It’s not just foreign investors who are looking favourably at India.
Domestic investors, too, are increasingly looking at investments in the
stockmarket. Speculation is rife now. The signs are there, too. The Sensex will
rise and shine again
The
script gets better — and even better. We are barely half-way into 2016, and the
Indian stockmarket has clambered its way up from the gut-wrenching slowdown and
sticky spells to the start of something new. Even after the shock of Brexit
vote and the unfortunate end of the Reserve Bank of India’s governor Raghuram
Rajan era, the stockmarket is not meandering, nor side ways — but is poised on
course to scale uncharted territories.
This is a
four-month old revival, fuelled by the rise in financials, consumer goods, and
agri-stocks. But it has rekindled widespread hopes of a broader market rally.
Now there is talk of the Sensex hitting 50,000.
Market
experts, no doubt, see the target as challenging, but not unachievable. “It’s
not an unrealistic figure,” says Manish Chokani, director, Enam Holdings.
“There has been no meaningful growth in the last five years. Now we are at the
start of what is proving to be a cyclical uptick. In a few years, this could
turn broadly secular, and that would be uplifting for our markets.”
The
rising earnings growth has turbo-charged the markets. The last quarter was
surprising to the markets as revenue growth spiked up to 7 per cent, a notable
feature that was absent for the previous four quarters. It signalled that the
wheels of the economy had begun to move, and that corporate growth was picking.
Many
pieces of the jigsaw are falling in place. Says Nirmal Jain, founder and
chairman of financial services player India Infoline: “Domestically, there are
other fundamental factors that have more weight. The monsoon, goods and
services tax (GST), increasing reforms, and rising government infra spending
are all influencing market forces.”
The key
to any market revival is earnings growth and return on equities (RoE). Indian
companies have made peak return on equities of around 24 per cent in the past.
But now, domestic behemoths are doing a sluggish 15 per cent return on equity.
This return is very low. RoEs have been so low only on two occasions in the
past 20 years.
Now,
after two years of deceleration and sputtering growth, signs of a recovery are
on the cards, and building strength. “The positive points are that the earnings
downgrades are bottoming out and, in the recent quarter, topline growth has
been positive, which is encouraging” says Chris Wood, author of CLSA’s weekly
Greed and Fear letter. “On a relative basis, I am overweight on India.”
With the
earnings cycle bottoming out and a cyclical recovery now clearly underway, the
markets are looking at higher returns on equity. “We are making 15 per cent RoE
now, and if we see a mean reversion of profits touching 6-7 per cent of gross
domestic product (GDP), from the currently depressed 4-5 per cent, an earnings
uptick of 75 per cent in four years is more than likely. On that, 50,000 should
be attainable,” says Chokani.
Agrees
Ajay Bodke, CEO and chief portfolio manager at stock broking firm Prabhudas
Lilladhar: “We can easily double from these levels in three years. The markets
are forward looking and a leading indicator of the economy; the cycle is
starting to turn.”
The
earnings recovery is due to a host of factors, particularly higher public
spends and the rise in urban consumption. But that could get even better with
the revival in monsoons. Says Nilesh Shah, managing director, Kotak Mutual
Fund: “The earnings recovery is driven by government spending in roads,
railways, infrastructure. With the outlook for monsoons getting better, we will
do well on public expenditure, urban and rural consumption. The only thing we
will lack is private capital expenditures, which anyway will take time to
recover.”
Historically,
Indian markets were always trading at above-average valuations. The high return
on equities of Indian markets gives a high degree of comfort to investors to
assign premium valuations to the markets. The stockmarket is currently trading
at a private equity (PE) of around 17 times forward earnings. An improving
earnings outlook coupled with good inflows is the perfect combination for a
long-term revival and even a re-rating of the Indian markets.
Besides,
global investors are increasingly looking at India, and other emerging markets,
to fuel global growth. With India’s above-average growth rates, many foreign
investors are beginning to look more favourably at the India growth story. Says
Kaku Nakhate, president and country head, Bank of America Merrill Lynch India:
“India stands out in that emergingmarket basket. Our macroeconomic fundamentals
are distinctly better, and continue to improve. The economy is more domestic
consumption-led; public spending is going up, and the GST Bill, if passed in
the monsoon session, could turn out to be the big kicker.”
Following
Brexit, stock markets surged 4.6 per cent, and the rally is covering nearly all
segments of the market. While the stock market surge began a few months ago, it
was gathering pace even before Brexit happened, and a major hiccup for the
European economy has not deterred the market’s upward movement one bit. Says
Ramesh Damani, member, National Stock Exchange: “The Indian markets are within
the street’s word of a bull market. We are seeing a recovery in corporate
earnings, interest rates have come down and that is fuelling the markets.”
