AN INVESTMENT OUTLOOK
Presentation by
MORGAN STANLEY INVESTMENT MANAGEMENT (INDIA)
GLOBAL MARKETS OVERVIEW
SECTION I
A Historical Snapshot
“History doesn’t repeat itself, but it rhymes” - Mark Twain
1
A Historical Snapshot
• Nasdaq correlation with 10-year lagging Nikkei 225 (US$) at 0.9 over past 15 years
300.00 5000
Nasdaq lagging Nikkei by 10 years 4500
250.00
4000
3500
200.00
3000
150.00 2500
2000
100.00
1500
1000
50.00
NASDAQ 100 (LHS) 500
0.00 0
Feb-75 Jun-79 Oct-83 Feb-88 Jun-92 Oct-96 Feb-01
Source Salomon Smith Barney
2
A Historical Snapshot
Source Morgan Stanley Research 3
A Historical Snapshot
Every extraordinary capital market gain has retreated 100% or more
Commodities
Gold Crude Oil Nickel Cocoa
1970-1999 1962-1999 1979-1999 1970-1999
2000 80 250 600
1600 200 500
60
Real Price
Real Price
Real Price
Real Price
1200 400
150
40 300
800 100
200
400 20
50 100
0 0 0
0
70 74 78 82 86 90 94 98 62 66 70 74 78 82 86 90 94 98 79 81 83 85 87 89 91 93 95 97 70 74 78 82 86 90 94 98
Currencies
US Dollar U.K. Pound Japanese Yen Japanese Yen
1979-1992 1979-1985 1983-1990 1992-1998
2 1.4 1.4 1.4
Cumulative Return
Cumulative Return
Cumulative Return
Cumulative Return
1.8 1.3 1.3 1.3
1.6 1.2 1.2 1.2
1.4 1.1 1.1 1.1
1.2 1.0 1.0 1.0
1.0 0.9 0.9 0.9
0.8 0.8 0.8 0.8
79 81 83 8 5 8 7 89 91 79 80 81 82 83 84 83 84 8 5 86 87 8 8 8 9 9 0 92 93 94 95 96 97
Stocks
S&P 500 S&P 500 Japan vs . EAFE ex-Japan S&P 500
1920-1932 1946-1984 1981-1999 1992-1999
2.3 2.5 3.0 2.8
Detrended Real Price
Detrended Real Price
Detrended Real Price
?
2.5
Relative Return
2.0 2.3 ?
1.8
2.0 ?
1.5
1.3 1.5 1.8 ?
Fair Value Fair Value ?
1.0
1.0
0.8 1.3 ?
0.5 Fair Value
0.5 ?
0 0 0.8
0
20 21 22 23 24 25 26 27 28 29 30 31 81 83 85 87 89 91 93 95 97 99 92 93 94 95 96 97 98 99 00
46 50 54 58 62 66 70 74 78 82
Source Grantham, Mayo, Van Otterloo & Co
4
Historical Snapshot
Market bubbles and manias
• Technological revolutions have come and gone for centuries - often leaving stock
disasters in their wake
• Manias almost always originate from some very fundamental development
– Pattern of slow recognition to too much capital chasing few real ideas
– Technological progress is not linear (economics matters as in the case of airlines)
• Sectors fade….canals, railways, automobiles, radio, biotech and now internet
• Star markets lose relevance….Thailand
• It almost always takes longer to repair the damage than people expect
“The interval between the decay of the old and the formation and establishment of the new, constitutes
a period of transition, which must always necessarily be one of uncertainty, confusion error, and wild
and fierce fanaticisim” - John C. Calhoun (1850)
5
Historical Snapshot
History suggests that once a grouping has lost its leadership position, it rarely
regains that title quickly
• Automobiles
– General Motors stock soared more than 5500% from 1914 to 1920
– Overcrowded auto industry failed to deliver on inflated expectations in early 1920s
– GM lost 2/3 of its stock value in six months
– Many once great auto companies: Packard, Studebaker, Hudson disappeared over time
• Railroads
– After the economic crash of 1837, it took a handful of railroad stocks a solid decade to regain
pre-crash levels - and most didn’t
• Radio
– Radio Corp of America rose 2000% over six years until the 1929 crash
– It took more than 3 decades for the stock to revisit its highs
6
Historical Snapshot
Golden ages - analysis of price and earnings trends
.
