Delta Global Partners Research: The Cutting edge

Title: Markets Losses: Due to the fire or the stampede after it?

Region: INDIA Date: 05th February 2010 No of Pages: 5

What did go wrong in Indian markets and in the world in 2010? From the peak in 2010,
investors around the world lost close to USD 4 trn in market capitalization (Bloomberg
WMC Index), almost equal to China’s GDP. That’s lower by around 8%. (Chart I).
Chart I: Bloomberg World Market Cap Index: The USD 4 trn hole from 2010 peak

48

46

44

Source: Bloomberg. Market Cap in USD trn (RHS)

What about Indian markets? India was supposed to be decoupled from the global
markets. Let’s see how the Indian markets have performed from its peak in January
2010. (Chart II). The Sensex lost 11% from its peak in 2010.The figure of 11% seems to
be average for the fall in Sensex as well as for other 10 BSE sectoral and market
capitalization indices. Early cyclical sectors like Realty (-33%) and Metals (-17%) took
some hard knocks whereas Consumer Durables, FMCG and Healthcare (Pharma)
outperformed the Sensex. Surprising? No. Why? Since broader valuations were being a
little stretched with cyclicals, the markets slowly moved to the non cyclical and low
volatility sectors, the so called defensives. More on Indian markets later in the note.
Chart II : BSE Sensex and Sectoral Indices from its peak in 2010

1%
BANKEX
SENSEX
POWER

OIL&GAS

REALTY
BSE-500

BSE-200

BSE-100

AUTO
CD

HC

PSU
FMCG

CG
MIDCAP
TECk

IT

METAL
SMLCAP

-4%

-5%
-9%
-8% -9%
-11% -11% -11% -11% -11% -11% -11% -11% -11% -11% -11% -12% -12%
-14%
-14%

-19% -17%
The -11% Club
-24%

-29%

-34%
-33%

-39%

Source: Delta Global Partners Research & www.bseindia.com Data from 2010 Sensex high to 05th Feb 2010

Non Institutional Research 1 www.dgp.co.in

Delta Global Partners Research: The Cutting edge

Title: Markets Losses: Due to the fire or the stampede after it?

Region: INDIA Date: 05th February 2010 No of Pages: 5

So what’s going on? It’s an old adage that “If you wear green color glasses, you can see
only green,” But what if you closed your eyes? It doesn’t matter then what color glasses
you wear. And when you close your eyes, the upper limit of what you can see is your
imagination. And the upper limit of imagination is infinity.

The imagination in 2010 came in form of the Global Green Shoots, the Global Fading
Risks as well as the hangover returns of 2009. What many investors did not realize is
that the interpretation of fading risks is not in any way the permanent disappearance of
risks. It often happens in a liquidity driven bull markets coming out of an economic
recovery, that investors tend to not only wear colored glasses, but also close there eyes.
And may be ears too, so that they don’t see or hear the train (risks) coming standing on
the tracks.

The Global Risks had never faded: It went behind the curtains for the time being only to
lurk out when the gusty winds blew the curtains high above the ground levels.

The Governments of the world transferred the risks from private and household balance
sheets to there own, in form of large public debts and deficits resulting from stimulus.
Thus the sovereign risk, though the most underrated risks in early 2009, reemerged
with vengeance. We had discussed this risk in our publication “The 36 trn burden of
coming generations” which can be read here http://www.dgp.co.in/DGPR-
TheUSD36trnburden.pdf . And who got sucked into the Sovereign Risk Whirlpool:
Dubai (many then had said “it’s a one off incident”), Greece and may be Portugal, Spain,
Ireland, Italy are on its way. And hopefully not Japan, UK or US.

The other outcome of a deeper financial crisis (rather abuse of banking) is “the Risk of
Over Regulation (financial) “whether its Obama’s take on Wall Street
compensations/bonuses or the recent restrictions on US banks proprietary trading or
the Volker Rule on sweeping changes on baking regulations. This risk is a present
danger to laissez faire coming at a time when new capital for banks is relatively a scarce
commodity in global markets. The policy error in form of early withdrawal of stimulus
(mis judging a recovery) also remains a source of global risk too. And for US it also
might be higher taxes or health care worries.

