Reliance Mutual Fund - Equity Market Update
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Reliance Mutual Fund - Equity Market Update
Bottom-line: In the current volatile environment, investors have started extrapolating the current context
and speculating about the repeat of the doomsday scenario of 2008.
We assess that the current environment, though challenging is quite different and most variables now are
far superior in comparison to those prevailing at that time. While near-term challenges for the economy
and Indian equities will test our patience, is it probably a great opportunity for long-term Indian equity
investors? We give our perspective.
Over the last few days, Indian market has materially sold off owing to the massive rise in global risk
aversion. Globally, key indices have declined over 10% in less than two weeks due to macro data
disappointments from all over the World, especially the US. The latest announcement of US debt rating
cut by agency S&P has also added to the concern about the direction of the global equity markets in
particular.
Indian equities have, in fact, been facing headwinds since the beginning of this year owing to “domestic”
macroeconomic concerns. The news flow on the political front has also not helped matters. The recent
global uncertainty has added to the market’s woes. The US downgrade has probably acted as the last
straw to break the back of the Indian investor’s confidence. Not surprisingly, a section of the concerned
market has started talking about a double-dip and whether there would be a repeat of year 2008.
While, we acknowledge that the investment climate remains challenging, we think the concerns on repeat
of 2008 kind of sell is a bugbear. We assess that the current market backdrop is starkly different from the
doomsday scenario of 2008. Moreover, post the global financial crisis, the relative resilience of many EM
(emerging markets) economies, in general, and India, in particular, has led to increased investors’ faith in
these economies/markets. We explore these individual variables and highlight that the fundamentals are
far superior, while animal spirits are running at rock bottom levels.
Global economy and markets: The 2008 financial crisis was centered around US banks and corporate.
The fundamentals of these banks and corporates have tremendously improved in the last four years.
Moreover, it’s a well established fact that owing to their superior fundamentals, EM (emerging markets)
economies’ growth is far more sustainable as compared to their DE (developed economies) counterparts.
In 2007-08, the engines of global growth were DM (developed markets), while in the last 4 years, EM
have emerged as the biggest source of growth. Share of EM in global GDP has gone up from 28% in
2007 to 35% now. In 2011, EMs are expected to grow by 6% in 2011 while DM to grow by 1.5%. Though
not completely immune, the world economy is far less vulnerable to US and other DMs growth scare.
Impact of US credit rating downgrade: While, in near term, this has resulted in heightened risk aversion,
this is a reminder of the unsustainable overleveraged situation of the Western economies. The silver
lining is that global equities are trading at a very reasonable valuations (MSCI World index at below 11x
PE ratio) and from relative valuation perspective, equities are looking better than debt as an asset class.
8th Aug 2011From the medium term perspective, such events clearly strengthen the case of EMs assets (India, China).
They have the potential, over a period of time, to hasten the fund flow into faster growing, more resilient
and domestic oriented economies like India.
Sharp corrections and a softer pricing outlook for commodities and oil can be an additional long-term
positive for India. The monstrous concerns of inflation and high interest rates might also be a thing of the
past.
Indian economy: Indian macro variables have remained challenging for the last 3-4 quarters. The
expectations from Indian economy are far more muted now as compared to FY07-08. We might have
already seen the worst of the inflationary pressure and consensus expects below 8% GDP growth in India
in FY12. Over the last few quarters, market has only focused on few negatives on Indian economy, while
ignoring the robust expansion of the domestic economy. Since FY08, domestic economy has grown by
65%, while India’s market capitalization has gone down by 20%. India’s market cap to GDP ratio has
come down from 145% in FY08 to less than 80% now. Falling oil and commodity prices bodes well for the
economy and the equity markets.
Earnings and valuations: Earnings growth expectations are far more reasonable than what it was in
2007-08. Similarly, valuations are far more reasonable. The overall health of corporate India is better than
what it was in 2008. Indian market is trading at 13.7x 1 yr fwd P/E ratio as compared to 24x in FY07-08.
India’s broad market is far cheaper. Indian small cap index is trading at ~7x 1 yr fwd P/E versus over 13x
in FY07-08. Indeed, Indian market is trading at well below average multiples as compared to its own
history as well as versus its peers.
Flows and positioning: Unlike 2007-08 when foreign investors were extremely gung-ho on Indian
market (decoupling argument), this time the level of excitement is limited. While, flows into equities in the
last two years have remained satisfactory, year till date flows in 2011 has remained subdued suggesting
lesser exuberance of FIIs towards Indian equities.
