The policy stance has clearly shifted from a consumption-led economic growth to investment-led growth. There have been several hits and some misses in terms of policy actions and decisions.
During the first two months there were three economic events which we think are very important and would like to highlight. The first one was the increase in rail fares, the second was the railway budget and the third was the Union budget.
The quote below reflects the economic situation with the three events in perspective. The heights charm us, but the steps do not; with the mountain in our view we love to walk the plains.
While we want to achieve higher secular economic growth, the determination would be measured by the tough steps the government takes. The case in point is the rail fare hike. It is a hugely unpopular decision by a popular government, to take in the first month itself. In the subsequent two major events like the rail and the Union budget, we saw a clear direction of investment-led growth with accountability. Major thrust has been given to infrastructure, manufacturing, improving the investment climate, jobs growth, and ease of business. While there has been a positive direction, it would have been a welcome if more emphasis on targets in terms of numbers and deadlines would have been listed. One of the misses in our view is the inability to clear the Insurance Bill. We think it was time the government enforced its resolve by showing the power of its mandate.
In the last five months, equity markets, in anticipation of reforms and buoyant economic growth, have rallied about 20% from their lows. However, to see the effect of the policy decisions of the new government on the economy will take some time. It will take time for improved business confidence to turn to fresh business plans and capex and increased economic activity. It is not going to happen overnight.
We are in the vacuum period where the stock prices have run up but the commensurate fundamentals of the companies are yet to catch up. At the same time there has been a rise in the geopolitical worries. It is the time where I think that the market will consolidate and wait for better data either on the economic front or improved corporate performance in the coming quarters.
The current quarterly performance has demonstrated that nothing major has changed for the stressed companies. It is the usual defensive sectors of IT, consumers and pharma which have performed. They may continue to perform going forward; however, the bigger opportunity lies in sectors like industrials, cyclicals and materials coming out of an economic slack.
The future performance of equity markets can be distinguished between early and late cycle performers. We think that the early cycle performers would primarily be those companies with higher operational leverage. The later cycle movers would be the companies which would stand to gain due to financial leverage and this is likely to happen when we start seeing a reduction in interest rates. The current rally has seen all kinds of stocks doing well. However, going forward, we will see stocks differentiating on the basis of the above theme. It is going to be a stock-pickers market.
To put things in perspective, FY15 will be an operating leverage story and FY16 would be a financial leverage play. The initial earnings increase will be a result of higher capacity utilisation and later by decrease in interest costs, but both with the assumption of increased economic activity. We think that the GDP growth is likely to be around 5.5% for FY15 and about 7% FY16.
Companies with an asset-heavy business model will come and raise money taking advantage of the buoyant capital markets. It would give them an opportunity to repair their balance sheets and plan for future growth. Equity markets will contribute risk capital to the capital-starved industry as the sentiment remains buoyant on a consistent basis. It is imperative that the government remains on a war footing to address the problems on the economic growth. As the much sought after sabka saath sabka vikaas will happen only if there is considerable increase in economic activity leading to jobs growth and poverty alleviation.
India has a tremendous opportunity on hand with hugely favourable demography and entrepreneurial spirit. What it needs is a hand to assist in terms of a pro-development government to facilitate a business environment. Capital markets are hopeful of reforms and swiftness in decision making to continue, going forward. It is the tendency of capital markets to keep asking Ye Dil Maange More, and this being the mantra of the PM we are pretty sure that it will be fulfilled.
The author is MD, Ambit Investment Advisors