India Hit by Record Low ‘Buys’ on Rate Outlook

By Michael Patterson and Shiyin Chen

Jan. 25 (Bloomberg) -- Investment strategists are cutting recommendations on India at a record pace after the country’s stocks surpassed China as the most expensive major emerging market for the first time since 2006.

The Bombay Stock Exchange Sensitive Index is valued at 20 times estimated profits, higher than China for the first time since November 2006 and the second-most expensive among the 25 biggest markets after Japan, according to monthly data compiled by Bloomberg. Even after the Sensex sank 4 percent last week, the most in almost three months, its stocks trade within 6.1 percent of analysts’ average 12-month price estimates.

Rising valuations prompted analysts to cut “buy” ratings on Indian equities to a record low. Goldman Sachs Group Inc. said the Reserve Bank of India plans its first interest rate increase since 2006 this week to curb inflation. The last eight times wholesale price increases climbed above their long-term average, the Sensex posted average losses of 5.6 percent, Bloomberg data show.

“There are better opportunities in other emerging markets,” said Roger Groebli, the Singapore-based head of financial market analysis at LGT Capital Management, part of a group that oversees about $84 billion. India “will be an underperformer for the first quarter,” he said.

Growth Rebounds

The Sensex gauge fell 0.9 percent to 16,715.34 as of 10:04 a.m. in Mumbai. The gauge surged 117 percent from its March low to a high on Jan. 6 as growth in the fourth-largest emerging economy after China, Brazil and Russia accelerated. Gross domestic product grew 7.9 percent in the three months through September, from 5.8 percent at the beginning of 2009. India may expand 6.4 percent in 2010, according to the Washington-based International Monetary Fund.

The rally pushed the Sensex’s valuation above China’s Shanghai Composite Index, which trades for 18 times analysts’ earnings estimates. Chinese valuations are falling as faster growth adds pressure on policy makers to slow the rise in asset prices. The government reported last week that the economy expanded 10.7 percent in the fourth quarter, the fastest pace since 2007.

Brazil’s Bovespa trades at 13 times earnings estimates and Russia’s Micex is valued at 9.2 times. Japan’s Nikkei-225 Stock Average has a ratio of 40, compared with 14 for the Standard & Poor’s 500 Index, Bloomberg data show.

Tata Motors Ltd., maker of the world’s cheapest car, led the Sensex’s advance since March with a 470 percent gain. The Mumbai-based company is valued at 27 times analysts’ earnings estimates, compared with 23 times for Shanghai-based SAIC Motor Corp., China’s largest carmaker.

Analysts Cut Ratings

Surging equity valuations prompted India stock analysts to drop their “buy” ratings to 49 percent of total recommendations, the lowest level since Bloomberg began tracking the data in 1997 and down from 59 percent a year ago.

The rise in price-to-earnings ratios may prompt companies to sell shares in stock offerings. Indian firms have plans to raise as much as $30 billion while the government may sell about $10 billion of shares in state-controlled companies, according to Kotak Securities.

Indian stocks risk a “tactical correction” because investors have failed to price in the effect of rising interest rates and inflation, according to Goldman’s Hong Kong-based strategist Timothy Moe.

Inflation Surge

India’s wholesale-price index climbed 7.3 percent in December, the fastest pace in more than a year. Central bank Governor Duvvuri Subbarao probably will raise the key reverse repurchase rate by 25 basis points to 3.5 percent and the cash reserve ratio by 50 basis points to 5.5 percent at the next policy announcement on Jan. 29, Moe said in a Jan. 15 research report.

Eleven of 15 economists surveyed by Bloomberg predict policy makers will keep the reverse repurchase rate unchanged. Subbarao said last week he aims to support the nation’s economic recovery without “compromising” on price stability. A basis point is 0.01 percentage point.

Overseas investors sold a net $123.9 million of shares on Jan. 21 as the government said food inflation stayed above 15 percent for the ninth week. The report dragged down financial shares from Housing Development Finance Corp. to ICICI Bank Ltd., which are both based in Mumbai.

‘Go Too Far’

India’s market “hasn’t factored in the risk of tightening whereas China has already begun to,” said Shane Oliver, the Sydney-based head of investment strategy at AMP Capital Investors, which oversees about $90 billion globally. “The macro backdrop in India and the share-market valuations are less favorable.”

The Shanghai Composite has dropped 10 percent from its 2009 peak in August as the People’s Bank of China raised the proportion of deposits that banks must set aside as reserves and allowed three-month bill yields to rise. Policy makers are trying to reduce funds in the banking system after record loan growth spurred concern that bubbles will form in the equity and property markets.

Stocks plunged around the world Jan. 21 as concern grew China will do more to cool its economy after the fourth-quarter GDP report.

“What China is trying to do is take the foot off the accelerator,” said Oliver. “It’s already having a negative effect on the stock market because investors are concerned that they’ll go too far.”

2010 Retreat

The Shanghai Composite is down 5.2 percent this year, the biggest decline among benchmark indexes in the largest emerging- market economies, or BRICs. The Sensex and the Bovespa dropped about 4 percent. Only Russia’s Micex is up this year with a gain of 3 percent.

AMP cut holdings of Indian stocks to “underweight” relative to China and other emerging markets near the end of 2009, Oliver said. India is the only underweight holding for money managers among the BRIC markets, according to a Bank of America Corp. survey this month.

India’s higher valuations are justified because profits are poised to rise as the economy keeps expanding, said Ivan Leung of JPMorgan Private Bank. Ten of the 16 companies in the Sensex that have reported third-quarter results topped analysts’ estimates, Bloomberg data show.

India Delivers

“Earnings growth looks solid and economic growth, even post-tightening, still looks pretty good,” said Leung, the Hong Kong-based chief investment strategist at JPMorgan Private Bank. “India simply trades at a premium because it strongly delivers on that earnings growth.”

Indian companies may post compound annual profit growth of 22 percent over the fiscal years ending March 2011 and March 2012, JPMorgan Chase & Co.’s brokerage estimates.

Better-than projected profits have failed to stem declines in the Sensex. The gauge dropped 3.5 percent since Bangalore-based Infosys Technologies Ltd., India’s second- largest software exporter, kicked off the earnings season on Jan. 12 with results that topped analysts’ estimates.

ICICI, India’s second-largest bank, sank 2.9 percent on Jan. 21 even after reporting better-than-expected results. Wipro Ltd., India’s third-largest software exporter, lost 1.7 percent on Jan. 20 after beating analysts’ profit estimates.

The Sensex posted an average drop of 5.6 percent during periods when wholesale inflation climbed above its long-term average of 5.2 percent, Bloomberg data show. That compares with an average decline of 3.4 percent in rupee terms for the MSCI emerging index during the same periods.

“Inflation pressures are rising swiftly,” Goldman’s Moe wrote. “India seems most vulnerable.”

To contact the reporters on this story: Michael Patterson in London at mpatterson10@bloomberg.net; Shiyin Chen in Singapore at schen37@bloomberg.net.