Similarly, exuberance from the domestic investors both retail and institutions is now starkly in contrast
with 2008 levels. Indian institutions have received virtually negative inflows over the last 2 years and
therefore it can be deduced that the animal spirits among the Indian investors are running at low levels.
Other indicators like Open interest (OI), turnover (volumes), leveraged positions etc, corroborates the fact
that the exuberance in Indian equities is far from being called excessive.
To conclude, we acknowledge that the headwinds to Indian equities have been significant over the last
few months and that the uncertain global macro environment has added to the volatility. However, we
assess the fears of massive selloff, reminiscence of 2007-08 global subprime crisis are overdone. On
comparison, the variables at around the sell-off of 2008 were different and far more menacing than they
are now. While currently, certain section of the market is worried about repeat of 2008, we believe as
investors one should avoid panic and rather look at the current adverse environment as an opportunity.
8th Aug 2011While the market has been pricing a lot of those concerns, many of the headwinds which have been
troubling our market (domestic inflation and interest rates) are likely peaking now. From an investor
standpoint, we think notwithstanding the events/risks in the next few months, if one invest in equities now,
in the ensuing period one can expect relatively better returns over the following 12- 18 months.
In the following page, we provide an exhaustive snapshot of key variables to highlight the difference in
fundamentals and risks prevailing at around 2008 crisis versus now. Please have a look.
Common Source: Bloomberg
8th Aug 2011Please mind the difference
Comparison of variables prevailing around the beginning of massive selloff in FY08 versus Now*
Variables Jan-08 Now
Previous 6 months index
performance (absolute returns) 35% -3%
Previous 8 quarters index
performance (absolute returns) 112% 1%
Previous 8 quarters earnings
growth (absolute returns) 77% 49%
Index futures OI value (Rs Bn) -
avg 3m 189 158
Stock futures OI value (Rs Bn) -
avg -3m 560 332
FII flows (last 6 months) 12812 (USD mn) 3658 (USD mn)
FII flows (last 2 yrs) 26891 (USD mn) 41662 (USD mn)
DII flows (Retail) (last 6 months) 7802 (INR cr) 3323 (INR cr)
DII flows (Retail) (last 2 yrs) 22162 (Inr Cr) -33018 (Inr Cr)
Equity Inflows in MFs ( last 6
months) 28905 (Inr Cr) 3691 (Inr Cr)
Equity Inflows in MFs (last 2
yrs) 72200 (Inr Cr) -12864 (Inr Cr)
Earnings growth expectations 1
year fwd 37% 20%
Relative valuation (against
peers) 53% premium to Asia ex-Japan (AXJ) 22% premium to Asia ex-Japan
Relative outperformance (last India outperformed the AXJ region by India has under-performed the region
six months) 12% by 12%
% deviation from average PE 41% premium to long run average 4% discount to long run average
Valuation (1 year fwd PE ratio) 23.6x 13.7x
Small cap index valuations (1
year fwd PE ratio) 13x 7.2x
Market cap to GDP ratio 145% 80%
Buoyant: Market was ignoring bad Subdued: Market is ignoring the good
Mood/Sentiment news (Bear Stearns) news (UID, GST)
India GDP expectations (for
coming year) 8.50% 7.80%
Indian Corporate debt (Net debt
to equity) 40% 36%
Rupee (INR) valuation More vulnerable to correction (1 yr Less vulnerable (1 yr appreciation of
compared to history appreciation of 12.5%) 8.5%)
Interest rates (over the next six RBI raised rates by 125 bps (from RBI is almost done with the rate hike
months) 7.75% to 9% in July 2008) (25 bps more likely)
Inflation (over the next six Jumped by 6.6% points (from 4.5% to
months) 11.1% in July 2008) Likely to fall over the next 6 months
There were shortcomings. Huge Far more robust. No restructuring on
Indian banking system restructured assets the horizon
EM as % of Global GDP 28% 35%
Global Growth expectations High expectation. 3.5% (DM) 8% Reasonable expectations. 1.5% (DM)
(coming year) (EM) 6% (EM)
Impaired (eg CDS for global banking Much robust (eg CDS spreads of key
Global banking system giants jumped to record levels) banks are stable at lower levels)
Vulnerable (eg US Cos.D/E ratio was Robust (eg US Cos.D/E declined to
Global corporates health 70%%) 35%)
*Data as of week ending August 5th, 2011, Source: Bloomberg, CMIE
8th Aug 2011Where will the market be in April - 2012?
