India : Falling GDP, Rising Market – Here’s Why | Citi

[Jay Shah]

India Equity Strategy

Falling GDP, Rising Market – Here’s Why

 GDP growth is slumping - but the market is rising — India’s GDP growth has slumped ~250 bps in the last 1 year, expectations have crashed (consensus sub-6%) and India’s ‘structural growth’ story is sounding more like a fable. But, even as GDP growth has been falling, the equity market has been rising (13%+ YTD, +7.5% relative to Asia-ex). Possible mispricing, but there’s a plausible explanation too.

 FY01-03 (last growth slump): the downsides of lower GDP growth — India grew 4.6% during FY01-03 (down 200+bps); earnings growth moderated, sales

momentum tripped, and market multiples dropped to lows. And the equity market fell 39% in FY01 (from dot-com highs) and traded sideways for the next two years. This suggests that equities should be doing poorly into the current slowdown, but that is not the case. So where is the disconnect?

 But FY01-03: upsides in macro and corporate health — The slowdown brought gains on the macro – inflation dropped to 3.4%, interest rates fell by 5% and the current account turned to surplus. Corporates gained too – ROEs rose to 22%, margins expanded and corporate gearing almost halved, and the FY03-04 bull

market followed. Today we see some early signs of a similar macro easing (liquidity/rates), and a corporate sector refocus on returns/risk vs. growth.

 Caught between FY01-03 bear years and the bull ones that followed – We see growth downsides being offset by (further out) macro upsides. This should keep the market tussling, and range-bound. In our view, the growth revival will be slower and macro gains quicker than market expectations: this should lend an upward (and cyclical) bias to the market. We maintain 18,400 Dec 12 Sensex target (+6%).

 Defensives do well going into a slowdown; cyclicals coming out of it — Defensives do well going into a slowdown, cyclicals coming out of it and it is a littlebit more balanced in between. In our opinion, India is probably in the middle of the economic down-cycle, and we see better risk-reward in cyclicals than defensives.

--
Best Regards,
Jay Shah, FRM
Expect the unexpected!!!