On the Outlook for India and Vegetarianism and Heart Disease!

From: aditya rana
Date: Sat, Oct 5, 2013 at 1:56 PM
Subject: On the Outlook for India and Vegetarianism and Heart Disease!


India continues to attract negative headlines, driven by widespread concerns regarding the uncertain political situation and its susceptibility to global capital flows arising from its burgeoning current account deficit. While the near term outlook is likely to remain volatile as the political uncertainty will not be resolved at least until the elections in the summer of 2014, it is helpful to step back and take a closer look at the underlying long-term trends which point towards continued outperformance of its economy and stock market. In a recent note, the Morgan Stanley India strategy team of Chetan Ahya and Ridham Desai provide a 20 year retrospective on the economy and stock market and make predictions about its possible future course. To summarise:

-Over the last twenty years, India’s GDP has increased by 6.9% per annum, the capitalization of its stock market has compounded at an annual rate of 17% , and the stock market index has outperformed the emerging markets index by 28% (in $). The 20 year period can be broken down into four distinct boom and bust cycles.

During the 1994-97 period; GDP grew by 6.5%, inflation averaged 8%, the current account deficit widened due to investments rising faster than savings and the rupee fell by 15%. While corporate earnings grew at their fastest pace ever (25% annual), and ROE averaged 16%, valuations were high as well (with P/E ratios averaging 18) leading to a relative underperformance of the stock market versus EM (-22% in $). Consumer staples were the best performing sector.

During the 1997-2003 period; GDP growth fell to 5.2%, inflation moderated and the current account deficit narrowed (eventually moving to a surplus by 2003) as savings increased relative to investments. Real rates were high compared to GDP growth with earnings growth falling to minus 1.3%, though ROE remained high due to increasing asset turn. However, the stock market outperformed EM on a relative basis (+17% in $), and financials were the best performing sector with eventually falling rates and improving macro fundamentals, setting the stage for the next phase.

During the 2003-2008 period; growth increased to 8.9% while inflation stabilized, investments increased leading to an initial increase in the current account deficit which then stabilized due to increase savings resulting from fiscal consolidation. Earnings grew by 24% , ROE reached record levels (20%) and the India stock market re-rated significantly versus emerging markets and traded at an average premium of 30%. The improvement in global conditions led to an increase in inward capital flows ($47BN for equities) and a decline in interest rates, resulting in a 44% compounded return on equities and a 90% (in $) outperformance over EM. P/E ratios averaged nearly 20 and Industrials were the best performing sector.

During the 2008-Present period; growth held at 7.7% following a strong fiscal and monetary stimulus response to financial crisis, but a continuation of the stimulus policies lead to higher inflation, a widening current account (and fiscal) deficit, high rural wage growth and lower real rates. Earnings growth declined to just 6% and ROE went back to average levels of 16%. While the stock market was basically flat, and P/E ratios held steady at 18% (due to outperformance by the index heavyweights), it underperformed EM by 30% (in $). Despite the poor performance, and a 60% fall in the rupee, foreign investors kept faith in the Indian stock market and bought $75BN during the five-year period. Consumer staples (once again) outperformed.

Looking forward over the short-term: The macro environment remains challenging, and India needs to improve its macro balance sheet through an increase in savings and a reduction in the current account deficit and inflation. Real rates would therefore need to remain high relative to GDP, and with a negative equity yield gap (equity yield minus real rates) equities are not cheap on this basis. GDP growth would therefore need to be boosted by policy reforms and an improvement in the business environment. The current cycle resembles that in the late nineties, given the level of real rates and corporate de-leveraging required, and therefore the global liquidity situation and next year’s election would be crucial in determining the outlook for the equity market in the next 12 months.

Longer-term outlook: The combination of demographics, productivity and globalization will continue to support the medium-to-longer term outlook for India.

Demographics: The decline in the ratio of the elderly and children to the working-age population from 68.1% in 1995 to 53.8% in 2012 has supported the rise in savings. During the period 2011-2020, India is expected to add 133 million working-age people which is 26% of the increase in the global working age population. Savings, investment and real GDP are expected to remain high with the favourable demographics.

Productivity: In addition to demographics, policy reforms to boost productivity are critical to achieve high growth going forward. The government in taking steps in the right direction since September 2012, by reducing the fiscal deficit significantly and controlling subsidies, while starting measures to revive private investment spending. An improving growth mix will increase productivity and enable higher GDP growth over the next 12-18 months.

Globalization: The steady rise in exports to GDP and capital inflows to GDP, following the reforms in the early 1990s, has also helped to increase the growth rate. Total exports of goods and services has increased to 24% of GDP in 2013 from 11.3% in 2001, and this integration into the global economy is expected to continue, providing support to the growth rate going forward.