Period Qtrs Price-ann. Earnings-ann.
Duration Compound chg Compound chg
Sector Market Sector Market
Aerospace & Defence 1Q73-4Q80 32 20.2% 3.5% 23.5% 14.3%
Food & Drug retail 4Q74-2Q92 70 20.5% 12.2% 15.3% 7.0%
Restaurants,Pubs & Brewerier 1Q77-2Q86 37 22.0% 14.2% 15.0% 7.7%
Mining 4Q77-3Q80 11 38.6% 13.3% 54.2% 17.2%
Oil & Gas 3Q78-4Q80 9 37.9% 10.0% 52.6% 15.7%
Water 3Q80-1Q85 17 34.4% 7.2% 68.5% -0.3%
Beverages 4Q80-2Q92 46 20.5% 11.1% 12.0% 4.7%
Tobaco 4Q80-4Q92 46 23.0% 10.7% 14.0% 4.3%
Retail 4Q80-4Q93 52 16.8% 11.6% 10.4% 3.9%
Food Processors & Producers 1Q81-3Q92 46 16.8% 11.2% 11.1% 5.5%
Speciality & Other Finance 4Q84-1Q87 11 83.8% 43.4% 51.5% 9.9%
Hotels, leis & entertainment 4Q84-3Q93 36 23.2% 14.1% 16.1% 5.6%
Construction & Building Materials 1Q85-2Q89 17 44.6% 24.8% 31.4% 12.6%
Packaging 3Q86-1Q92 22 16.2% 7.3% 13.6% 6.3%
Steel and other materials 4Q87-1Q89 5 80.4% 17.1% 203.4% 11.6%
Life assurance 4Q88-3Q98 39 15.6% 6.0% 15.7% 6.2%
Personal goods and household prods 4Q88-3Q98 39 14.0% 6.0% 9.7% 6.2%
Software 1Q90-1Q00 40 37.4% 11.2% 20.8% 5.9%
IT hardware 3Q92-2Q00 31 38.6% 13.7% 31.4% 8.0%
Pharmaceuticals 4Q94-1Q99 17 31.9% 14.1% 11.7% 7.4%
Average 31.2 31.8% 13.1% 34.1% 8.0%
Source Salomon Smith Barney
7
Historical Snapshot
Dark ages - analysis of price and earnings trends
Period Qtrs Price-ann. Compound Earnings-ann.compound
Duration Chg chg
Sector Market Sector Market
Personal goods & household prods 1Q76-4Q80 19 -1.9% 9.5% 12.4% 16.4%
Chemicals 1Q76-1Q01 100 7.1% 9.9% 5.3% 7.9%
Forestry & Paper 4Q76-3Q00 95 3.5% 11.4% 3.5% 7.8%
Telecoms 1Q77-4Q80 15 -5.5% 12.5% 5.3% 16.0%
Autos 1Q78-1Q01 92 6.8% 10.6% 2.4% 7.0%
Engineering (Period1) 3Q78-1Q87 34 8.3% 16.6% -0.8% 6.6%
Mining 3Q80-2Q86 23 -6.4% 15.5% -15.4% 1.9%
Oil & Gas 4Q80-2Q87 26 5.8% 19.2% -9.8% 3.7%
IT hardware 3Q84-4Q91 29 5.0% 16.3% -2.2% 7.3%
Aerospace & Defence 3Q85-4Q94 37 6.5% 12.5% 2.3% 7.6%
Electricity 4Q86-1Q00 53 -3.1% 11.2% 1.3% 7.7%
Speciality & Other finance 2Q87-3Q92 21 -7.9% 1.6% -0.2% 6.7%
Steel & other metals 3Q89-1Q01 46 -7.0% 5.3% -3.2% 5.5%
Transport 4Q89-1Q00 41 -1.8% 9.2% 3.6% 5.7%
Household Goods & Textiles 2Q90-1Q01 43 1.4% 6.4% 2.4% 5.9%
Construction & Building Materials 2Q90-1Q01 43 -3.2% 6.4% 1.5% 5.9%
Engineering (Period 2) 3Q90-3Q00 40 4.4% 11.7% 3.1% 5.6%
Distributors 4Q90-1Q01 32 -3.1% 7.4% -1.2% 5.5%
Packaging 2Q92-2Q99 28 4.6% 13.4% -1.6% 7.3%
Food Producers 4Q92-1Q01 33 5.1% 9.1% 3.5% 8.6%
Real Estate 4Q96-1Q01 17 -8.5% 5.6% -7.0% 4.8%
Average 41.3 0.5% 10.5% 0.2% 7.2%
Source Salomon Smith Barney
8
Historical Snapshot
The power of mega trends is generally underestimated
