The current bull run on India's equity markets started when negative sentiment on the economy was at its peak - about a year ago. The economy continued to be on the skids, the rupee had depreciated sharply, India stared at a large twin deficit problem, and the markets were lacklustre by any count (2013 ended with nine per cent return versus 25 per cent in 2012). But if you quizzed veterans of the market then, you would have heard the following: the current account looks like it is on the mend; forex reserves are indeed healthy; inflation will be reined in by our relentless central bankers; and the economy can't really get any worse. Add to it a growing thrum that the ruling United Progressive Alliance would get the boot in the general elections. It was looking at the glass half full, rather than half empty, but made for a definite case to bet on India.Says Anish Damania, Head, Institutional Equities at IDFC Securities: "The major indicator of weakness in the broad market, at that time, could be gauged from the fact that nearly 40 per cent of the stocks traded at their 52-week lows, the highest in the last 20 years except in 2008." Expectations that things will move ahead and be brighter became the central attraction of the India markets story. The markets, measured by Bombay Stock Exchange's benchmark Sensex, rose four per cent in September 2013 and 9.21 per cent in October.
That trot of bulls today has become a wild riot with a sentiment not seen since the 2009 bull run. The markets have risen about 42 per cent since September 2013, around 29 per cent year-to-date (YTD, since the beginning of a calendar year) and, touched a high of 27,324 points on September 8. The clamour for Indian equities makes it the best-performing market globally with the closest being Indonesia (19 per cent YTD). Mid-cap stocks here have run up 45 per cent since January and a large number of stocks have breached their 52-week high. Some 218 shares - spread over automobile, finance, health care, information technology, banking, consumer goods, and construction materials businesses - from the BSE 500 pack have touched their all-time high.
Which Way? Up!
Judging by the rise in stock prices across different sectors and across market capitalisation, there is a consensus amongst market experts that the rally seems rather broad based. "Although initially domestic cyclicals, which had been laggards for past few years, led the rally, in the past couple of months we have seen consumer, pharma and IT perform strongly," says Jyotivardhan Jaipuria, Head of Research, Bank of America Merrill Lynch (BoAML). There, indeed, seems to be a consensus amongst analysts that this is a sustainable run and not just cyclical and short term. Neelkanth Mishra, India Equity Strategist at Credit Suisse, lists three factors behind this hypothesis: bottoming out of growth in India; a benign risk environment globally that is conducive to equity valuations; and a change in government at the Centre.
India's GDP growth, for instance, has accelerated to 5.7 per cent in the first quarter of 2014/15 from 4.6 per cent in the previous quarter. This was also much higher than 4.3 per cent in fiscal 2013 and 4.7 per cent last fiscal year. India's current account deficit (CAD) has narrowed to 1.7 per cent of GDP in the April-to-June quarter compared with 4.8 per cent a year earlier.
Inflows from foreign institutional investors (FIIs) have been strong as also foreign direct investments in the quarter (see Smooth Ride). Damania points out that the FII ownership of Indian stocks as a percentage of free-float rose from 43 per cent in fiscal 2009 to close to 53 per cent currently, despite the fact that India went through a period of slowing GDP expansion and slower corporate earnings growth. Clearly, there was ample global liquidity and FIIs favoured a market that was relatively more attractive. "Over the past four years, despite all the disappointment surrounding government policy and growth deceleration, total capital flows (from all sources) into India were more than $60 billion a year and we expect capital flows to be $76 billion in fiscal 2015," says Mishra.Domestic mutual funds have started buying, too. "Since the elections, FIIs have invested $6.5 billion in the market and domestic MFs have invested $2 billion. In fact, after a long time mutual funds were a bigger buyer than the FIIs in a month in August," says BoAML's Jaipuria. While retail investors were late to start putting money in equities, they have invested aggressively in past few months - Rs 25,000 crore has flown into mutual funds in the last four months.
With the market scaling new highs, a comparison with previous bull runs may be instructive. Ridham Desai, Managing Director and Head of India Research, Morgan Stanley, compares the market's behaviour in the past year with the period between April 2003 and 2004 (the Sensex returned 72 per cent in 2003 and a compound growth of 42 per cent between 2003 and 2007; see Sensex Over the Years) and points to differences. Market-specific factors - global liquidity, earnings growth expectations (15 per cent for both periods), and valuation multiples - are similar while economy-related factors were better off a decade ago.
