No time to buy the India story
Exclusive to Hardnews Atim Kabra, Singapore
The wealth destruction happening all over the world is on an unprecedented scale. The scale of the collapse of the markets is gigantic and almost all asset classes have moved south in tandem. There is no place to hide. As money searches for a safe haven, the US Dollar has been the biggest gainer. These gains are driven by the relative transparency of the US financial system and the flexibility in the American system to take drastic cost cutting measures through job layoffs and shutting down of unprofitable and unsustainable businesses. There is a flight to safety though the CDS pricing (Credit Default Swap) on US treasury has been creeping up with investors seeking protection from a potential default by the US government itself. Year to date, the major best performing equity markets in US dollar terms have been USA (Dow Jones down 38%), Switzerland (down 36%) and Chile (down 36%) while China (down 73%) and Russia (down 72%) have been amongst the worst performers. India, Austria, Greece, Hungary, Norway, Turkey, Indonesia and Venezuela are all down in excess of 60% year to date in US dollar terms. On a year on Year basis, metals are down over 44% since November last while Oil has closed at its 20 month low on its journey south. Gold which was thought of a safe haven in times of imploding markets and a cloudy future is down 9% over its closing previous November. Commodity index is down over 40% over November 07. Indian equity market has been amongst the worst performers in the world. Partly it is because it was amongst the world’s best performing markets last year and had attracted a lot of portfolio inflows and the trend has since reversed. The surging liquidity in the markets had attracted a lot of new players in the markets (primarily new hedge funds) who value short term price considerations and value the ability to trade in and out quickly. The long term fundamentals of the companies take a relative back seat to short term stock price movements. One can make a case that this factor distorted the fair pricing mechanisms of many companies which got priced at unsustainable valuations in the giddy days of daily new stock market highs. The market demanded new stories and the soaring ambitions of Indian entrepreneurs backed by stratospheric valuations supplied new investment opportunities with scant regard for valuations. While the going was good, it did generate a favorable climate for attracting new equity for large capital intensive projects. New projects were announced and easy availability of money and limited analysis assured that not only they got funded but the companies embarking on these projects also got a boost in their valuations as future earnings streams from these projects were captured in the stock prices while scant attention was paid to the gestation periods and operational aspects of these projects. In retrospect the disastrous performance of Reliance Power post listing should have set the warning bells ringing for the market. However, greed overshadowed reason and the party continued. Now the chickens have come home to roost. The pendulum has swung in the opposite direction and a lot of value stocks have emerged. The very stocks which were the darlings for many investors have suffered a horrendous bashing and now quote for a fraction of their peak valuations. This has led to several calls in recent past arguing that India is a fundamentally attractive market right now and can be bought with a 12 month horizon for decent gains. My argument is that indeed while many attractive investment opportunities have emerged in individual stocks, it is premature to buy the market as a whole at this point. This is at best a trading market and there well may be a scenario where there will be market rallies which will not sustain and indiscriminate buying at this point in time may well lead to significant losses. Fundamentals based investors could do well avoiding the markets at this point in time. In a massively interlinked world as it exists today, recessionary conditions globally are being transmitted across to India at warp speed. The main arguments for arguing serious long term investors to wait before investing are based on the following thought processes which I shall expand in detail over the next few posts: • The sectors which led the boom suffer from serious issues at this point in time. Slowing global and domestic demand, excess capacities coming on stream globally, shortages of capital, credit squeeze at suppliers end, job losses abroad and domestically leading to tapering demand etc. One can argue that there will still be further value erosion there. (Real estate & commodities sector) • Poor availability of credit (infrastructure & industries dependent on financing: autos) • Unavailability of funds for equity portions of large projects (infrastructure) • Wealth destruction on a global scale (banking) • Expected defaults amongst corporate and retail borrowers (banking) • Repricing of risk • Dramatic reductions in overseas orders (IT & export focused industries : textiles, Gems & Jewellery) • Reducing GDP growth rate assumptions and decreasing earnings estimates However, I need to state that most of the damage is already priced in the valuations today. We now have to wait for the impact of the above to become clearly visible in the earnings stream of the corporate sector. I would be closely watching for the capitulation which has to happen. Somehow there still seems to be a vague hope for recovery which has still lingered on due to the rapidity at which the correction has happened. Only when that hope is crushed beyond redemption that the market will be a screaming buy again. Till then trade with abundant caution.
The author is based in Singapore and manages two private equity funds. He can be reached at firstname.lastname@example.org