• “I think there is a world market for maybe five computers”
- Thomas Watson, Chairman of IBM, 1943
• “Computers in the future will weigh no more than 1.5tonnes”
- Popular Mechanics Magazine, 1949
• “640K ought to be enough for everybody”
- Bill Gates, 1981
• “There is no reason anyone would want a computer in their home”
- President of Digital Equipment Corporation, 1977
• “The total market for mobile cellular phones will be 900,000 subscribers by year 2000”
- McKinsey Consulting study for AT&T, early 1980s
9
Global Economic Environment
A new global growth contagion is taking the world economy sharply down
• This is the fifth global recession since 1970, the first synchronised one since 1974
1973-74 - By-product of oil shock 1982 - Shock therapy of Fed’s anti-inflationary assault
1990-91 - By-product of oil shock 1998 - Global currency crisis in Asia
• Global trade accounts for nearly 25% of world GDP
– 4 times the share compared to 1970
– Foreign trade accounts for 15% of US GDP - 2 times the level of 1980s
– IT exports accounted for 40% of non-Japan Asia’s total GDP growth in 2000
– Increased role of multinational corporations and global media
• US played a disproportionate role in driving global growth over the past 5 years
– US economy accounted for 40% of cumulative growth in world GDP (mid-1995 to mid-2000)
– This is almost twice the share of US in world GDP (22%)
– America - once the land of a virtuous cycle is now caught in a vicious cycle
– Unfortunately the rest of a US-dependent world economy is trapped in this same dynamic
10
Global Economic Environment
The global economy post September 11
• Reasons for the broader downturn were well entrenched even before September 11
– Current economic slowdown not merely a cyclical lapse
– Downturn more secular in nature as some of the underpinnings of the 1990s come unstuck
• September 11 attack the most tragic, but just another sign, of that unwinding process
• V-shaped recovery talk is back with a bang
• Focus has shifted from looking beyond the valley (i.e. the next two quarters)
• Forecasters assume that a sharp fall in US led global growth this year will set the stage for a
more powerful recovery next year, aided by an unprecedented policy stimulus
• As per the National Bureau of Economic Research the average duration of a
contraction phase is 18 months since 1854 and 11 months since World War II
• Recessions have gotten shorter over time - but haven’t been eliminated
• Downturns are almost required to clear systemic imbalances created after a period of heady
growth
11
Global Economic Environment
Global economics - a V-shaped recovery ahead ?