-India is expected to average 7% growth over the next 10 years, with investment, exports and consumption contributing to the growth rate. India’s favourable demographics which are expected to continue until 2040, provide the basic support for high growth going forward.

-High growth rates do not necessarily translate into high equity returns – there are two key additional factors: 1) a sensible starting point for valuations, and, 2) the ability of companies to translate growth into earnings by maintaining discipline on equity supply – i.e. reasonable ROE. India scores well on both counts.

-Based on a variety of valuation measures, the long-term growth rate priced into Indian equities is moderate. The equity risk premium is estimated at 5%, which added to the 10-year bond yield of 8.5%, implies an annual expected return of 13.5%. P/E and P/B multiples suggest similar outcomes.

-ROE has currently dropped to a cyclical 10-year low, driven by a fall in net margins and asset turnover. While ROE is likely to decline over the long-term with long-term interest rates, it is still expected to be in excess of interest rates for a while longer due to: 1) the historically high correlation between GDP growth, industrial growth and earnings growth which is expected to continue, 2) corporate balance sheets are underutilized providing an upside for ROE growth, with Indian corporations being disciplined about equity raising, and, 3) India’s growth dynamic providing for lower cyclicality in earnings going forward than what has been observed over the last 10 years.

-Lastly, the favourable demographics is likely to support an improvement in the structural liquidity going forward, as a younger population directs a larger share of the increasing savings into equities. A strong capital markets infrastructure provides support for this shift.

-In conclusion, the long-term returns from equities are likely to match the 10-year trailing trend of a 15% per annum compounded growth rate.

-Charts to illustrate some of the above points:

A helpful framework to look at the medium-to-longer outlook for the Indian economy and stock market. Given current valuations, and the macro-economic fundamentals, one can expect compounded returns in the 10-15% range (in rupees), and therefore any significant market dips (like we saw in August) should be used as an opportunity to add to long positions. In addition, my short-term outlook for Indian equities is also positive, as the global liquidity situation is expected to actually improve later in the year (despite a gradual tapering by the Fed) with the ECB reversing course on its asset reduction strategy which has been in place over the last year or so (as noted in my newsletter of 9/7). The financial sector is likely to outperform, as it has been down sharply and will benefit most from improving liquidity.

Vegetarianism and Heart Disease:

The serialization of the book "The Blue Zones of Longevity" will resume from next week. Meanwhile, please take a look below at a recent finding from the Oxford University, which shows that vegetarianism can lower heart disease by 32%!.

-The risk of hospitalisation or death from heart disease is 32% lower in vegetarians than people who eat meat and fish, according to a new study from the University of Oxford.

-Heart disease is the single largest cause of death in developed countries, and is responsible for 65,000 deaths each year in the UK alone. The new findings, published in the American Journal of Clinical Nutrition, suggest that a vegetarian diet could significantly reduce people’s risk of heart disease.

-Most of the difference in risk is probably caused by effects on cholesterol and blood pressure, and shows the important role of diet in the prevention of heart disease,’ explains Dr Francesca Crowe, lead author of the study at the Cancer Epidemiology Unit, University of Oxford.

-This is the largest study ever conducted in the UK comparing rates of heart disease between vegetarians and non-vegetarians.

-The analysis looked at almost 45,000 volunteers from England and Scotland enrolled in the European Prospective Investigation into Cancer and Nutrition (EPIC)-Oxford study, of whom 34% were vegetarian. Such a significant representation of vegetarians is rare in studies of this type, and allowed researchers to make more precise estimates of the relative risks between the two groups.

-Professor Tim Key, co-author of the study and deputy director of the Cancer Epidemiology Unit, University of Oxford, said: ‘The results clearly show that the risk of heart disease in vegetarians is about a third lower than in comparable non-vegetarians.’

-The Oxford researchers arrived at the figure of 32% risk reduction after accounting for factors such as age, smoking, alcohol intake, physical activity, educational level and socioeconomic background.

-Participants were recruited to the study throughout the 1990s, and completed questionnaires regarding their health and lifestyle when they joined. These included detailed questions on diet and exercise as well as other factors affecting health such as smoking and alcohol consumption. Almost 20,000 participants also had their blood pressures recorded, and gave blood samples for cholesterol testing.

-The volunteers were tracked until 2009, during which time researchers identified 1235 cases of heart disease. This comprised 169 deaths and 1066 hospital diagnoses, identified through linkage with hospital records and death certificates.

-The researchers found that vegetarians had lower blood pressures and cholesterol levels than non-vegetarians, which is thought to be the main reason behind their reduced risk of heart disease.

-Vegetarians typically had lower body mass indices (BMI) and fewer cases of diabetes as a result of their diets, although these were not found to significantly affect the results. If the results are adjusted to exclude the effects of BMI, vegetarians remain 28% less likely to develop heart disease.

Here’s to maintaining a largely vegetarian diet!




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