Value Getting Visible???

Before coming to the title of my post, let me cover another subject which is causing lot of turbulence across the global financial markets- Inflation...or should I call- Inflation Hoax???Numbers released in last few days show huge month on month inflation in US....though the core inflation is mostly benign yet. Fed talks have been hawkish and anticipation of hardening interest rates in US have contributed to Dollar rally. The bond yields have gone up in recent days, but the gap between long dated bonds and shorter duration bonds is still miniscule. Mr Greenspan's conundrum remains unresolved....but is there any conundrum at all? What is the bond market signalling??....many things, but primarily that interest rates and inflation down the road will be low by historical standards. What are the underlying causes for this....again many, but primarily that technology induced productivity gains will ensure that there are no sustainable spikes in input prices. Just look at huge capacities being built in China and paradigm shift in global cost structure of manufacturing...and it gets extremely hard to believe sustainably high prices of manufactured goods. Talking about wage induced inflation....did anyone see in past cycles a huge sea of manpower being available through outsourcing? Talking about oil...yes it is a concern...but demand is not as inelastic as most of us thought...there have been resistance to high prices. The only area of concern is overheated US housing market....and Mr.Greenspan is trying his best to take some air out of it through talks whenever he gets opportunity...and there are signs of some cooling off.
So here again is my broad view on inflation and interest rates....we will continue to see lower numbers for both, compared to historical averages. Fed will achieve price stability through what they call "measured pace" and my estimate of peak rate is 4.5%-5.0% by second or third quarter of next year. We are in a phase of sustainable above average expansion of global economy(barring certain events that I mentioned in my earlier post).
My take on Indian Markets at this juncture....as earlier stated, the compelling growth in Indian economy, a big domestic consumption story and unique India centric advantages available to certain set of industries will ensure that India will get a serious look from global money. This government has hardly delivered any concrete liberalization....it has to start delivering that...fast.....or it will have to learn that hard way through foriegn money's exit. Though we are not on the verge of fiscal fiasco....government has to prune fiscal deficit. And importantly...RBI should get slightly more aggressive with its monetary policy and boost up interest rates so it does not lag behind....I think markets have already priced that.
Now the most important thing....yes, I see value getting visible at current prices(sensex is at 7800-7900). The extreme optimism of past few months have given way to some degree of pessimism...though not sufficient enough to make this a valid bottom. But finding the bottom has no monetary value and its better to focus on stocks where value is getting visible and also to see the broad long term picture.....and the picture is compelling. However, as mentioned earlier, the markets going forward would be turbulent and its better to stay in the company of the strongest. The best way to make money in an economy growing at 7%-8% is by being bullish but to get your act correct you need to price the growth correctly and ride right "vehicles".
The beaten down prices of today and depreciated Rupee will sow the seeds of next bout of foriegn fund inflow into Indian Equities.

The Potent Vehicles

In my previous post, I talked about identifying the vehicles which can reliably ride the growth in Indian economy. So what those vehicles are? Though I have an independent view on that, I thought of looking into what some of the good money managers are thinking. I shortlisted 2 money managers for whose research I have high regards: Fidelity and Morgan Stanley. A peek into the most recent publicly disclosed top 10 holdings of the largest mutual funds of Fidelity and Morgan Stanley in India sprung up only 2 names in common: HDFC Bank and Hindustan Lever(HLL).

There is a unaminity among most fund managers about HDFC Bank....its a good stock to own over the long haul. Its lineage and trackrecord of delivering growth is impeccable. What better way to ride credit expansion in one of the fastest growing economies in the world....and virtually exploding consumer banking franchise( though ICICI Bank is a better bet for riding consumer banking growth...I will save that discussion for a future post)?

Hindustan Lever's case is much more interesting.....majority of the fund managers have a bearish/underperformer outlook on this stock( this is based on my research over the web). As far as my view is concerned....you cannot play India without owning this stock. Most of the money managers are underestimating the stamina, tenacity and reach of the Unilever machine in India. It holds key to potentially one of the few large untapped consumer franchise in the world. A long list can be made highlighting strong competitive position of HLL....I'll mention one-Distribution Reach.It runs highly complex, efficient and difficult to replicate distribution system that reaches smallest of the villages in India(70% of Indian population is in villages) and it will ensure that HLL captures disproportionate share of spending on consumer goods. I consider HLL a Long Term Buy with 12 month target of Rs 210( 20%+ return on Friday's closing prices).

