Over the recent weeks, there has been much ado about excess liquidity, the stock market and the term ?overheating?. That excess liquidity can cause inflation, including asset inflation, has been pointed out repeatedly in our past contributions. Considering the fact that since the beginning of this quarter, the stock market has moved up by 7%, it is perhaps time to provide an updated outlook on the SEM.

It is undeniable that excess liquidity in the economy has found its way towards the stock market in recent years. This movement has been more pronounced following the imposition of tax on interest on deposits held at banks in the 2006 budget. Since June 30, 2006, the SEMTRI has grown by 83% !

On a market valuation perspective, our Rs 145-147Bn market cap target is likely to be exceeded by the end of this year since we are already at Rs142Bn and hotel and commerce stocks results only come in by year end and into next year. In our view, the market has now reached fair value with a trailing PE of 14,32 and a forecast forward PE of 12,03. If the market crosses the Rs 150Bn mark by next April, we could be looking at a PE of around 12,75. Based on our valuations on some of the largest cap stocks of this market, most of these stocks have reached fair value. This essentially means that we would now expect the market growth rate to begin to converge towards earnings growth rate.

Nonetheless, we believe that there still remains about 20% of growth left in the SEM-7 by the end of 2008, considering our two-year profit outlook. Bearing in mind that the SEM-7 has already clocked around 40% this year, a slowdown would be healthy for the market. 20% growth over the next 18 months is after all a good performance to expect.

However, we are concerned about disclosure/transparency aspects of the regulatory framework of the market. On average, it takes five weeks for companies to release their quarterly results in most stock markets of the world. In Mauritius, companies have 90 days to file their half-yearly results. This long time lag to release financials may allow insiders to benefit from price sensitive information and create speculation and bubbles in the market. While this would not be noticeable in a bullish environment when the market was genuinely undervalued, it is a different case now since the market has reached its fair value. So far, among the SEM 7 stocks, only Naïade Resorts Ltd and New Mauritius Hotels Ltd have released their second quarter results around the same time as other listed stocks have around the world.

Beyond the lack of frequent and quickly disseminated information, other aspects such as liquidity, quality of management and hence net profit growth outlook on many companies force institutions and foreign investors to concentrate their investments on the largest cap stocks. While foreigners may have the luxury of the entire African region to choose from, most rupee-denominated local funds are mostly invested locally and their local equity investments are heavily concentrated in the eight largest cap stocks of this market. Some funds have hence diversified their portfolio by investing abroad in order to reduce concentration risk. Initial public offerings should be encouraged on the local market.

We have previously pointed out that the earnings yield of the market, be it trailing or forward, is lower than the after-tax yield on the seven-year bond, thus making the latter more attractive than the former. Considering our long-term projections on earnings growth of the market, prices of most stocks have already converged to their fair value. Hence, we expect price growth to slowly but surely begin to converge towards earnings growth. The long-term nominal GDP growth rate of the economy can be used as a broad measure of long term earnings growth. It will hence become increasingly important to track and forecast earnings growth in the coming years before buying into local equities, and regulations will need to be enhanced in order for investors to make the right decision.

<B>Contribution by INVESTMENT PROFESSIONALS LTD (Feedback at [email protected]) </B>