Marketfield Bets on Sensex Fall as India Small Caps Drop

India’s smallest companies are trailing its biggest corporations by the most since 2008 in the stock market, feeding pessimism about the central bank’s ability to boost economic growth from the weakest pace in a decade.

The S&P BSE Small-Cap Index has dropped 29 percent this year as earnings sank to a record low. The gauge of companies with a median market value of $68 million lagged behind the benchmark S&P BSE Sensex index, where stocks have a median value of $14 billion, by 23 percentage points. The only other times small-cap shares trailed this much were during an economic slowdown in 2004 and the global financial crisis in 2008, when the Sensex fell at least 12 percent in three months.

Declines in smaller companies from SKS Microfinance Ltd. to Automotive Axles Ltd., which get an average 87 percent of their revenue from domestic sales, reflect concern that the Reserve Bank of India will sacrifice growth to combat a record tumble in the rupee that threatens to increase consumer prices in a nation where 800 million people live on less than $2 per day. Policy makers raised interest rates in July, even as car sales sank to an 11-month low and industrial output contracted.

“In the end, you’d expect the largest companies to get dragged down,” said Michael Shaoul, the chairman of New York-based Marketfield Asset Management, whose $13 billion MainStay Marketfield Fund has outperformed 99 percent of peers tracked by Bloomberg in the past five years and is betting against Indian shares. “The catalyst for that may be the currency.”

BRIC Losses

Indian small-cap stocks last trailed the Sensex by this much during the three months ended March 2008, data compiled by Bloomberg show. The large-company index lost 12 percent within three months as the global economy slipped into recession. The small-cap gauge’s underperformance in 2004 preceded a four-quarter economic slowdown in India.

The Sensex rallied 2.3 percent to 18,312.94 at the close in Mumbai. The MSCI Asia Pacific Index declined 0.8 percent.

While the Sensex has posted a smaller decline than benchmark equity indexes in Brazil, Russia and China this year, the S&P BSE Small-Cap index has trailed similar gauges in the so-called BRIC markets.

Brazil’s Bovespa has dropped 17 percent during the period, Russia’s RTS Index is down 14 percent and China’s Shanghai Composite Index has lost 8.9 percent.

Rupee Tumble

The 29 percent tumble in the BSE Small-Cap gauge compares with declines of 18 percent in the MSCI Russia Small Cap Index and 17.6 percent in Brazil’s Bovespa small-cap gauge. China’s ChiNext index has surged 65 percent.

SKS Microfinance, a Hyderabad-based lender to the poor, and Automotive Axles, a Mysore-based auto-parts maker, have paced declines in India with losses exceeding 30 percent this year.

The rupee has weakened 15 percent this year and reached a record low of 65.56 per dollar today. That means dollar-based investors have lost 20 percent from Sensex shares and 40 percent from the 458-stock S&P BSE Small-Cap gauge.

India is in danger of entering a “vicious cycle” as the rupee’s tumble spurs policy makers to drain cash from the financial system and impose capital controls to support the currency, Shaoul said. That may stifle economic growth and deter investors, putting further downward pressure on the rupee, according to Shaoul.

Relative Valuation

The rupee’s decline is boosting revenue at some Sensex companies, which get an average 33 percent of their sales from outside India. Tata Consultancy Services Ltd., the nation’s largest software services exporter, rallied to a record on July 19 after reporting profit that beat analyst projections. Smaller rival Infosys Ltd. surged the most in six months on July 12 as its sales forecast in dollar terms topped projections.

The Sensex’s valuation has dropped to 2.3 times net assets, the lowest level since April 2009, according to data compiled by Bloomberg. That compares with 1.5 times for the MSCI Emerging Markets Index.

“We are beginning to see value emerge” in India, Jonathan Bell, the head of emerging markets equities at Nomura Asset Management, which oversees about $287 billion, said in an interview on Bloomberg TV India. “We are interested in companies that have global exposure.”

Expensive Onions

Currency weakness spurs inflation in the nation of 1.2 billion people, which imports about 80 percent of its oil. The country’s consumer inflation rate of 9.64 percent is the second fastest in the Group of 20 major economies, according to data compiled by Bloomberg.

A government gauge of prices for onions, a key ingredient in Indian cuisine, surged 145 percent in July from the same month a year ago. India’s per-capita gross domestic product of $1,592 compares with $51,248 in the U.S., according to International Monetary Fund estimates.

The RBI began tightening monetary policy last month to slow depreciation in the currency. India’s central bank raised two interest rates on July 15 and restricted lenders’ access to cash. Policy makers also tightened limits on overseas investments by local companies and curbed gold imports.

The central bank said Aug. 20 it will seek to limit increases in borrowing costs by buying long-dated government bonds. Yields on 10-year notes rose to 9.48 percent on Aug. 19, the highest level since 2001. India’s three-month interbank rate, a benchmark for borrowing costs in the $1.8 trillion economy, reached a 15-month high of 11.14 percent on Aug. 14.

Slower Growth

“The RBI’s actions of keeping very tight liquidity and high interest rates have to be very short term,” said Sampath Reddy, the chief investment officer at Bajaj Allianz Life Insurance Co., which manages about $6 billion. “These measures, if not reversed soon, will have severe impact on large cap companies as well as the economy.”

Asia’s third-largest economy may expand 5.5 percent in the year to March 2014, versus 5 percent in the previous 12-month period, the weakest pace since 2003, according to central bank estimates. The 10-year average is about 8 percent. Car sales have dropped for nine straight months through July, while industrial production fell 2.2 percent in June.

“We don’t see any improvement in macroeconomic numbers for next six to nine months,” said Shishir Bajpai, a senior vice president at IIFL Wealth Management Ltd., which has about $1.8 billion of shares under management and advisory. “Investors will be less interested in putting money on India.”

Earnings Slump

Combined profits for the 30 companies in the Sensex increased 1.4 percent in the three months ended June, compared with an estimated gain of 5.8 percent before the earnings season began, Bank of America Corp. wrote in an Aug. 19 report.

Trailing 12-month profit in the India small-cap gauge has tumbled 77 percent during the past year to the lowest level since Bloomberg began compiling the data in 2006. Earnings at Automotive Axles sank 38 percent in the June quarter, following an 87 percent decline in the three months through March, data compiled by Bloomberg show.

HSBC Global Asset Management, which oversees more than $400 billion worldwide, is reconsidering its bullish stance on Indian equities.

“In India, we have been very, very positive there” Bill Maldonado, the chief investment officer for Asia Pacific at HSBC Global Asset, said in an interview in Hong Kong yesterday. “We’re really wondering whether we got that wrong.”

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