Indian Stocks Too Costly to Sustain Rebound, Strategists Say

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June 19 (Bloomberg) -- Indian stocks may be too expensive even after falling from records set last month, and many of the region's analysts say the market will fail to extend the biggest two-day rally in two years.

Strategists at Deutsche Securities Asia Ltd., Merrill Lynch Asia Pacific Ltd., JPMorgan Chase & Co. and Nomura International (Hong Kong) Ltd. are among those who see share prices as too high relative to other emerging markets.

``I don't think that this market has finished falling,'' said Spencer White, chief equity strategist at Merrill in Hong Kong. ``I simply don't see enough factors to convince me that the 25 percent decline we have had in the last month really is the end.'' White has a ``market-weight'' rating on India, suggesting that investors' stakes track regional indexes.

The Bombay Stock Exchange Sensitive Index, or Sensex, has tumbled 22 percent from its peak on May 10, the biggest decline among Asian benchmarks. All 30 stocks in the index have fallen, led by a 36 percent plunge in Hindalco Industries Ltd., India's biggest non-ferrous metals maker.

Last week, the Sensex surged 11 percent in the final two trading days as concern eased that rising interest rates around the world will limit economic growth. The rally was the biggest since May 2004 and resulted in a 0.8 percent gain for the week, the index's first in six weeks, to 9884.51. The Morgan Stanley Capital International Asia-Pacific Index added 0.7 percent.

MSCI's Emerging Markets Index also snapped a five-week losing streak, adding 0.1 percent. The global index has fallen 20 percent from a record, reached May 8, on concern that higher rates will reduce demand for riskier assets. During that time, the Sensex has lost 21 percent.

10 Percent Tumble

Indian stocks tumbled 10 percent on May 22, sparking one- hour trading halts by exchanges. Prices rebounded after Finance Minister Palaniappan Chidambaram said banks would help investors meet calls for cash and urged individuals to stay in the market.

Earlier this month, stocks fell after the Reserve Bank of India unexpectedly increased the rate at which it removes funds from the banking system by a quarter point, to 5.75 percent. The central bank's June 8 decision was in keeping with similar moves in the euro region, South Africa, South Korea and elsewhere.

``We are still some way away from stability,'' said Jayesh Shroff, who helps manage about $1.9 billion of Indian stocks at SBI Funds Management Ltd. in Mumbai.

The Sensex is valued at 15.2 times estimated earnings for the current year, down from a high of 20.5 times on May 10. The price-earnings ratio is still above the MSCI emerging-markets index's 12.2 times.

More Rate Increases?

``It is early to say that a lot of value is emerging,'' said Adrian Mowat, JPMorgan's regional equity strategist, based in Hong Kong. ``I don't plan on changing my `underweight' view on Indian stocks yet.''

Local mutual funds were net sellers of stock from June 2 to June 14, according to data from the Securities & Exchange Board of India, the market's regulator. The nine-day stretch, with as much as $475.4 million in net sales, was the longest this year.

Overseas investors have sold about $2.4 billion more stock than they bought since May 11, almost half their net $5 billion of purchases for the year through May 10, the data showed.

Economists see India's central bank raising its key interest rate next month for the third time this year as the economy's expansion and higher oil prices spur inflation. The Reserve Bank will increase the rate at a July 25 meeting by a quarter point, to 6 percent, according to 10 of 11 analysts surveyed by Bloomberg News after this month's move.

Doubting 'Growth Story'

``We see more rate increases in India as the central bank tries to tackle rising inflation,'' said Sean Darby, head of Asian strategy at Nomura. Darby estimates the Sensex's fair value at 7,000, or 29 percent below last week's close.

Higher rates may impede economic expansion. Increases in gross domestic product averaged 8 percent in the three years ended March 31, making India the second-fastest growing major economy after China. The government is counting on rising farm and industrial production to accelerate the pace to as much as 10 percent a year over the next decade.

``I don't believe in the growth story,'' said Mark Jolley, Deutsche Bank AG's Asian strategist, based in Hong Kong. ``I don't believe the government can make the market grow without causing inflation.'' Jolley also rates India ``underweight.''

JF Asset Management Ltd., on the other hand, sees India as a ``a very good long-term growth story,'' said Grace Tam, a Hong Kong-based investment services associate for the firm.

Seeing the Bottom

``We have become even more bullish because the valuation has become even more reasonable,'' Tam said. JF Asset oversees $81 billion in Asia and favors stocks such as Associated Cement Cos., India's biggest cement maker by capacity.

Hayes Miller, a manager of global equities at Baring Asset Management Inc. in Boston, said emerging-market valuations are low relative to developed markets, helping countries such as India. MSCI's emerging-market index is valued at 12.2 times estimated earnings, below the 14.4 for the MSCI World Index.

``We aren't too far from the bottom,'' said Miller, whose firm oversees $37 billion.

Still, some investors share the concern among strategists. They said the Sensex will need to fall further before they are tempted to buy.

``India just doesn't make sense for us at the moment,'' said Angelo Corbetta, who oversees $4.3 billion at Pioneer Investment Management Ltd. in Singapore. ``The 8,000 level for the Sensex is a good entry point.''