• Current consensus is calling for less than 1% fall in real economic output on a peak-trough
basis, with two quarters of negative growth before a revival next year
• If true, it will be the shortest and most shallow US recession post World War II
• Too short to correct imbalances (low savings rate, high level of private debt, current account deficit)
• Productivity gains of the new economy have been overestimated
• Historically the stock market bottoms out 4-6 months prior to a trough in the economic cycle
• Does this rationalise why global equity markets today are higher than on September 11?
MSCI Indices From Sept 11 YTD 1 year 3 years 5 years
World Index 2.1% -20.0% -21.3% -3.7% 19.0%
USA 0.9% -16.2% -19.6% 1.0% 57.4%
Japan -3.3% -22.8% -31.6% -3.8% -34.1%
Europe 8.0% -24.5% -19.3% -13.0% 27.6%
Emerging Markets -2.4% -18.8% -24.0% 2.1% -40.0%
India -5.5% -27.8% -23.3% 5.5% -18.6%
As of October 26, 2001
12
Global Investment Outlook
Crises events - what pointers does history offer?
Event Reaction date range % Gain/ DJIA Percentage Gain
(m/d/y) Loss 1m 3m 6m
Fall of France 05/09/40 – 06/22/40 - 17.1 - 0.5 8.4 7.0
Pearl Harbor 12/06/41 – 12/10/41 - 6.5 3.8 - 2.9 - 9.6
Korean War 06/23/50 – 07/13/50 - 12.0 9.1 15.3 19.2
Sputnik 10/3/57 – 10/22/57 - 9.9 5.5 6.7 7.2
Cuban Missile Crisis 10//62 – 10/27/62 1.1 12.1 17.1 24.2
JFK Assassination 11/21/63 – 11/22/63 - 2.9 7.2 12.4 15.1
U.S. Bombs Cambodia 04/29/70 – 05/26/70 - 14.4 9.9 20.3 20.7
Arab Oil Embargo 10/18/73 – 12/05/73 - 17.9 9.3 10.2 7.2
Nixon Resigns 08/09/74 – 08/29/74 - 15.5 - 7.9 - 5.7 12.5
U.S.S.R. in Afghanistan 12/24/79 – 01/03/80 - 2.2 6.7 - 4.0 6.8
U.S. Bombs Libya 04/15/86 – 04/21/86 2.6 - 4.3 - 4.1 - 1.0
Invasion of Panama 12/15/89 – 12/20/89 - 1.9 - 2.7 0.3 8.0
Gulf War Ultimatum 12/24/90 – 01/16/91 - 4.3 17.0 19.8 18.7
Gorbachev Coup 08/16/91 – 08/19/91 - 2.4 4.4 1.6 11.3
World Trade Center Bombing 02/26/93 – 02/27/93 - 0.5 2.4 5.1 8.5
Oklahoma City Bombing 04/19/95 – 04/20/95 0.6 3.9 9.7 12.9
U.S. Embassy Bombings, 08/07/98 – 08/10/98 - 0.3 - 11.2 4.7 6.5
Africa
Mean - 6.1 3.8 6.8 10.3
Median - 2.9 4.4 6.7 8.5
Source: Ned Davis Research Inc.
13
Global Investment Outlook
The 2000-01 Bear matching the 1973-74 Crash
The index is Datastream’s World Equity Index
Source Salomon Smith Barney
14
EMERGING MARKETS OVERVIEW
SECTION II
Emerging Markets Lifecycle
Snapshot
• 79% of world population
• 20% of global GDP
• 11% of corporate net income
• 5% of global market capitalisation
15
Emerging Markets Lifecycle
Full cycle of relative performance with the developed world
• Structural re-rating
– Early 1990s: emerging markets, then a relatively new asset class, underwent a structural re-
rating.
• Macro-economic maturation
– Starting in 1994, currency systems underwent an adjustment from fixed exchange rate to flexible,
part of macroeconomic maturation.
• Higher correlation to the rest of the world
– Since 1998, the markets have traded roughly in line with the rest of the world
– High global sector correlation
• Market drivers in the future
– In the medium term, microeconomic reform and corporate restructuring will become a driver of
market performance.
