A year ago, there was value in the market but spurts of optimism on the grounds of a stable government having an agenda of strong reforms led the market to perform well. Themes like domestic cyclical sectors, midcaps and small caps outperformed the broader markets. Surprisingly, while domestic cyclicals have now stagnated, the defensive sectors have showcased a good rally. Hence, the market is now fairly valued with most sectors trading near their long-term average valuations, and clearly discounting the 2014-15 earnings numbers. These unprecedented returns delivered over the last few months have built up huge expectations in the minds of investors. However, we believe that the near-term is likely to see head-winds as in the next 6-9 months the global markets have to absorb the monetary policy stance in the West.
Having said that, factors that characterise a market top - like industrial production growth in double digits, much lower interest rates and inflation - are still two to three years away from this point. Therefore, we advocate that the market rally has more legs to go. One can derive valuation comfort by looking into the future because therein lies confidence of an economic recovery over the next 3-5 years. This is true for most sectors considering the 2016-17 valuations. There is also scope for capacity utilisation to pace up in many of the industrial and manufacturing sectors. In fact, themes like banking, infrastructure and public sector units look reasonably valued for the long-run. Therefore, essentially, investors need to have a mind-set of investing for the long term and moderate their expectations towards reasonable returns.
Domestic recovery on the anvil
The Indian economy is in a much better shape with stable Current Account Deficit (CAD), downward looking inflation, higher forex reserves, growth impulses picking up, and a less-volatile currency. The correction in crude oil prices has further abated worries in areas of domestic macros and corporate margins. Many parameters, barring near-term valuations, are also conducive for markets to perform reasonably well.
While an environment with falling wholesale price index inflation and low credit growth is not suitable for corporate earnings, it does not change our view for India. With robust demographics, no credit bubble, potentially much higher growth and saving rates, India’s long term outlook continues to look robust. Growth in any economy is savings multiplied by incremental capital output ratio (ICOR). After China, India has one of the highest savings rate much ahead of other advanced economies. So an increase in the savings can easily translate to higher Gross Domestic Product (GDP) growth.
Retail investors have been under-invested towards financial assets and over-invested in physical assets like gold and real estate. This keeps the domestic investors bereft of the structural opportunity that India offers. We believe investors should incline their portfolios towards financial assets in order to create wealth over the long term.
Investors could now allocate towards equity strategies which are defensive, so that if the markets offer opportunities over next few months or one year, these strategies will have enough cash to buy equities. Also, given that India’s CAD has corrected and inflation numbers have come down along with reasonably good valuations and fear in the market, long-duration fixed income is also a suitable asset class to invest in.
This article was published in Business Standard supplement- ‘Fund Manager’ on 20th November