Globally,
India has already emerged as the fastest-growing economy in the world. It has overtaken
Brazil and Russia to emerge as the second-largest economy (after China) in
terms of nominal GDP. Says Nakhate: “We will probably cross France and UK in
GDP to emerge as the fifth-largest economy, overall, by 2019. So the India
story is hot.”
Global
investors, too, are looking at India favourably; now, with the Indian economy
perking up, they are lapping up more equities. In the emerging markets basket,
among all other similar markets, India has been put in the overweight category.
Since February, foreign investors have bought stocks worth Rs 35,884 crore, and
remained invested despite the global uncertain situation.
At the
same time, no good economic growth stories seem to be emerging across global
financial markets. Even in the last two years, when foreign investors were
selling emerging markets, India was relatively less sold. Wood says that
despite the earnings slowdown, foreign investors did not sell too much in the
Indian markets last year because there is a lack of good stories across the globe.
In the
next few years, foreign investors are expected to increase their allocations to
India. Says Nakhate: “India is in a position of relative strength compared to
other emerging markets. Foreign institutional investors are, therefore,
overweight on India.”
It’s not
just foreign investors who are looking favourably at India. Domestic investors,
too, are increasingly looking at investments in the stockmarket. SIP inflows
into domestic mutual funds are said to be averaging Rs 2,000 crore every month.
Since January 2015, net fund inflows have scaled to Rs 76,721.73 crore,
substantially higher than in the past. Domestic investors have been
continuously pouring into the stock markets via mutual funds.
Demand
for Indian offerings is on the rise. Domestic initial public offerings (IPO)
are commanding oversubscription figures as never seen before. The recent
offering of Mahanagar Gas was oversubscribed 65 times, and was among the top
three IPOs in recent times. In fact, the total number of applicants in the
Mahanagar Gas IPO is about 1 million. It’s estimated that this number can go up
to 3 million for future IPOs in the next three years.
In fact,
such phenomenal oversubscriptions in IPOs are becoming increasingly common. The
Rs 400 crore IPO of Quess Corp, too, saw demand worth Rs 50,000 crore. The norm
nowadays within merchant banking circles for good consumer facing well-priced
IPOs are targets of at least 15 times oversubscription.
It’s
little surprise that the consumption theme is driving the Indian economy
forward — and the stockmarkets upward. The Indian burgeoning middle class with
the majority of its working population below the age of 30 years is not only
lapping up new bikes and cars but also stocks.
Valuation-wise,
stocks are fairly valued. The Mcap-GDP ratio, popularised by billionaire
investor Warren Buffett, shows that the markets are near fair valuation. At its
peak, the valuation was stretched to 100 per cent of GDP in 2008, but right now,
it is just in the right zone at above-average valuations; it’s at nearly 70 per
cent, just about fair valuations. With the GDP growth expected to surge
following good monsoons, this indicator is bound to contract on current stock
prices.
Besides,
on the earnings multiple, stocks are trading at just a tad above historical
valuations. The market’s current PE is around 17 times earnings, compared to 15
times of historical earnings.
But that
is because of the strength of the Indian economy, and the premium in valuation
it has historically commanded among other emerging market countries.
One
indicator of India’s growing edge in the recent past is that the domestic
economy is increasingly decoupling from the rest of the world. While Indian exports
have slipped to a 13-month low due to a slowdown in the global economy, the
economy is still managing to set a good growth rate of over 7 per cent. As a
result, the Indian economy is not dependent on global growth to oil its
economic wheels. Instead, the economy is increasingly looking inward for
growth.
This, is
turn, is making the market resilient and more thickly insulated against global
swings. In the carnage of the 2008 Lehman crisis, the Indian markets dipped to
valuation levels in single digits. But, in the recent fall, despite the sharp
deceleration in profits and 20-year low RoEs, stock valuations barely hit the
15-PE average of past valuations before quickly rebounding to current upbeat
levels.
Says
Mehraboon Irani, principal and head, private client group at broker company
Nirmal Bang: “The Indian investor is getting savvy and looking at future
earnings. Markets are always right, having got a whiff of improving earnings a
lot earlier than it happened.”