Following table gives a scenario analysis of where the Sensex could be trading on a 1 yr forward basis
(PE ratio) on April-2012 under various earnings growth and PE multiples scenario. With your own
assumptions you can see the implied level of Sensex.
Implied Sensex levels at different earnings growth assumptions and PE multiples
Sensitivity PE***
analysis 12 14 16 18 20
12% 15,977 18,640 21,303 23,966 26,628
14% 16,553 19,312 22,070 24,829 27,588
EPS growth**
16% 17,139 19,995 22,852 25,708 28,564
18% 17,735 20,691 23,646 26,602 29,558
20% 18,341 21,398 24,455 27,511 30,568
Implied Sensex for April 2012 = FY11 EPS * CAGR EPS for two years upto end FY13
*PE multiple.
*Base for earnings growth is actual Sensex FY11 EPS of 1061
**Earnings growth CAGR for two years FY12 and FY13.
***1 yr fwd PE ratio, To cite, 5 yr average of 1 yr Fwd PE is 16.5x
Source: Bloomberg
8th Aug 2011Disclaimers:
The views expressed herein constitute only the opinions and do not constitute any guidelines or recommendation on
any course of action to be followed by the reader. This information is meant for general reading purposes only and is
not meant to serve as a professional guide for the readers. Certain factual and statistical (both historical and
projected) industry and market data and other information was obtained by RCAM from independent, third-party
sources that it deems to be reliable, some of which have been cited above. However, RCAM has not independently
verified any of such data or other information, or the reasonableness of the assumptions upon which such data and
other information was based, and there can be no assurance as to the accuracy of such data and other information.
Further, many of the statements and assertions contained in these materials reflect the belief of RCAM, which belief
may be based in whole or in part on such data and other information.
The Sponsor, the Investment Manager, the Trustee or any of their respective directors, employees, affiliates or
representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability
of such information. Whilst no action has been solicited based upon the information provided herein, due care has
been taken to ensure that the facts are accurate and opinions given are fair and reasonable. This information is not
intended to be an offer or solicitation for the purchase or sale of any financial product or instrument. Recipients of this
information should rely on information/data arising out of their own investigations. Readers are advised to seek
independent professional advice, verify the contents and arrive at an informed investment decision before making any
investments.
None of the Sponsor, the Investment Manager, the Trustee, their respective directors, employees, affiliates or
representatives shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary
damages, including lost profits arising in any way from the information contained in this material.
The Sponsor, the Investment Manager, the Trustee, any of their respective directors, employees including the fund
managers, affiliates, representatives including persons involved in the preparation or issuance of this material may
from time to time, have long or short positions in, and buy or sell the securities thereof, of company(ies) / specific
economic sectors mentioned herein.
Statutory Details: Reliance Mutual Fund has been constituted as a trust in accordance with the provisions of the
Indian Trusts Act, 1882. Sponsor: Reliance Capital Limited. Trustee: Reliance Capital Trustee Co. Limited.
Investment Manager: Reliance Capital Asset Management Limited (Registered Office of Trustee & Investment
Manager: 'H' Block, 1st Floor, Dhirubhai Ambani Knowledge City, Koparkhairne, Navi Mumbai - 400 710,
Maharashtra). The Sponsor, the Trustee and the Investment Manager are incorporated under the Companies Act
1956. The Sponsor is not responsible or liable for any loss resulting from the operation of the Scheme beyond their
initial contribution of Rs.1 lakh towards the setting up of the Mutual Fund and such other accretions and additions to
the corpus.
Risk Factors: Mutual Funds and securities investments are subject to market risks and there is no assurance
or guarantee that the objectives of the Scheme will be achieved. As with any investment in securities, the
NAV of the Units issued under the Scheme can go up or down depending on the factors and forces affecting
the capital markets. The name of the Schemes do not in any manner indicates either the quality of the
Scheme; its future prospects or returns. Past performance of the Sponsor/AMC/Mutual Fund is not indicative of
the future performance of the Scheme. The NAV of the Scheme may be affected, interalia, by changes in the market
8th Aug 2011conditions, interest rates, trading volumes, settlement periods and transfer procedures. For details of scheme
features and for Scheme specific risk factors, please refer to the Scheme Information Document which is available at
all the DISC / Distributors / www.reliancemutual.com. Please read the Scheme Information Document and
Statement of Additional Information carefully before investing.
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