Decoupling – Myth or Reality?

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The ticking time bomb has finally exploded and it has once again reminded the world how a financial or economic crisis can attain huge proportions. The world saw the Great Depression, the South-East Asian meltdown and now history has been made with the year 2008 tipped to go down as the 'Year of Sub-Prime Crisis'! A year that marked the end of independent investment banks as we know it. Who could have thought that the 'Sub-prime Crisis', a phrase which came into vogue in less than two years, could wipe off the best names on the Wall Street and shake the very foundation of the American financial system. Wall Street would never be the same as before as top five of its investment banks have either been sold, filed for bankruptcy or gone for makeover. Freddie Mac, Fannie Mae and AIG got the Fed's olive branch, while Washington Mutual and Merrill Lynch were advised to go for merger. Morgan Stanley and Goldman Sachs were encouraged to lose their 'I' status and turn themselves into traditional banking institutions, while Lehman Brothers (LB) filed for bankruptcy. As the dust now settles after the past chaotic couple of weeks, we pick up the tidbits to take a view on what lies ahead for the US economy and the impact which emerging markets such as India would witness going ahead.

Getting straight to the point, the US govt had to do what it did. Some liked it while some did not. While US Treasury Secretary Henry Paulson sees its $700 bn bailout as the last resort to drag out the country’s financial systems to safety, the American taxpayers are feeling otherwise and blame it on the Wall Street’s carelessness. But there are few interesting pointers that have emerged from this crisis. On the positive front, faster decisions and dissolving the line between investment banking and banking would allow faster cleaning up of the whole financial system. This augurs well as it would restore the market confidence which has been badly shaken. Secondly, with these institutions being brought under the purview of the US Fed, the Fed would now emerge as a leading regulator thereby leading to better control. Though the solution looks easy with this huge bailout package, it could push the US economy into deep recession, a scare that is already hovering over the economy. These symptoms are similar to that of Nordic countries (Sweden, Norway and Finland), which faced a similar crisis in the 1990s. [PAGE BREAK]

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Though such aggressive steps were successful, it dragged these economies into recession. Secondly, the move would ultimately hurt the American taxpayers more. In short, the road to recovery is not too easy and the government and Fed have a tough task cut out to keep its economy from sinking. Also, the unemployment numbers could rise in the coming period.

Should We Buy The India Decoupling Story?
Till early January this year, many continued to sell not only the India growth story but also the decoupling myth amidst global concerns. But the year 2008 has proved once again how vulnerable the global markets can be and that India isn't really decoupled as it was believed to be. Hence, India would see the impact of the crisis going forward. India wouldn't see the kind of foreign inflows that it has witnessed during the last few years. With the monetary tightening, money would now become dearer raising the cost of debt. Though the government has relaxed ECB norms for infrastructure companies, this higher debt cost could pinch the companies. As a result, companies could curtail their capex plans and also go slow on the new orders, thereby hurting their future earnings growth. IPOs have already dried up lately and although many companies continue to file prospectuses with SEBI, nobody would dare to come out so soon. Also, many companies displacements before IPOs which carry a one year lock-in period. This would get over soon for some companies and hence this can see some desperate selling on these counters. Realty could be the worst hit sectors as the funds that were easily available for huge projects would now dry up. Secondly, these companies won't beable to raise funds at the higher valuations as they did in the past. Thus, the realty sector could see some sluggishness in the coming period. Already, BSE Realty is down 53 per cent in the last one year. The other sector is IT, which could see its business shrinking in coming quarters. The US financial biggies would be focusing on restructuring their organizations and putting a rationalized structure in place. Hence, the IT budget could take a back seat for now, thus affecting the IT companies. Besides, the sudden rupee depreciation is of little help to the IT companies as most of them have hedged their earnings at around Rs 40 or Rs 41 against the dollar.

India – The Last Bull Standing!
Despite the main market drivers FIIs exiting the market for obvious reasons, mutual funds have stepped in to become the major force driving the Indian market. On a year-to-date basis, the FIIs have been net sellers to the tune of Rs 39311 crore while, during the same period, despite weak [PAGE BREAK]

sentiments, mutual funds have actually pumped in money to the tune of Rs12705 crore.  In fact, since the sharp fall in global markets witnessed in June and July this year over the US concerns, only Indian market has been in the positive zone, notching up gain of 9 per cent, even while all other markets are in the red. [INSERT_3]

HSBC Holdings PLC in its report has stated that in such a turmoil, there is a dearth of bullish fund mangers globally, but they found them aplenty in India. Thus, we can say that we are the last bull standing! It is quite clear that the domestic investors have seen value in the Indian market and hence the investment. Besides, with Finance Minister assuring time and again of GDP growth of close to eight per cent, there is nothing more investors can ask for in a situation where global economies are finding it much harder to maintain growth.

What's In Store Going Forward?
It's just three months for the close of the current calendar year, but we feel there are few important triggers which will guide the Indian market going forward. We don't expect the market to move up sharply in the next quarter and feel that it would be a period of consolidation. Firstly, amidst all the uncertainty, the September quarterly results that would kick in soon and any positive surprise could help in stabilizing the market to some extent. Then, the market would be closely watching the US Presidential election and would react depending the perception about the new US President. Besides, it being the year-end and holiday season abroad, historically the fund inflows tend to slow down during this period. It is only in January next year that we would see new portfolio allocations taking place and fresh funds pouring in. Hence, we don't expect the market to see any major inflows during the next quarter. We believe it is time to go back to basics of investing and focus more on the fundamentals which many would have been inclined to ignore during the bull run. Considering even an estimated EPS of Rs 950 for FY09, our broader market is available at a P/E of just14.42x, which is at a discount to its historical valuations of 15-16x. It would be prudent to invest in at the current levels with time horizon of next two to three years for better returns.