The Hindu Business Line : Rounding off 2007 with rich valuations

The deluge of FII inflows in September and October caused a breathless rally in stock prices that has resulted in Indian stocks closing the year with rich valuations. The Indian market has also become the second most richly valued among the major equity markets.

Movers and shakers… (Clockwise from top left) Messrs Anil Ambani and Mukesh Ambani, Dr Y. V. Reddy and Mr Ben Bernanke.

S. K. Lokeswarri

The year 2007 began, as did the four years preceding it, with the usual dollop of scepticism and the widespread belief that “this year, the returns will be moderate.”

Though the nay-sayers were right in the first six months, when the Sensex gained just 6 per cent, the fireworks in the second half ensured that the benchmark ended the year with a handsome 38 per cent gain in rupee terms and nearly 65 per cent gains in US dollar terms.

Interest rates

The subdued performance in first half was largely due to the Reserve Bank of India going on the warpath against inflation.

Efforts to control inflation (the wholesale price index surged by a record 6.75 per cent in February) resulted in a series of interest rate and CRR (cash reserve ratio) hikes that were sometimes sprung on the investors when they were at their most unsuspecting.

The resultant slow-down in credit off-take and the trickle-down effect on interest rate-sensitive sectors kept stock markets edgy.

It was only when the inflation started easing in the second quarter and Dr Reddy ceased springing surprise rate-hikes that the stock market could breathe easy.

Turbulence overseas

Interest rate was not the only millstone around the market’s neck in 2007. All three major corrections (over 10 per cent) last year were caused by upheavals in global financial markets.

The 16 per cent fall in February was caused by a meltdown in Chinese stocks leading to FIIs going on a selling spree.

The other big falls of 2007, in August and then in October, were triggered by sub-prime mortgage foreclosures in US.

This led to bedlam in financial markets due to the CDO (collateralised debt obligation) on these loans falling through, taking many hedge funds, brokerages and banks to the brink of bankruptcy.

But the sub-prime crisis in US and Europe proved a blessing in disguise for Indian markets.

FII flows

Money flying out of these developed markets were attracted to Indian shores, lured by — you guessed it — high GDP growth, a domestic-consumption driven economy, relatively low reliance on the US economy, and so on.

September and October saw copious net inflows into the cash market from the FIIs, to the tune of $9 billion, taking the tally for 2007 to $16 billion.

This is more than double the inflows received in 2006. Mutual funds were less aggressive and remained net sellers last year.

Valuations

The deluge of FII inflows in September and October caused a breathless rally in stock prices in this period that has resulted in Indian stocks closing the year with rich valuations.

The Sensex currently trades at a price to earning multiple of 27 times, trailing earnings. This is a premium of nearly 68 per cent over its five-year average.

The Indian markets have also become the second most richly valued market among the major equity markets.

However, the small- and mid-cap stocks have outdone their large-cap brethren in 2007; the BSE Smallcap Index gained 73 per cent while the Midcap Index gained 58 per cent.

These stocks started whizzing skywards once the domestic investors took over from the FIIs following the imposition of the restrictions on offshore derivative instruments in October.

Needless to add, the valuations have sky-rocketed in these segments; those of small-cap stocks doubled in the last quarter of 2007 while the mid-caps have almost caught up with the large-caps.

Reliance pack

A stock market round-up of 2007 would be incomplete without mention of stocks from the Reliance group (both factions). Reliance Industries gained 117 per cent this year and contributed almost 1600 points to the 6000-point rally in the Sensex.

The bellwether’s stellar performance appears to have ignited the belief among the investment fraternity that the Reliance tag would open the door to instant riches.

And thus began the frenzied chase of stocks with the ‘Reliance’ tag, such as Reliance Petroleum, Reliance Natural Resources, Reliance Capital, Reliance Chemotex Industries and so on.

Though the rally in many of these stocks lost steam towards the end of the year, the last word on the Reliance pack has not been written yet.

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