Mutual Funds

There’s steam left in Indian stocks

Mahesh Patil | Updated on May 18, 2014

Sanguine signs: The cyclical recovery thesis is on track



Returns from the previous market peak are still low and there’s plenty of upside in mid- and small-cap stocks, as well as cyclicals

The whole country has aggressively participated in the general elections with significant voter turnout in almost all the States.

There is significant hope that the new Government with a strong mandate will make quick fixes to revive the investment cycle. The equity markets are now eagerly waiting to determine the direction forward. While the broader equity markets currently trade at an all-time high, we must ignore the recent sharp movement and focus on returns over a longer time frame, consisting of a full business cycle.

In this context, it is important to note that the Sensex has returned a meagre 8.9 per cent in absolute terms from its peak in January 2008. We believe that the large FII flows into the Indian market of $5.5 billion (year to date) are part of the re-balancing of the ‘long developed markets, sell emerging markets’ trade.

The year-to-date returns in the Indian market (6 per cent) are commensurate with or even lower than other emerging markets such as Indonesia (15 per cent) and Brazil (6 per cent). Admittedly, there are apprehensions about the pace at which India can revive its investments and consumer sentiment. However, investors’ perception of India has changed from ‘much-hated’ to ‘loved’ as a result of the political change, micro-level policy reforms, not to forget a watchful central bank.

The majority of foreign investors refrain from taking a call on the election outcome (political risk) and hence, now we can expect increased global investor participation in the Indian markets.

Even domestic mutual funds haven’t seen any additional inflows, implying aversion of retail investors to participating in this rally, pending the election result.

Positive overhaul

We have started 2014 with a significant positive overhaul to our macro parameters. Inflation is trending down as measured by WPI as well as CPI, the runaway CAD has been also brought under control. Our exporters, due to rupee depreciation, have become more competitive and this is at a time when the world is seeing a steady economic recovery.

Over the medium to long term, the investment cycle is expected to pick up.

Given the strong Government with a single ‘governing’ structure, changes in the food procurement policy and calibration of MSP with market prices, targeting suppressed inflation can be expected. All of this will eventually enable stable to lower interest rates. The initial phase of this market rally was driven by large-caps, but the last six months have seen broader market participation. The increased market breadth suggests greater confidence of market participants in economic revival. It is interesting to note that the BSE Mid-cap index is still 27 per cent below its peak in 2008 even as the large-cap index is 9 per cent ahead of its peak.

We believe there is significant value in mid- and small-cap companies, which will be realised as the expected benefits of economic upturn and operating leverage flow in. We believe that the cyclical recovery thesis is very much on track irrespective of the election outcome, though its pace depends on the outcome.

We expect the Sensex earnings growth to improve from what we saw in the past two years which, along with valuation expansion, will drive equity returns. We would advise investors not to worry about pre-empting a small part of the potential exponential move and not be perturbed by the near-term volatility due to the election outcome. Investing with a focus on the long term will enable higher wealth creation.

Published on May 18, 2014

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