Happy birthday, global stock rally
The global stock rally is one-year old. World stock markets closed at their low for the crisis 12 months ago on March 9. The rally that then started is still intact. The FTSE All-World index is up 75% in dollars, no significant market is down and big emerging markets have had huge gains-more than 160% for Russia and Indonesia. The S&P 500 index is up 2.7% for the year. The index is 69.3% above the March 9, 2009, closing low, which is 26.8% below the peak in October 2007.
But a year on, we can see the rally had two distinct phases. First came 7 months of explosive growth, led by financial stocks. Since then, financials have stalled or even fallen back, and the main indices have basically consolidated since then. Investors remain confident that the Armageddon scenario of a collapse of the world's payment system has been averted. But they are not so certain about the recovery. Instead, they fear a different Armageddon scenario, where the government spending that averted the first disaster will lead to sovereign debt defaults.
Let us look at the stock trajectory of Citigroup. A rally was sparked with an internal memo by Vikram Pandit, chief executive of the financial conglomerate, confirming that it had made money in the first 2 months of last year. Fear of nationalisation for Citi had spurred the final market plunge. As that fear abated, Citi's outperformance was explosive. By August, it was up 240% from its nadir. Since then, however, it has dropped 31%. The broader KBW Banks Index is up 162% for the past 12 months, but slightly below its peak last October.
In a week of anniversaries, it is 10 years since the Nasdaq Composite peaked, crashed and burned. The dotcom bubble seems to be from another world, a speculative aberration that is now over. But we are still living with its consequences. The dotcoms were a classic tale of speculative excess and overvaluation, to be compared with Japan in the 1980s or the US in the 1920s. The fallout was identical.
The US Fed took deliberate steps to avoid a repeat of the US in the 1930s or Japan in the 1990s. It slashed interest rates, helping ensure that the macroeconomic damage from the dotcom crash, in the form of a very brief and shallow recession, was remarkably light.
Emerging markets are likely to outperform the developed markets over the long run due to strong domestic consumption and forward-looking infrastructure investments. Yet, there are increasing questions concerning the fact that the rise in emerging markets resembles previous stock market bubbles and will fizzle out, just as in the past.
In India, we are currently in the midst of a synchronised global recovery, and with aggressive government stimulus, strong balance sheets and an ever-growing share of global GDP.
Current correlation between MSCI India and MSCI Emerging Markets is 0.80 (it was 0.30 in January 2003). The correlation between MSCI India and MSCI World is 0.70 (was 0.15 in January 2003). This strong correlation was driven by synchronised global growth and liquidity. Over the last 3 years, MSCI India P/E commanded premium over MSCI Emerging Markets. Since December 2008, Indian markets have been at par with the emerging markets and are gaining momentum post May 2009. By the end of 2009, the MSCI India P/E was ahead of MSCI Emerging Markets.
On a yearly basis, MSCI India has outperformed MSCI Emerging Markets. Returns in MSCI India and MSCI Emerging Markets increased by 91.5% and 74.5%, respectively, in absolute terms over the last one year.
FIIs have invested $1.35 billion in Indian equities in just a week-the most in 5 months and the best in any week after the Union Budget since 2001. The fiscal consolidation plans outlined by the Indian government have strengthened the relative attractiveness of India as an investment destination of choice.
Infrastructure spending in India has lagged its global peers (4% of GDP in India compared to 9.5% in China). Lower investment in infrastructure along with 8.5% GDP growth rate during the last 6 years has resulted in severe pressure on existing infrastructure. The sheer size of the opportunity and the huge returns offered by investment in infrastructure makes investment in India particularly attractive.
Currently, there is an estimated shortfall of about 2.5 crore dwelling units in India. With growing urbanisation and higher affordability (household income to cost of home is 5-6 times compared to 18 times-plus in 1995), there is going to be a strong and sustained demand for housing in India. Aspirations, awareness and access to credit provide a nice tailwind.
The cumulative amount of FDI inflows from August 1991 to December 2009 stood at $127.46 billion. India's FDI inflows touched $26.5 billion in the April-December period this fiscal. The country has attracted FDI worth $23.82 billion in the January-October 2009 period and October 2009 alone witnessed a 56% YoY jump in FDI with inflows of $2.33 billion. India attracted FDI equity inflows of $1.54 billion during December 2009.
Total FDI inflow in India is likely to cross $35 billion for FY 2009-10. India's share of FDI inflows into Asia has increased to 10.6% from 2.4% in 2000, making it one of the most attractive destinations for foreign investment.
The 2009 survey of the Japan Bank for International Cooperation conducted among Japanese investors continues to rank India as the second most promising country for overseas business operations, after China. According to commerce and industry minister Anand Sharma, FDI equity inflows as a percentage of GDP has grown from 0.75% in 2005-06 to nearly 2.49% in 2008-09.
The services sector comprising financial and non-financial services attracted FDI worth $3.54 billion during April-December 2009-10, while computer software and hardware sector garnered about $595 million during the said period. The telecom sector attracted $2.36 billion FDI during April-December 2009-10.
The Indian retail market, which is the fifth largest retail destination globally, has been ranked as the most attractive emerging market for investment in the retail sector by AT Kearney's annual Global Retail Development Index in 2009.
FII investment in Sensex-based stocks has already touched 17%. However, I expect FIIs to continue their chase in mid and small cap Indian stocks as these companies are expected to perform as the growth engine of the Indian economy turns full circle. The midcap P/E is currently at 27% discount to large cap P/E (historical average is 11) and midcap valuations are currently more attractive. Yet, as FIIs increase their exposure to India, they will invest in large cap stocks as well. Investors in Indian markets should take some heart from the fact that India has outperformed the world's markets by a good margin.
For years, there was easy money in the 'yen carry trade'-borrowing in yen at very low Japanese interest rates to invest in higher yielding assets elsewhere. But last August, three-month Libor rates in the US fell below those of Japan. This made a 'dollar carry trade' more attractive, so the correlation between selling dollars and buying stocks took hold. When Greek fiscal problems triggered a crisis in the eurozone, this made it too risky for big funds to continue their bets against the dollar.
In recent weeks, US Libor has stabilised as the market believes the Fed decision to raise its discount rates could be equated with signs of tightening monetary policy, although chairman Ben Bernanke has vowed to keep interest rates low for an extended period of time. Libor rates in yen and dollars are now virtually identical.
Carry traders' desire to bet against the dollar has dwindled. And in the process, the US is again outperforming other world stock markets. And the rest of the world is expected to piggyback on the stock market rally led by the US in 2010, till another global event causes the stock market leadership to change once again. But that is for another day.
Investors had a funny way of commemorating the first anniversary of the market's bottom on March 9. They rewarded some of the stocks responsible for most of the problems in the first place. Shares of Citigroup, AIG, Fannie Mae and Freddie Mac-all of which, to varying degrees, remain dependent on the federal government for support-surged on March 9. AIG led the way with a more than 13% pop.
If Lehman Brothers, Bear Stearns and Washington Mutual were still around, I'm sure their stocks would have soared on March 9 as well. When a bull market begins, junk often outperforms the quality companies because they get a special premium simply for survival. March and April 2010 should prove to be quite beneficial for equity investors across the world.