I start this discussion with a rhetorical question. Is the Bull Run witnessed by the Indian capital markets over the past six months a respite from the long wait investors have had since the debacle witnessed in FY’08, or is it a Kafkaesque short-lived one? Should we pre-empt the irrational exuberance because the Oracle of Omaha forecasts an impending crash or should we attempt to heal our burnt fingers in the hope that Modi’s charm will cast a spell on the capital markets and more than offset the yesteryear losses?
Whatever be the case with investors across the board, a market-cap of $1.5 trillion of the BSE has positioned India as the 10th largest economy by stock market-capitalisation, in the world. This is twice as large as the Russian market (Russian RTS Index) and inching closer to half of the Chinese market (Shanghai Composite Index).
This recent buoyancy and the momentum it will carry, in my opinion, will outlive the prior negative effects endured since 2008.
The one-sided majority victory of the BJP has given succor to the most important aspect of our economy – “decision making.”Coalition politics paralysed the earlier regime and the ones before it.It is for the first time in 30 years that a single part has a clear majority in the Lok Sabha; this will help the nation progress through a period of decisive governance over five years. The Bull Run we witnessed since the start of CY’14 is more a case of a political cycle than that of an industrial/sector one.
The handover of the UPA government to the NDA government on count of macro-economic indicators was – Current Account Deficit at 2%, fiscal deficit at 4.6%, stable Brent Crude price at an average of USD 106 (owing to relatively stable geo-political scenario in the OPEC), a stable commodity price – gold at an average of USD 1250 an ounce and last but not the least a GDP growth of 4.6%. Today, the market capitalisation to GDP ratio of the Indian economy is almost 100%. Does this sound a caution bell? I don’t think so. India has been one of the worst performing markets over the last four years and did not give any respite to the investors. It has, however, eventually turned out to be the best performing emerging market in the Asia-Pacific region and the BRIC countries YTD CY’14.
All macro indicators remaining the same and a GDP growth of 6-7%, I feel we will witness a stable growth trajectory with the new government at the helm. Mr.Modi’s mantra of effectiveness, no-nonsense attitude and shredding of bureaucratic layers, thus expediting the fundamentals requisite for economic growth shall putthe Indian economy back on track.
Considering the economic data today, I feel one can look at an equity market upside in CY’14 to an extent of 10-15% from the current levels. We could witness a correction of 10-15% from the current levels, around the budget and owing to a few geo-political developments in the OPEC region. What prompts this case of Indian equities becoming foreseeable today, are the fundamental indicators. Some of the key points to note are:
- P/E levels: One-year forward P/E of the BSE Sensex has been hovering at an average of 17. This means a one-year forward EPS of approximately 1550. Historically, the Indian markets (An Emerging Market) have witnessed an average P/E of 15-15.5 and the case today is only marginally more than the average. This lends some credence to the growth story ahead. The debacle in FY’08 had witnessed a spike in the P/E to extreme levels of 27-30 when the Sensex had breached the 21,000 mark. But, the same is not likely today.
- Debt yields: The 10-year Government of India yields averaged 8.4% in FY’14 and have averaged 8.7% YTD CY’14. This implies shrinkage in the risk premia an investor would seek for equity asset class. This should also help investors leverage to an extent on their respective debt portfolios where an upside would be sought in case of downward interest rate revisions. In FY’15 YTD the Sensex has grown 14%. Assuming an average dividend yield of 1.3 the total return turns out to be 15.3%. This in turn is only a 6.6% equity risk premia (equity yield less debt yield). A smart and a cautious investment can actually build an equity risk premia of 10%, failing which an investor is better off in a debt instrument like PPF or FD.
A performance of the BSE Sensex over the last 4 years and the dividend yields has been captured below:
- Sentimental cushion: The global sentiment towards Indian markets has been phenomenal since the beginning of the CY’14. This has primarily been owing to the change in the Government and has been reflected in the FII flows in CY’14, in the equity and wholesale debt markets into the country. FII’s have been net buyers both in equity and debt markets to the tune of USD 7.5B and USD 7.6B respectively. These net investments are likely to go up over the rest of the year, as the USD denominated return has been at least 3-4% more than the INR based return. The assumption here is that USD would not rise drastically and the RBI would maintain stability.
- The INR as a currency has leveled at an average of INR 60 to the USD since the beginning of the year. Further relaxation on FDI norms would help bring in more capital into various sectors and become another force restraining INR depreciation. A lowering of trade deficit by increases in exports and stable crude prices should also help the central bank and the government to allay fears of currency risk.
Thus, considering the current scenario, the markets from the current levels appear well poised to attain a few more highs before closing at a level of 10-15% from the current levels in CY’14. The picks and investments could be mixed between equity in companies and mutual funds. While making such choices one must be mindful of good fundamentals, good corporate governance and good dividend yields that these equity stocks and mutual funds offer. Historical Data on total returns (Capital Appreciation plus Dividend Yield) and financials could help take a prudent call, provided investments are done in tranches. A reasonable amount of diversification into debt and preferably capital/principal-protected funds is also advisable.
Disclaimer: The suggestion and advice rendered in this article are purely personal and has no bearing on any investor contemplating investments in the current market conditions. My opinion is based on personal information I have gathered and personal analysis of the current economic scenario. All investments are risky and subject to market risks. Any of my advice basis historical observation or current scenario, is not indicative of assured yields.
Ravi Shankar Y M
PGPX (One Year Full Time Programme for Executives)
Class of 2015