The Sovereign scare in Europe has taken the EUR, Gold, Oil and other commodities
down with it. Improved unemployment figures in US were overshadowed which is not
unusual though. Commodities were already a little shaken on China liquidity tightening
actions to rein in the excessive bank lending and asset bubbles. If not China, who will
then buy commodities?

Risk aversion is back as the USD appreciates (highest vis a vis EUR since July 2009) and
VIX a risk aversion measure rose again (Chart III). CDS (Credit Default Swaps) shot up
and were already reflecting the deteriorating fiscals of many European countries. The
fact went unnoticed that the CDS on some of the US states (California) are as high as the
troubled European nations. Treasury Bonds in US are marginally higher. The scare also
Non Institutional Research 2 www.dgp.co.in
Delta Global Partners Research: The Cutting edge

Title: Markets Losses: Due to the fire or the stampede after it?

Region: INDIA Date: 05th February 2010 No of Pages: 5

made the early hikers (Central Banks of Norway and Australia) to pause for a while. The
worry on the sovereign risk would also postpone the withdrawal of stimulus for a while
now. Inflation has been a worry in Asia too.
Chart III: The VIX index: Return of Risk aversion as of now?

Source: Bloomberg

What are the implications for Indian markets?

India remains linked to the global risk appetite and sentiment via the FII flows. If a
systemic global collapse materializes, India won’t be able to escape it. The 2010 flows
from FIIs till February 03rd were barely a whimper (net purchases of around USD 45
mn). On 11th January 2010, the FII net purchases till date in 2010 were at a high of USD
1.88 bn. If we knock off one or two large QIPs/placements with FIIs of around USD 1 bn,
the net FII figures would have been net sales of around USD 955 mn, which is not very
encouraging. INR is back at 46.7. The Mutual funds continue to suffer from redemptions
(or is it valuations driven?) and the regulatory assault on it. Net outflows from equity
funds were almost USD 400 mn in January 2010 as a result of which they sold some
USD 328 mn worth of stocks in 2010. The crowning glory was the Insurance sector
which was on buying side in January 2010 to the extent of closer to USD 3 bn.

For the moment, let’s forget about the negative global impulses. What about Indian
fundamentals? Do they continue to be robust? Yes, if IMF and RBI have to be believed.

RBI in its credit policy gave away its clear intention to normalize the liquidity in coming
months and make it dear. Much of the exit is already in the prices, at least in Bond
Markets. RBIs priority remained managing inflation and yet sustaining growth
momentum. RBIs growth projections were reasonable with the usual caveats on risks.
Inflation at 8.5% by March 2010. Growth estimates were raised by RBI as well as IMF
(8.00% in 2010-11) recently. IIP (Index of Industrial Production) is growing in double
digits though a little uneven across industries. Hopefully it should compensate the risk
of agricultural sector not doing well. The twin deficits, fiscal and current account will be
the dampeners. And the up coming Budget would address the fiscal issues with the roll
Non Institutional Research 3 www.dgp.co.in
Delta Global Partners Research: The Cutting edge

Title: Markets Losses: Due to the fire or the stampede after it?

Region: INDIA Date: 05th February 2010 No of Pages: 5

back of some of the industry specific benefits extended in last year. One needs to watch
these industries such as Autos which have benefited from the Government largesse,
how they will fare without the benefits. The Union Budget should also provide a road
map for reforms and inflation control.

Bank credit is showing some signs of picking up being into hibernation for a while.
Remember Bank Credit is a lagging indicator. Loans to infrastructure and iron and
steel sectors were much higher on a year on year basis. The danger to interest rates
(and bond prices) comes from a simultaneous pick up in the capex cycle and bank credit
off take and a supply or demand driven rise in inflation especially, if the coming
monsoon goes awry. The Government borrowing program in 2010-11 will be watched
closely too.

