Bet On Emerging Markets

Prateek Agrawal
Chief Investment Officer
ASK Investment Managers

• COMFORTABLE LEVELS
  On the valuations front, on one year forward PE we are trading at 10-15 per cent below the long term average PE. On the historical price to book value, the Indian markets are trading at some of the lowest levels seen over the past 10 years.
• LOOKING OPTIMISTIC
  Businesses with strong balance sheets, steady operating parameters and high return ratios have been witnessing a CAGR with profits over a long period of time, and present an interesting investment opportunity.

At this point of time, we are ofthe opinion that the emerging markets (EMs) are available at very attractive valuations. In fact, a look around the globe points to the fact that the developed markets are not that attractive at this juncture. Some Euro zone markets look good as far as their valuations are concerned, but one has to consider that they have their own set of issues. The EMs have corrected, and they are looking pretty good now. With the kind of growth and the higher ROEs that the EMs have earned over a number of years, we believe that investing in these markets is a pretty good idea at this point of time. Among the EMs, India has improved its attractiveness over the last one year, and its premium to EMs has fallen quite significantly.

On the valuations front, on one year forward PE we are trading at 10-15 per cent below the long term average PE, which provides comfort. On a matrix like historical price to book value, the Indian markets are trading at some of the lowest levels that we have seen over the past 10 years. Clearly, the markets have come to these levels due to the macro issues.

There is a sense that many of the macro issues could be improving, and that the currency could appreciate from where it is now, given that it is trading below the REER levels. The current account deficit has started coming down as a consequence of lower oil prices and gold imports. Secondly, the liquidity situation, which was extremely tight, has improved over the last couple of months and should improve further. The third big factor has been the concern over the government financials. While we believe that there would be a slippage against the budgetary estimates, the key would be the progress made over reduction in subsidies and the steps taken towards the auction of telecom spectrum and coal assets. The current scenario could also be used to raise import duty selectively for revenue generation.

As for corporate performance, we expect the Sensex companies to deliver earnings growth of around 15 per cent in FY13. This would be higher than the nominal GDP growth. The growth could come from margins improvement on account of lower interest costs and better pricing power on account of rupee depreciation.

It must be remembered that at present, liquidity in the system is tighter than what the RBI targets. Hence, chances of liquidity enhancement measures (including continued OMOs and CRR cuts) cannot be ruled out. A CRR cut would be positive, as it releases liquidity and also lowers the banks’ cost of funds. We continue to hold the view that a higher inflationary scenario has not been caused by monetary expansion, rather, it is on account of fiscal issues or supply-side issues. We believe that the window available to the RBI to effect cuts is narrow, as while core inflation is seen to be falling to stable levels at this point in time, it may start to inch up soon enough on account of inflationary pressures and rupee depreciation.

In the equity markets, we are not seeing any specific triggers coming up. We believe that the main reasons for investing in Indian equities are the lower valuations and low expectations. Moreover, if there is any improvement on the margins front or on the asset turnover ratios (which have fallen over the past few years), the return ratios would improve and the markets could settle at a significantly higher level.

Real GDP growth rate would be low for a period of time on account of several reasons, including high cost of capital, stress on the current account, land and resource-related problems, etc. As of now, we believe in businesses with strong balance sheets, steady operating parameters and high return ratios. These stocks have been witnessing a CAGR with profits over a long period of time, and present an interesting investment opportunity. Over time, only stocks with underlying businesses generating more than the cost of capital can deliver sustainable value. Free cash flow generating businesses stand a better chance of delivering growth in the present uncertain environment.