and US economists, we believe that growth in the US is likely to be moderate and we still have an expectation that possibly the Fed would be cutting rates from around September onwards. I must also mention that the original expectation was that Fed will possibly be cutting rates from the beginning of this year. So the time horizon continues to get postponed to some extent. Coming back to the Indian markets, the correction was triggered by combination of many things. Firstly, the market had run up too sharply in recent month, it was trading at about 17.7 times, one year forward multiple. If you look at history of corrections over the last one and half to two years, every instance of correction in the Indian market has started from these similar valuations levels. In a sense, the correction was overdue and I think this US weakness and rest of Asia weakness was somewhat of an excused to do that kind of selloffs.

 

Q: Your point about India not being affected by subprime woes is taken. But this has been a fairly widespread and synchronised global party, all global markets have gone up. Do you think this US situation can trigger off a correction in global equities generally and we may fall in line with that as well?

 

Samir Arora: That of course for some of time day to day it looks as though the correlations are high but if you look at it over a year and two years, then things are very different. Although it appears every morning that what happened overnight in the rest of the world happens in every market, actually it doesn't. Also look at it in what currency you are measuring. My point is when the US stock market corrects for its own reasons; the stock markets are not a zero-sum game.

 

Therefore all markets could follow each other and go down. But let us think for a minute that the problem emanates from US currency. Now US currency weakening is not a zero-sum game. By definition it means some other markets currency or some other country's currency are strengthening, because currency weakening is not an absolute event. What I mean is everybody should have some basis that a little bit of this problem, if not all of it is related to the fact that US currency has weakened a lot in recent months. And therefore investors in the US who are worried about the fact that they are losing on the buying or purchasing power of the currency also have a logic to be investing outside the US.

 

In fact it could be very easily argued that the reason why the US market and Dow has done well i and the Dow has done well in recent months because the Dow is made of multinational companies, who actually have a lot of their earnings outside the US. So therefore they are also in some sense just playing the same them, except that they are playing it from homegrown companies and therefore I feel that if that were to become the predominant theory, then the compulsion or attraction of US investors to invest outside the US will go up and India as we have seen from the tech sector woes, seems to be perceived by all of you and all of us, as one of the countries, which is going to be hit by the fact that it has a strong currency. And so if you believe that, that means the money coming from a weak currency market will come more to India relative to other markets.

 

 

Q: How do you expect global investors to approach this first dip in global markets after a long time? We have seen big flows into India in the month of July, record flows. What do you expect to see now?

 

Samir Arora: My problem with the market is the complete low quality of speculation by both domestic and foreign investors and for that I don't have an easy answer. What I mean by low quality speculation is, right now we reward every company for its dreams and plans, as if that company has done what it had set out to do. We started that with the real estate guys, piece of land and we then call it a project and discounted it. More recently, we have done it with media companies, who talk about starting 20 channels. Some other company says that I will raise a billion dollars in private equity; we say okay that means you make USD 20 million management fee, you will earn 20% performance fee, therefore that is so many billions, now this is your market cap. Some other company says that I will go and set up multiplexes in Malaysia, you say okay how many 100 multiplexes into Rs 3 crore per multiplex, Rs 300 crore is your revenue. 

 

We discount everything that he has set out to do, without any emphasis on execution and the fact that 95% of these things will not happen and the fact that when subsequent offerings of companies are announced, the stock prices go up. This used to never happen in our life before, that a company says I will raise a billion dollars and its stock goes up because everybody assumes that this billion dollar will be oversubscribed. So anyway I will not get it. This has happened in all the banks recently. So that low quality of speculation is what I think is leading to maybe a stronger than normal correction and people will pay for it and then it will become normal again.

 

Q: You started by saying that a correction around that 80 P/E multiple sets in generally. How deep do you expect this correction to be?

 

Manishi Raychaudhuri: That's an even more difficult question to answer. Again, if we look at the recent history, right from October 2005, to May 2006 to February 2007, the episodes of correction that we have had have ranged between about 10-12% to about 30%. Now I don't think this particular episode would be as deep as 25-30%, what we saw in May 2006. Part of the reason for that is that there is still a lot of money waiting in the sidelines to be invested in India.

