How decoupling will play out

Sandip Sabharwal - Uncategorized - How decoupling will play out

I find the hypothesis difficult to digest that all markets will remain coupled for all times to come. I have always maintained that decoupling plays out over a longer time frame and in the short run due to the linkages of the financial markets the movement of asset classes across countries tend to be linked to each other. However given the widely different growth prospects across economies in the longer run there is likely to be a very significant decoupling.
For example if we consider the real estate market in Western economies and in India. The Indian real estate market after going through a strong upmove in the mid 1990s went through a phase of nearly 10 years where the prices did not move up at all. A number of investor who bought property in the mid 1990s got the same or lower price for them till the year 2004, at which point the real estate boom started in India. However this was a time when real estate performed exceedingly well in countries like the US, UK and a large part of Europe.
The hypothesis that all markets are coupled and follow the US markets is the story of Western analysts who refuse to believe that the engines of economic growth are shifting Eastwards today.
The most historic event of decoupling has been the big boom in the US stock markets right through the 1990s, which corresponded to the bursting of the Japanese stock market bubble. The Dow went up from a level of 1938 at the end of 1988 to a level of 11500 by the end of the year 1999. In the same time period the Japanese markets fell from a level of 39000 at the end of 1989 to a level of 19000 at the end of 1999. Thus the biggest boom of the stock markets in the US corresponded to the big decline in Japanese stock markets and the economy.
I believe that a similar thing is likely to happen over the next decade for India (and some other emerging economies).
The reasons are very similar. The Indian economy is very well placed to grow at a rapid pace over the next decade given the huge structural strengths. The financial system in India is in a very robust position, Savings rate is high and household debt is extremely low, fiscal consolidation seems to be well under way with the government willing to take key reformist decisions. Funding costs for the huge investments required for infrastructure development will remain low due to the deflationary scare in Western economies which will key rates low for a prolonged period of time. As such both equity and debt funding should be easily available. Consumption growth in India will be strong with the nearly 10% expansion in Percapita GDP per year over the next decade. Thus both investment and consumption will drive economic growth.
It is estimated that over the next five years the average growth in the US economy will be 1.8%, Europe 0.8% and Japan 0.5%. As against this India is expected to grow at the rate of 8.5% and China at 7.5-8%.
The key is to see how this will play out in the decoupling story. The reason is very simple. If the US grows at 1.8% pa with fears of deflation then the long term i.e. 10 year earnings growth should track the nominal GDP growth plus some benefits due to productivity improvements and due to the fact that US MNCs have got a significant overseas presence which will benefit from the growth of the emerging economies where they have a presence and will contribute to their growth. In Indian the nominal GDP growth will be around 15% pa and there will be significant productivity improvements over the next decade. Now if we take the base of earnings today at 100 as on today both for the US and India and take an earnings growth rate of 4% for the US and 20% for Indian companies then the base of 100 will be 148 for the US and 619 for India at the end of 2020. As such the Dow Jones index from a level of 10000 is likely to be 15000 in that year and the BSE Sensex from a level of 18000 is likely to be 110000 by that year. Looks slightly incredulous so let’s discount it by 20% to get a level of around 90000 by that time.
In both the decades of the 1980s and 1990s the Sensex went up by around 6 times. This was a time when the average GDP growth in India was around 5.5%. Now that we are in an 8-9% GDP growth phase a similar thing is most likely and probable than not.
The overall financing costs in India are also likely to go down due to the upgrade of the countries credit ratings which will reduce the risk premium of investing into India. As such valuations are likely to only move up rather than down and the levels of the markets at 5 times the current levels are more on the conservative side than on the aggressive side.

As such investors will be better of buying into all dips to play the long term bull market of India.

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