Add to
that, the stability in rupee that is attracting more foreign investors to the
Indian markets, and insulating them further from macroeconomic shocks. The
current-account deficit is likely to continue within control at less than 1.5
per cent for FY17 despite the rise in oil prices. A comfortable forex reserves
position of over $340 billion is helping stabilise the damage caused by global
choppiness. The Indian rupee has held up nicely despite the several breaches
beyond Rs 68 in recent times.
Even as
Brexit drove the rupee briefly to Rs 68, the rebound was swift because of the
strong external account.
Global
commodity prices are also in a sweet spot for the Indian economy. With oil
hovering around $50 and a small recovery in commodity prices, the Indian
economy is in the goldilocks spot. At this level, oil prices do not impact the
costs of the Indian economy keeping the external accounts under control. At the
same time, this also signals that the global economy continues to strengthen.
In
January 2016, when oil tumbled to levels not seen in years — of nearly $20 —
the international financial markets began to panic and the contagion effect
rubbed off on the Indian markets.
That
said, Indian markets are increasingly able to withstand global shocks.
Initially, after the surprise Brexit vote, the BSE Sensex plunged a 1,000
points. It quickly recovered though. And even volatile global markets have not
dented the gains in the Indian market, which has surged 4.6 points after the
fall.
Because
of the slow, but steady, cyclical recovery in the Indian markets, most experts
feel that it is time to get exposed to Indian equities as and when the market
dips. Says Motilal Oswal, chairman and managing director of brokerage
MotilalOswal: “Volatility is a friend of investors because it allows them to
buy when prices are lower.”
The
confidence springs from the fact that there are several triggers for the Indian
markets. Experts point out that the salary hike by the Indian government
according to the recommendations of the 7th Pay Commission is likely to
increase the spending power of individuals. Around Rs 1 lakh crore is expected
to be disbursed due to these pay increases. That will add to the spending power
of Indian consumers.
While
this could stoke inflation in the near term, India’s inflation situation has
structurally changed. With lower commodity prices and better external accounts,
the pressure on inflation would be eased, and it is likely to hover around 5-6
per cent in the medium term.
As a
result, interest rates are expected to be low in coming months. The 10-year
G-sec yield has dipped from 7.8 per cent in June last year to 7.4 per cent this
year. And in coming months, the interest rates are expected to slip to levels
of 7.2 per cent, according to experts.
Lower
interest rates act as a catalyst for stock markets. Indian companies show
better profitability when the interest tumbles, which boosts earnings growth.
That
said, one of the key things that is holding back growth in India is private
sector capital expenditure, which has dropped from 12.8 per cent of GDP in FY11
to 7 per cent in FY16. Private project implementation is weak, while
public-project implementation is strong. CLSA’s Wood reckons that privatesector
capital expenditure is one of the most critical indicators that he will be
watching over the next year or so. He reckons that unless there is a revival in
private capital expenditures, markets are likely to consolidate for the next 18
months.
“Private
sector capital expenditure (capex) will depend greatly on the recapitalisation
and clean-up of banks in the near term,” says Wood. “I would put that as the
single biggest factor the market will watch out for.”
To be
sure, one of the large overhang of the market in the next three years is the
recapitalisation of banks. The government had provided Rs 25,000 crore for
this, about 17 per cent short.
Non-performing
loans are in the range of around 17 per cent of state-owned banks’ balance
sheets, and the clean-up of the banking sector needs to continue for them to be
able to fund capital expenditure requirements in future. A strong banking
sector is vital for the growth of private sector capex, which would be the
ultimate sign of a revival in corporate sector profitability.
To be
fair, private sector capex also depends on external revival and higher
capacities in the corporate sector. Hence, in the initial phases of a recovery,
private sector capacity utilisations would have to rise from the present 70 per
cent or so. But, as consumption demand picks up, greater capacity utilisation could
take 4-6 quarters to play out.
Apart
from capital expenditure, the structural story driving growth in the Indian
economy has to traverse the next 4-6 quarters.
And much
of that would depend on the rural economy. For now, the rural economy
constitutes just about 17 per cent of GDP, but it plays a huge factor in the
consumption story. Two-wheeler sales, seen as a proxy for rural demand, has
picked up in the last four months.
While we
are crystal-ball gazing into the future, three years is a long time way. And
anything can derail the market revival, especially in this increasingly
interconnected economy.
A key
factor in the recent optimism in the market has been the above-average
forecasts of the monsoon. So far, a 12 per cent deficiency in rainfall has not
dampened the market mood.