That said, Desai believes, most variables are moving in the right direction today as in 2004: growth is improving, inflation is falling, CAD is compressing, and real rates are rising. "Some of the structural issues, which had been impacting the economy for the past few years, are getting addressed," adds Dipen Shah, Head of Private Client Group Research, Kotak Securities. In fact, Amar Ambani, Head of Research at IIFL, finds comfort in the fact that investors are not queuing up to buy anything and everything in the current rally. They are punishing stocks such as Bhushan Steel that has governance issues or ones with large debt on their books, like Jaypee Associates , or simply the ones that have no visible earnings in sight.The other important factor to the sustainability of the current bull run is earnings growth of listed companies. Jaipuria expects earnings to double in four years and markets returns will likely mirror it. Of course, markets will keep seeing some tactical corrections on the way. "There is a sense that we could see a bit of pullback now, given that India is already the best performing market in the world YTD and most FIIs are already over weight on India," he adds. Any decline in the market, according to Ambani, should be treated as a buying opportunity in an otherwise upward trending market. He expects earnings to grow at 16 per cent next year compared to 14 per cent this year. Corporate earnings as a percentage of GDP in 2013/14 was at 4.2 per cent, which is lower than the long term average of 5.4 per cent. "To achieve the long term average ratio, earnings will have to grow at a CAGR of 22 to 25 per cent over the next four to five years," adds Ambani. Credit Suisse's Mishra doesn't think that's an ambitious number. He, too, has high expectations - both of earnings growth and the Sensex. Given that investor risk appetite globally is likely to stay high and the outlook for India's medium-term growth should improve over time, the P/E multiple on one-year forward earnings can improve from the current 16-16.5x to 17x or higher. A keenly followed indicator, MSCI India's one-year forward P/E is at 16.3x, which is closely approaching the previous peak seen last in October 2010, but it is still much below the peak seen in November 2007 when the forward P/E was near 24x.
"A 30 per cent return over two years is therefore quite likely even if the investment cycle does not revive," says Mishra. He believes India will primarily be riding on three themes: a reduction in funding cost by 0.5 to one percentage point due to high capital inflows making excess funds available in the market for the first time in seven years. Two, pent-up consumer demand. The index of consumer durables production saw the sharpest decline recorded in fiscal 2014 and will rebound, he says. Lastly, currency depreciation will lead to greater indigenization in autos, IT services volume growth, and a pick-up in agricultural exports.
Going forward, Indian equities could see some sector rotation in favour of banks, PSUs, and oil and gas sector. The decline in oil price (below $100 for the first time in 14 months) has put India in a sweet spot today. "The oil market has moved from sellers' market to buyers' market," says Raamdeo Agrawal, Co-founder and MD, Motilal Oswal Financial Service. "By just getting the oil pricing in India's favour, it solves the CAD and fiscal deficit problem, and also the inflation problem."
According to Agrawal, the downside in the Indian market looks very limited at this point (five to 10 per cent). The real differentiator could be the governance. There is a 60 to 70 per cent chance that the government will deliver, but there is also a 30 to 40 per cent chance that it may not, he says. "Investors must keep in mind that you are not likely to see any fireworks from the government in the first 100 days but with a mandate for 1,825 days, 180 days upward, is when we will start seeing the difference," he adds. But the real action in the Indian reforms story is shifting elsewhere: states governments, whose decisions now mean more for the economy than the Centre. Their combined budgets are already 40 per cent higher than the Union budget and growing spending is being backed by a rising tax efficiency.
On the corporate side, Dhananjay Sinha, Head of Institutional Research, Emkay Global Financial Services, is of the opinion that although the first quarter corporate results suggest that there is certain amount of affluence as far as the domestic corporates are concerned but the numbers have still not moved up significantly. "My view is that 5.5 per cent real GDP growth that we have seen in the last quarter may actually flatten going forward because a considerable amount of growth has been contributed by lower current account deficit which is essentially an artificial compression," says Sinha.
A lot, then, will depend upon global liquidity and the dollar movement. Which is where the decisions of Janet Yellen become important. The biggest fear looming large on global markets is that the US Federal Reserve - Yellen chairs it - will start hiking interest rates soon sucking out capital from emerging markets, India included. "The exchange rate, which has been fairly stable since the same time last year, might come under pressure once the Fed stops Quantitative Easing. In fact, if the Fed hikes interest rates earlier than anticipated, the pressure on the rupee could become very significant, given that there is more than $20 billion of FII debt investments in India," says Saurabh Mukherjea, CEO, Institutional Equities, Ambit Capital. Despite comfortable forex reserves of nearly $320 billion, FII outflow might also prompt the RBI to raise rates to ease the pressure on the rupee, he adds.Frenzied capital raising may suck out liquidity, too. "As markets rally, animal spirits awaken and fund raisings turn out to be natural fall-out," says Arun Thukral, MD and CEO, Axis Securities. To put this in perspective the market rally of 2003 to 2008 saw a total of 300 initial public offerings (IPOs) raising Rs 96,000 crore and about 56 Follow-on public offers (FPOs) raising Rs 46,000 crore, shows data from Prime Database. There are slew of companies likely to get on the fund raising spree now, with the first round of qualified institutions placements sailing through. FPOs from the government side could be next. "Clearly, FPOs will have to be staggered in sync with the investor's appetite, with markets so buoyant the government has already chalked out plans to offload stakes," Thukral adds. The cabinet recently cleared stake sales in Coal India, ONGC and hydropower utility NHPC, which could garner it Rs 43,000 crore. The fund raisings could keep the markets in a narrow band in the short term, he adds.
The conditions for a multi-year bull run, like from 2003 to 2007, are all there. But the euphoria in the trading rooms of financial capital Mumbai needs to be tempered with how global liquidity and Indian economic fundamentals change in the coming quarters. If those two factors hold in the positive territory, the current bull run may indeed turn into a big virtuous murmuration.