16
Emerging Markets Lifecycle
Mexican
4.0
Peso
"Young Adulthood"
3.5 "Nascent Promise" "Difficult Adolescence" Microeconomic &
Structural Re-Rating Macroeconomic Maturation Governance Driver
3.0
Thai Bhat
2.5
R ussian
Ruble
2.0
Turkish
Lira
1.5
1.0
Brazilian
Real
0.5
Emerging Markets Emerging Markets Emerging Markets
OUTPERFORM UNDERPERFORM IN LINE
0.0
Jun-88 Jun-90 Jun-92 Jun-94 Jun-96 Jun-98 Jun-00
Source MSIM Asset Allocation, MSCI
17
Emerging Markets Lifecycle
The 360 degree markets
• Emerging markets have come back a full circle over the last one decade
– Risk-reward relationship out of whack
• US has behaved like an emerging market in terms of economic growth
– US markets have risen by nearly 4 times than emerging markets over the past decade
– Dollar has strengthened against most emerging market currencies
• Disconnect between topline and bottomline growth
– Earnings have disappointed despite stronger top-line growth
– Over-investment, low RoE
– Poor corporate governance norms
• Macro economic performance has not translated into stock market returns
– Particularly relevant in Asia
– Low productivity, capital-consuming growth
18
Emerging Markets Lifecycle
Analyst community has over-estimated in the past
• In 7/10 years analysts have made an initial overestimation at the start of the year of the
full year’s earnings per share growth for emerging markets
MSCI EMF monthly US$ aggregate FY1 forecast EPS estimates v/s actual EPS (1991-2000)
Source CSFB
19
INDIA IN THE EMERGING
MARKETS CONTEXT
SECTION III
Indian Macroscope
India is still revving up its engines on the runway
• Indian economy ranks in the bottom quartile of the index of economic freedom
– In low economic freedom countries small changes in economic freedom have disproportionate
changes in growth
– India can produce very high economic growth rates on the back of small reform impulses
20
Indian Macroscope
India - reform momentum slowing
• 5% economic growth not popular enough
– Growth rate sounds good in a global meltdown scenario
– But important to remember that India has not experienced the ‘highs’, and hence seems
relatively good when the world is facing the ‘lows’
• Attention diverted from core economic issues
– Political shenanigans
– Stock market scam, UTI fiasco
– Agra Summit
– Terrorist attacks of September 11th and the war against terrorism
• Economic growth inadequate to provide a cushion from competitive pressures in a
global economic environment
21
Indian Macroscope
China: Laser focussed on economic issues
• While non-economic issues divert India’s attention, China’s attention is focused on
getting the economics right
China India
GDP $1100bn $426bn
GDP per capita $867 $424
Televisions 177m 82m
Telephones – Fixed line 164m 34m
Mobile handsets 117m 4m
Mobile subscribers added in June ‘01 5.9m 0.2m
Cable connections 90m 31m
Motorcycles 31m 11m
Internet users 26.5m 6m
Computers 16.3m 5.5m
Aerated water (litres p.a.) 6300m 900m
Source CLSA, Salomon Smith Barney
22
Market Snapshot
Correlation with emerging markets is increasing
MSCI India versus MSCI emerging markets
23
Market Snapshot
India relative to emerging and US markets
24
Market Snapshot
Several myths are being shattered
• Bonds outperformed equities by almost 50% over the last 18 months
• Beating the benchmark (Sensex, BSE 100..) increasingly difficult
• Selectivity has become more critical and stock universe is shrinking
• Character of Indian market continues to change
– No longer a smokestack market, increased global correlation
• Greater institutional participation
– Mutual Fund industry is evolving
– US64 restructuring an important event in the evolution process
– Investors are understanding risk in equity products
– Institutional investors forming a larger proportion of daily volumes
25