I would mention another great Indian stock.....you cannot have meaningful exposure to India's GDP growth without owning Reliance Industries Limited(RIL). In my previous post, I briefly touched upon the subject of emergence of hypercompetitive Indian MNCs....RIL is one of them. I consider RIL a Long Term Buy with 12 month target of Rs 925( 20%+ return on Friday's closing prices )....more on this extraordinary corporation in my future posts.

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Global Liquidity and Indian Markets

Last week's Indian market behaviour was more or less in line with my expectations....but the bigger events happened away from Indian shores. Last week was dominated by emergence of extraordinary inflation numbers in the US(biggest month on month rise in 25 years), more hawkish Fed talk, and strengthening Dollar. Does this mean we are near to seeing the rise in core inflation, extraordinary Fed tightening and spike in bond yields???My view is.....No. I believe, the inflation numbers were combined effect of Katrina and oil spike witnessed during past month. The oil consumption pattern indicates that the demand is not as inelastic as everyone thought. I continue to hold a view that Fed would achieve its objective of price stability through measured increase in rates....with peak rate target of around 4.5-5.0% by the second or third quarter of next year. The broad view continues to be that of above average expansion of global economy, consolidation across broad range of industries, further integration of various national economies into global economy, and moderate interest rates by historical standards. The only threats to this view are emergence of terrorist attacks on a big scale, protectionist measures or impediments to free trade flow.

Where is Indian market headed??? I believe the global liquidity tide is on the ebb and it has implications for emerging market like India.....but there is a compelling growth in the Indian economy which cannot be ignored.The key is to identify the companies which can capture that growth and convert it into enterprise value. Also, the unique India centric advantages might already have begun the phenomenon of emergence of hypercompetitive Indian MNCs. History shows that in emerging markets only handful of companies can deliver growth in a sustainable way over a longer duration. I continue to hold a view that India will continue to attract foriegn money and fund managers would more intensely be focussed on a few companies which will reliably capture the growth in underlying economy or leverage India centric advantages to scale up globally.

I believe, at 8000-8200 levels, there might be some value that is getting visible. However, handful of companies will move ahead, with majority getting left behind. There might be some churning of portfolios with bets being taken off from aggressive sectors and moving into defensive sectors.

India will continue to be on global fund managers' radar...barring some fiscal fiasco. The issue is: what is the correct price for that growth and whether there are vehicles which can reliably ride that growth?????

Where is it going?

The Indian equities remain attractive for long term global investors with strong domestic consumption story intact and several other themes, leveraging India's competitive delivery capabilities for global markets( IT outsourcing, auto components......), in place. But the big question is: Is all the goodness captured in current valuations???
My answer is....probably yes. At a sensex level of 8800, the broad market was reasonably valued for the near term.To break this level in a hurry, and hold beyond that level, there has to be strong evidence of accelerating GDP and some market forecast beating growth numbers from the leading companies. The likely scenario is for the market to consolidate in 8300-8800 range for few months or fall to around 8000-8200 level, where serious money would start smelling value in the market.
The global liquidity, which was chasing emerging markets in general, might get sucked back to US due to hardening rates. US equities too are looking attractive with stock prices not getting compensated in last few years for reasonable growth and are currently having very attractive yields. Emerging markets have another big competitor in form of Japan, which is now in an almost confirmed mode of long term economic expansion(...after 20+ years)....it will attract lot of money.
Foriegn investors have placed big bets on India's future....for the bets to remain on table, Indian companies will have to show numbers, Indian economy will have to sustain 7-8%+ GDP growth and Indian Government will have to work overtime on delivering concrete liberalization. Don't forget...its the smartest money in the world which have taken Indian equities to the heights never seen before....and there are strong reasons for it to behave this way....but it is a demanding money.