This year
the monsoon has revived. But for markets to do well in the long term, the
monsoons have to be good for the next two or three years. Says Oswal: “While
confidence levels are high, there is a broad-based revival due to rural
consumption. For the markets to see a significant revival from here in two
years, we will need to have good monsoons.”
In some
respects, the earnings of the Indian markets will have to grow at 22 per cent
compound rate for the next three years. At present levels, the Sensex earnings
per share stand at the levels of Rs 1,600. At a 20 per cent compound growth
rate, earnings could surge to nearly Rs 2,900. Applying normal levels of
valuation of 18 times, the Sensex could reach the coveted 50,000 target in
three years.
Markets,
however, could be more restrained than that. Says Vikas Khemani, president and
CEO at brokerage Edelweiss Securities: “For the markets to grow at that rate,
there needs to be a significant rush of tailwinds. So my own guess is that
growth will be around 18 per cent.”
Even if
the recovery is a lot slower, the fact that the RoEs are expected to rise in
the near future is a vital signal that investors will be looking for. In fact,
a lot of investors are taking exposure in the market in the hope of a strong
revival.
One word
of advice from the experts says that investors can buy good businesses at all
times. Says Damani: “Buy great businesses at cheap prices, whether they are
large cap or small is not particularly relevant. We look for high-quality
businesses, the market is misunderstanding and we are market capital agnostic.”
In this
market, where should investors focus? A better part of the market has run up,
taking along with it a large number of mid- and small-cap stocks to higher
levels. So, it’s advisable to be picky and choosy in this market. Sectors that
are looking good are housing finance, sugar, cement, banking and financial
sector. But as a lot many stocks have run up, investors are advised to buy on
dips. Says Oswal: “The nature of the markets is that they will show some dips
in the future. In the best interest of investors, buying the dips is always
advisable.”
Quite a
sizeable number of small stocks have raced up tremendously in the past few
months because they were beaten down. In some of these counters, investors
should exercise caution when investing.
In fact,
from October 2013, the BSE Mid-cap index has been on a structural rally, and
corrections have been minor for small periods of time. The index has more than
doubled from 5,300 in October 2013 to 11,857 points currently, a rise of 223
per cent. Says Khemani: “In a bull market, the growth profile of mid-caps ends
up being better. But it must also be said that they come with a lot higher
risk. And it depends on the risk appetite of the individual. Obviously large
cap will lead the rally, then the cycle shifts to other segments.”
Obviously,
a target of 50,000 on the market implies compounded annual returns from here of
23 per cent in the next three years. However, analysts believe that the number
might be a little stretched for three years. Instead, analysts are working
around a CAGR of 18 per cent return on the bellwether index, which means that
investors can see levels of 44,000 on the Sensex in three years, and 50,000 in
four years.
That’s
still a return that is good enough to make investors happy in the long run.
Just hope the script plays out in the bull zone.
The Choicest
Sectors
Sweet sugar: Globally, sugar prices are rising on
the back of growing demand and lower production. Indian sugar production is
expected to be at around 25.5 million tonnes, a drop of 10 per cent from
previous years, according to ICRA. That will keep domestic sugar prices
buoyant. Sugar stocks have already surged in anticipation, so keep an eye out
for dips.
Resurging housing finance : A housing shortage of 22 million units is
fuelling the demand for housing loans. In the past year, interest rates on
housing loan have come down from 12 per cent to below 10 per cent. Some housing
finance stocks are trading at inexpensive valuations. It’s an unfolding
long-term story, and some stocks are trading at inexpensive valuations.
Consolidating cement: The rise in domestic public expenditures is
triggering demand for cement. The capacities of cement companies were
underutilised, and incremental capacity utilisations were driving profit
growth. Cement stocks, however, have run up in the recent past, hence tread
with caution.
Booming financial services: Financial services companies are increasingly
becoming the proxy for private sector consumption. These companies can derive
better operating efficiencies for every incremental increase in business
because of their unique position. A monsoon revival will also drive rural
consumption. While stocks have run up too soon, the story is still unfolding.
Perked up PSU banks: Despite a 17 per cent bad loan problem, the clean-up
in PSU banks will see banks emerge with stronger balance sheets. Retail loans
are growing at a faster clip for PSU banks. The government is re-capitalising
PSU banks which will provide capital for future growth. Some banks are still at
single-digit valuations.
Cutting-edge chemicals: The chemical sector is undergoing a structural
change, thanks to a slowdown in overseas production. However, most stocks have
run up significantly on the back of improved sales and profit numbers. Lower
commodity prices and improving demand are driving up margins of specialty
chemical companies. One must, however, watch out for the valuations.