 

I think the major part of the emerging market investors are still underweight on India and if you look at the domestic major funds, I think even though they have raised the money in the funds through the NFOs, they are still sitting on a lot of cash because in 2007 YTD they have been net sellers in the market. In fact, the major part of domestic inflows into the market has come from the insurance companies. So there is still a lot of money waiting on the sidelines to be invested in the Indian equity market and that would possibly cushion the market valuations from going down too steeply.

 

When stock prices go up just on hopes of things that are likely to happen in future, it means that the margin of error is very low and that is exactly what is afflicted this market or even on the previous occasions, there was a very sharp upmove in particular sectors and those were the sectors that corrected more sharply. So in a nutshell, we believe that possibly this correction may not be very sharp, certainly not like 25%-30% as we have seen in May 2006 and maybe there are certain sectors, which could correct more than the others.

 

Q: What do you think, you started by saying that you were expecting a correction in any case given the spike that has preceded this sell-off, how dip do you think the sell-off could be?

 

Samir Arora: Before that I would like to say, because I am bullish on India, I think the performance comparisons that Manishi and others make about India up 12 and others up 20 odd is a bit wrong, because for foreign investors, the Indian market is up more than 24-25% because they have made money on the currency. Now it's not an independent and additive thing that you made 12% on the market and you made 9% or 10% on the currency, so you have made 22%-23%, because the fact that you made the money on the currency meant that you did not make money on the Indian tech sector and the Indian tech sector did badly.

 

So therefore from a foreign investors point view, it would be wrong to say that they have made 12%, they have made 24%-25% and the fact that they have made 24%-25% or they made an additional 10% on the currency is the reason why they did not make enough in local market terms because 20% of the market was negatively affected by the same strengthening of the currency.

 

But in general I think the market correction this time will not be very significant and it could be less than 10% of which quite a bit has already happened; at least from a local investor's point of view, the market is up 10-12%. Also if there is a big correction then that would normally mean that you will start feeling that the currency strengthening phase is a little bit over and therefore the 20% on the market that has not performed will perform a little better and act like an internal hedge within the same market.

 

So all in all, I do not think the correction will be very deep and I also believe the foreign investors are hugely underweight India. We are already expecting very significant amounts on August 1st in our fund and we have been getting it every month but that does not seem to reducing the interests; of course if for few more days the US market falls down then everybody will become nervous and we will also back off a little bit but right now it does not appear to be the case.

 

Q: Can you ignore the global factor completely or are you slightly apprehensive of how things may pan out in the US and what it could mean for global equities over the next 2-3 months?

 

Samir Arora: No, we cannot ignore it at all, I am right now only looking at it as a relative that India is more attractive than others but as India being more defensive than others.0ver time that relative becomes absolute because investors then start focusing on this and ignoring others. Unless the US market completely collapses or goes down really as badly as it did yesterday for a few more days, this thing will move on. Right now, if the US market were to correct 7-10% and we correct 2-3%, I think that means we are really ignoring them but if they fall 20%, we will fall 5-10-15%.

 

 As the US markets fall more, your correlation will become more, because then that means there is a panic. Right now, we do not expect a panic in the US market without the US market exhibiting that panic. As of now, I believe that the US futures are flat, the European markets are green, so I am not going to sit here and make too many assumptions about the US market, all I am saying is that we may be in for a reasonable correction but it would not be of the same magnitude as they have.

 

Q: What is your sense of how fundamentals look out here because we have gone through an earning season, are you coming out of it feeling pretty confident if you strip the earnings of the forex gains of most companies or are you feeling a bit skittish or jittery about it?

 

Manishi Raychaudhuri: By and large, earnings have been pretty much in line with what we expected if you look at the major sectors though there have been some positive surprises particularly on the auto side where the expectations have been beaten down very sharply. In general, we are expecting somewhere between 18%-20% topline growth and similar earnings growth for this quarter. Some large companies are yet to report, they will report over the next three-four days, so we still have to keep our fingers crossed but by and large, I do not really expect any major negative surprise or for that matter a major positive surprise from this quarter. If you extend that time horizon a little longer and look at the fiscal 2008 as a whole, we have an earnings growth expectation of somewhere between 22%-23% for fiscal 2008 and between 17% and 18% for fiscal 2009, which means that from the previous two-four years where earnings CAGR was between 30% and 35%, it is now settling down in a more reasonable range and we believe that the sustainable earnings growth for this market is possibly around 15%-20%, maybe closer to the higher end of that range.

