As a country, just a few months back we were in the midst of a vicious cycle of low growth, high inflation, high interest rates and low capital expansion,one feeding on the other. With consumer and business confidence improving, all these variables are now coming on to positive mode—slowly but surely. A virtuous cycle is beginning to form with growth looking up, inflation slowing down and expectations of a better capital expansion in the country. This change in the cycle is a result of a secular uptrend in economic cycle, benign global commodity prices and a confidence boosting strong government formation. Both sentiment as well as fundamentals are coming together in a very positive way. We expect these factors to continue to improve and the growth rates and prosperity in the country will improve at a faster rate over the next few years.
While the country’s growth rates will continue to remain sub-6% in the current year, it is expected to improve consistently over the next few years and if the government successfully executes the initiatives that it has identified, economic growth and corporate profitability will further move upwards. Recent measures by the central government has led to a gradual improvement in investment climate. Investment uptick and lower macro-economic imbalances may help sustain growth rates of 7% + over the next 5-10 years helping address constraints on sovereign credit profile.
Corporate profitability is one of the key drivers of equity market performance. We believe the corporate earnings could surprise us on the upside as against the current expectations, which is predicated on a ~6% GDP growth. Moreover, with a cool off in commodities, falling fiscal deficit and gliding down inflation, it would have a sobering effect on the interest rates. So, with risk free rate heading towards~@6%, the delta on equities will be big. On valuations, the headline NIFTY trades @~15.5x on FY16 consensus earnings, which are closer to the means. So it is not euphoric as yet. P/E (price-to-earnings ratio) expansion has traditionally always accompanied earnings growth. So a 10000+ NIFTY by December 2015 is a reasonable estimate given the improvement expected in the medium term.
Over the last three months, we have started seeing retail investor participation in equities either through direct investments or through mutual funds. However, the participation has been limited to few smart and high net worth investors. Real retail participation is expected to happen and will drive the next stage of the rally. The improving hiring environment, higher savings and better channelising of the financial savings would lead to more money into equity markets. Hence the ~R80 trillion lying in fixed deposits will have to find better investment avenues, as deposits will get re-priced lower (in the expected environment of softening interest rates). Even if a miniscule portion of such savings were to find a way into the equity markets, it will be enough to fuel a smart rally. Besides,the recent outlook upgrade of India’s sovereign rating is a precursor to an eventual ratings upgrade, which in turn will make India “investible” for many of global portfolio allocators.
In the last few years, while overseas investors were investing in the markets, Indian mutual funds and institutions were selling into the rallies as they were seeing redemptions from their retail investors. This time around we expect both the overseas investors and the Indian institutions will remain buyers resulting in a positive demand for Indian equity.
The returns in equity markets traditionally have always been lumpier and they come with steep intermediate corrections. That is the very characteristic of equity markets. One should not get perturbed by this and in fact, use this volatility to his/her advantage.
While headline indices (Sensex and Nifty) are important they are not the only benchmark for the returns from equities. Just to put things in perspective, while the markets have risen 25%, many domestic MFs have delivered 50%+ returns. So there are many companies beyond the ones in indices and there are several MFs schemes that have outperformed the headline indices and continue to do well. Now with overall environment and capital expansion cycle expected to look up the profitability growth will be wider and therefore the performance of wider market is expected to pick up pace and get in sync with the headline performance.
It would be wise for individual investors to invest consistently and regularly in the equity markets or MFs to realise the benefit of better returns that the equities are likely to provide over the next few years compared to any other asset.
SUDHAKAR RAMASUBRAMANIAN
The author is managing director, Aditya Birla Money