Stray Where You Are

lobally, consumer confidence is resurgent and the infectious optimism that the worst is over has catapulted stock markets to new heights. India has been among the best performing markets in the world since early May. Confidence and stock market gains have had a happy relationship over the years. But the nature of the relationship between a revival in confidence and rising stock markets is somewhat fuzzier. Is it possible that markets tend to influence perceptions of reality which, in turn, are a vital feedback loop for the markets?

After being battered into submission from October 2008 to February 2009, emerging market investors are right to feel buoyed by tangible signs of recovery in the real economy. The Baltic Dry Index quintupled from its October lows, copper rose more than 70 percent from its nadir and the announcement of 5.8 percent Q4 GDP growth in India was a huge boost for jittery local investors. In a sense, therefore, the return of “animal spirits” may not be wholly misplaced.
Yet, surely it is worth thinking about the implication of the precipitous decline in manufactured exports, if not in India then certainly in Korea! The joyous reaction to the bankruptcy proceedings initiated by GM, the 20 percent drop in volumes at China’s two largest container terminals and the fall of 5.7 percent in US GDP last quarter (upgraded from -6.1 percent) remains an enigma for investors who retain even a vestige of rational thinking.

The journey from “green shoots” to “sustainable recovery” seems to take a lot for granted. Few will argue that the synchronised global recovery owes a significant debt (pun not intended!) to massive co-ordinated fiscal and monetary stimulus. De-leveraging and financial restructuring remain a work in progress in the developed economies after the credit bubble burst. The process of catharsis could take far longer than many assume today.

The domestic economy is rather like the curate’s egg. While agriculture, mining and energy are in relatively fine fettle, large swathes of manufacturing (the automotive industry stands out) as well as retailing, tourism and construction are still not fully out of the rot. Stirring proclamations of intent by the new Cabinet have been enough to set the firecrackers alight. Nevertheless, implementing policy reform in India has always been a challenge for a host of reasons, not least of which is the agenda of our omnipotent babus.

There are other reasons to fear that the euphoria of May is overdone. The incredible urgency to complete qualified institutional placements by a number of financially stricken companies is an ill omen. Equally, the monstrous gains by the smaller companies relative to the blue chip constituents of the bellwether Nifty index are a sign of a market rapidly running out of steam.

Are there any opportunities then for those not inclined to punt? Thankfully, the answer is yes.
Corporation Bank (Rs. 301) is a conservatively managed regional bank which is extremely well capitalised. The bank is well capable of profitably growing its pristine loan book by 12-15 percent, yet it trades around 5 times trailing earnings and 0.9 times FY 09 book value, a surprisingly large discount to its PSU bank peers. Then, eClerx Services (Rs. 275) represents a winning bet on a brave, new India’s competitive advantage in the BPO universe. This pint-sized upstart could easily triple revenues and cash-flows in the next four years. Interestingly, it sports the highest average return on capital employed of any Indian company with a capitalisation above Rs. 250 crore during the last five years. Despite this, it trades at an 2008-09 earnings multiple of just over 8 and offers a dividend yield of 4 percent.

To be cautiously contrarian at this juncture would be par for the course. Institutional investment managers would do well to heed the wisdom of the poet-saint Kahlil Gibran, “the fear of hell (under-performing the benchmark!) is hell itself”.