 

In that context, this 17-17.5 times P/E multiple is not really excessively expensive. Basically, the market is telling us that 15%-20% earnings growth is sustainable and it is only because the market movement over the last six months to one year has been narrowed that we are seeing such a sharp fall in the frontliners. But all in all, we believe that the earnings growth environment is likely to remain stable and I would also point out in this regard that the major concern that we have regarding earnings on inflation and the interest rate cycle seemed to have peaked. In fact, it is our point of view that the interest rate cycle at least in the near-term has peaked and the lending and deposit rates are unlikely to go up much further from the current levels, which obviously has positive bearing for consumption. 

 

 

Q: How do you read the technical factors now because today's fall in the Indian market might have been accentuated by very large F&O positions. Do you think there are reasons to worry out on the kind of leverages out there in the system if the global situations remains a bit murky for a day or two?

 

Samir Arora: Actually I do not look at technicals and I don't know how to overly read them but if you say that there was lot of shorting and that can't be a risky factor as it can only be a source of strength because if the market were to fall, then people are hedged and therefore the risk is less. If the market goes up then they will be short squeezed and we are not going to sympathize too much with bears being short squeezed. So if they have shorted whether rightly or wrongly that cannot increase the risk, if they had all gone long that would increase the risk. Now you basically created a capacity even if there is a murky situation in the world for few more days you created a capacity for shorts to cover and therefore they will provide liquidity on those days when the longs are panicking.

 

Q: What do you do with the sectors, which have run up quite a bit in the last one-month when that real spike happened? Do you find any pockets of excessive valuations even in those sectors where valuations are not based on promises but in some sense delivered numbers?

 

Samir Arora: Actually the only thing we did was marginally trim a few of them but we did not get out any positions, in the big companies, there is lot of value being created in subsidiaries, we do not today turn up in P/E numbers, I think Manishi Raychaudhuri also did that sometime ago, and recently I think CITI also did the same kind of report, which is that the P/E of the market would be lower if you eliminated the fact that ICICI bank has a insurance company, which does not turn up in earnings but obviously turns up in the price. Similarly Reliance's Oil finds and all do not turn up in earnings yet, and therefore P/E looks a bit overstated.

 

So here in such cases you have to make a little bit of view on what these subsidiaries are and how much value they can create and therefore in bullish market everybody becomes a little more bullish and so do we; right now we haven't found in these cap goods and the big Reliance and all any logic to think that they are to be sold completely. But just because they went up quite a bit in the last two months; capital goods in two months and Reliance in last month, we just trimmed everything a little bit.

 

Q: How high a probability would you attach to the prospect of fairly significant two-three months sell off in global equity markets, maybe more than 10%-15% across emerging markets including India, how much probability would you attach to that?

 

Samir Arora: For a 10%-15% from today's close, I would put maybe 20%-25%.

 

Manishi Raychaudhury: There is of course a difference between 10% and 15%, I am just throwing doubts here, I think it is impossible to put a number to this correction but honestly I would not really find a very high probability to a deep correction from here, maybe at most 8%-10% but possibly not more than that.

 

Samir Arora: Today when we talk about the market, we mean investors and institutional investors and particularly more than me others who are comparing across markets, today they still reasonably look at India on March 2008 earnings. In three-four months as we move towards September and October, it is more reasonable for the world to start looking at Mach 2009 earning. The currency has been flat for sometime, for example Infosys or TCS or all these exporters and tech guys will suddenly start looking as if they are 20% growers for 20 multiples and they suddenly wants to start looking reasonable.

 

Today a big part of our market, entire tech pack, looks as if it is growing below 20% and has 22 multiple but as soon as you pass three-four months and if during that time if the currency has strengthened, this means that the market would in any case have gone up because it is very unlikely that the market would be falling 10% and your currency would be strengthening.Therefore I do not think that because of this beautiful hedge that India has into its stock market index, you can have a very big correction unless of course the rest of the world is totally falling a part but if the world is falling 10, you could fall much less than that, if the world is falling 25, yes, you will fall that  much.