So the key is the replacement of the government stimulus driven demand by private
demand/corporate investments, by creating conducive policy environment, to ensure
sustainable growth. The domestic driven lead indicators are showing reasonable
buoyancy. In its recent policy RBI did talk about some demand pressures in the
economy, which could hopefully give corporates the much required pricing power.
Chart IV: Long Term Trailing PER & P/BV for SENSEX

6.50
47 6.00
42 5.50
37 5.00
32 4.50
4.00
27
21.19 3.50
22 19.57 3.00
17 2.50
12 2.00
CY 1991

CY 1992

CY 1993

CY 1994

CY 1995

CY 1996

CY 1997

CY 1998

CY 1999

CY 2000

CY 2001

CY 2002

CY 2003

CY 2004

CY 2005

CY 2006

CY 2007

CY 2008

CY 2009

Avg since 1991

2010 current (5th Feb)

SENSEX Trailing PE Avg ( LHS) SENSEX Trailing P/B Avg (RHS)

Source: Delta Global Partners Research and www.bseindia.com

Earnings so far in Q3 of FY 10 were reasonable. The broad market net profits were
higher by around 40% (yoy) driven mainly by margins (higher by almost 2.5 pp yoy).
Corporate revenues showed some life after a lull for last few quarters by rising at 10%
yoy. Productivity gains, external recovery and pricing power in some pockets are
helping.
Non Institutional Research 4 www.dgp.co.in
Delta Global Partners Research: The Cutting edge

Title: Markets Losses: Due to the fire or the stampede after it?

Region: INDIA Date: 05th February 2010 No of Pages: 5

Incidentally, the SENSEX is now trading at around 14.4x Price Earnings Ratio (PER)
on FY11 estimated earnings and lower by around 11% from its peak of 2010. The
SENSEX valuations are now marginally lower than its long term 1 year average of
forward as well as the trailing PER (Chart IV). Non index stocks are further lower. In
fact Sensex PERs are lower than the average trailing PER in the year of 2006. Indian
markets in 2010 have witnessed a favorable combination of shrinking PER and rising
earnings. The Global risk appetite as well as the liquidity remains reasonable as of now
but not as high as in 2009.

If we presume that the aforementioned global risks don’t materialize in a systemic

manner, the 11% correction or more can be used by longer term investors to start
increasing exposure in every dip to the broader Indian markets and to quality stocks.
We surely don’t know which way the markets will go in short run, but the underlying
fundamentals of India (corporate earnings and economic growth) are showing good
promise. 8% Real GDP growth rate projected for India by IMF for 2010-11 is very
encouraging. And if the earnings and growth expectations are not revised dramatically
lower, India is on a good wicket after the recent corrections in markets.

And the difference between the fair value of stock markets based on economic
fundamentals and the prevailing stock market levels is the “Short Term Mis pricing”,
which would ultimately re align. Here is a thumb rule on market valuations.

In the long run, ignoring the leads and lags in relationships:

Weaker Economy + Weaker Earnings + Falling Markets = Fair Valuation

Weaker Economy + Weaker Earnings + Rising Markets = Over Valuation
Growing Economy + Rising Earnings + Falling Markets = Under Valuation
Growing Economy + Rising Earnings + Rising Markets = Fair Valuation

Source: Delta Global Partners Research

But investors should not put on the colored glasses and close their eyes to the risks in
stock markets especially those which emanate from the evolving adverse circumstances
beyond India and in the developed world. And India is not immune to it from the short
term volatility perspective. Since in a packed auditorium when someone shouts “FIRE”,
the losses are more due to the stampede that follows, rather than from the fire itself.

Devendra Nevgi Delta Global Partners

deven@dgp.co.in Founder & Principal Partner
Tel: + 91 9867 277 977
IMPORTANT DISCLAIMER:
The note and the suggestions are for information purposes only and not to solicit any business. Delta Global Partners do not take any
responsibility of the losses that may arise out of actions taken based on the note. The figures and charts are not authenticated by any
authority. Please make an independent review before taking any decision. Delta Global Partners does not intend to act as a portfolio
manager or investment advisor registered with SEBI or under any other law. The author of the note may or may not exposure to the
strategies suggested, if any.

Non Institutional Research 5 www.dgp.co.in